Chapter 7: Monopoly McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.

7-2 Monopoly Structure: Monopoly = Industry oThe essence of market power is the ability to alter the price of a good or service. oA monopoly is one firm that produces the entire market supply of a particular good or service. oSince there is only one firm in a monopoly industry, the firm is the industry. LO-1

7-3 Monopoly = Industry oThe firm’s demand curve is identical to the market demand curve for the product. oMarket demand is the total quantities of a good or service people are willing and able to buy at alternative prices in a given time period. LO-1

7-4 Price versus Marginal Revenue oMarginal revenue (MR) is the change in total revenue that results from a one-unit increase in quantity sold. oPrice equals marginal revenue only for perfectly competitive firms. oMarginal revenue is always less than price for a monopolist. LO-1

7-5 Price versus Marginal Revenue oA monopolist can sell additional output only if it reduces prices. oThe MR curve lies below the demand (price) curve at every point but the first. LO-2

7-6 Price versus Marginal Revenue oTotal revenue before price reduction = 1 ton x $6,000/ton = $6,000 Total revenue after price reduction = 2 tons x $5,000/ton = $10,000 Marginal revenue = $10,000 – $6,000 = $4,000 LO-2

7-7 Where Price Exceeds Marginal Revenue LO-2

7-8 Where Price Exceeds Marginal Revenue LO-2

7-9 Monopoly Behavior oA monopolist must make a pricing decision that perfectly competitive firms never make. LO-3

7-10 Profit Maximization oThe monopolist uses the profit- maximization rule to determine its rate of output. oAccording to the rule, a monopolist maximizes profit at the rate of output where MR = MC. LO-3

7-11 Profit Maximization oThe profit maximization rule applies to all firms: –A perfectly competitive firm produces the quantity where MC = MR (= p). –A monopolist produces the quantity where MC = MR (<P). LO-3

7-12 The Production Decision oChoosing a rate of output is a firm’s production decision. oIt is the selection of the short-term rate of output (with existing plant and equipment). oA monopolist finds the rate of output where the marginal revenue and marginal cost curves intersect. LO-3

7-13 The Monopoly Price oThe intersection of the marginal revenue and marginal cost curves establishes the profit-maximizing rate of output. oThe demand curve tells us the highest price consumers are willing to pay for that specific quantity of output. oOnly one price is compatible with the profit-maximizing rate of output. LO-3

7-14 The Monopoly Price and Profit Maximization LO-3

7-15 Monopoly Profits oTotal profit equals profit per unit times the number of units produced. oProfit per unit = price minus average total cost Profit per unit = p – ATC Total profit = profit per unit times quantity Total profit = (p – ATC) x q LO-3

7-16 Monopoly Profits oProfit can also be calculated by subtracting total cost from total revenue: Total profit = TR - TC LO-3

7-17 Monopoly versus Competitive Outcomes oA monopolist produces less and charges a higher price than a competitive industry. LO-4

7-18 Barriers to Entry oBarriers to entry are obstacles that make it difficult or impossible for would-be producers to enter a particular market, e.g., patents. LO-4

7-19 Threat of Entry oA monopoly attains higher prices and profits by restricting output. oThe threat of entry does not affect a monopolist due to high barriers to entry. LO-4

7-20 Barriers to Entry oPatent Protection oLegal Harassment oExclusive Licensing oBundled Products oGovernment Franchises LO-4

7-21 Patent Protection oA patent is a government grant of exclusive ownership of an innovation. oA patent is a source of monopoly power. oPolaroid’s patents forced Kodak out of the instant-photography business. LO-4

7-22 Legal Harassment oSuing potential new entrants can deter entry into an industry. oLengthy legal battles are so expensive that the threat of legal action may deter entry into a monopolized market. LO-4

7-23 Exclusive Licensing oLack of a license makes it difficult for potential competitors to acquire the factors of production they need. LO-4

7-24 Bundled Products oForcing consumers to purchase complementary products thwarts competition. oBundling products makes it difficult for competitors to sell their products profitably: oMicrosoft bundles software applications with its Windows operating systems. LO-4

7-25 Government Franchises oA monopoly granted by a government license: oThese include local power, telephone, and cable TV companies. oAnother example is the U.S. Postal Service in providing first-class mail. LO-4

7-26 Comparative Outcomes oA monopoly’s market power allows it to change the way the market responds to consumer demands. LO-4

7-27 Competition versus Monopoly oIn competition, as well as monopoly, high prices and profits signal consumers’ demand for more output. oIn competition, the high profits attract new suppliers. oIn monopoly, barriers to entry are erected to exclude potential competition. LO-4

7-28 Competition versus Monopoly oIn competition, production and supplies expand and prices slide down the market demand curve. oIn monopoly, production and supplies are constrained and prices don’t move down the market demand curve. LO-4

7-29 Competition versus Monopoly oIn competition, a new equilibrium is established and average costs of production approach their minimum. oIn monopoly, no new equilibrium is established and average costs are not necessarily at or near a minimum. LO-4

7-30 Competition versus Monopoly oIn competition, economic profits approach zero and price equals marginal cost throughout the process. oIn monopoly, economic profits are at a maximum and price exceeds marginal cost at all times. LO-4

7-31 Competition versus Monopoly oIn competition, the profit squeeze pressures firms to reduce costs or improve product quality. oIn monopoly, there is no profit squeeze to pressure the firm to reduce costs or improve product quality. LO-4

7-32 Near Monopolies oTwo or more firms may rig the market to replicate monopoly outcomes and profits. LO-4

7-33 Near Monopolies oIn duopoly two firms together produce the industry output. In oligopoly several firms dominate the market. In monopolistic competition many firms each have a monopoly on its own brand image but still must contend with competing brands. LO-4

7-34 WHAT Gets Produced oThere is a basic tendency for monopolies to inhibit economic growth. oThere is no pressure to produce at minimum average cost. LO-5

7-35 WHAT Gets Produced oMonopolies do not engage in marginal cost pricing: –Marginal cost pricing means firms offer (supply) goods at prices equal to their marginal cost. Monopolies do not deliver the most utility with the available resources. LO-5

7-36 FOR WHOM oHigher prices charged by monopolists favor purchases by higher-income consumers. oMonopolists get fat profits and thus access to more goods and services. LO-5

7-37 HOW oMonopolists have less of an incentive to innovate. oThey can continue to make profits with existing equipment and technology. oThere is a tendency to inhibit technological improvement by keeping competition out of the market. LO-5

7-38 Any Redeeming Qualities? oDespite the strong and general case to be made against monopoly, monopolies could also benefit society. LO-5

7-39 Research and Development oIn principle, monopolies have a greater ability to pursue research and development. oThey have the resources available to invest in expensive R&D functions. oThey have no clear incentive for invention and innovation and can continue to make profits by maintaining market power. LO-5

7-40 Entrepreneurial Incentives oThe promise of even greater profits is a strong incentive for monopolies to innovate. oInnovators in perfect competition also have the ability to earn large profits. LO-5

7-41 Economies of Scale oEconomies of scale are present if average costs fall as the size (scale) of plant and equipment increases. LO-5

7-42 Economies of Scale oA large firm can produce goods at a lower unit cost than a small firm because of economies of scale. oConsumers may not benefit from the lower costs if the monopolist doesn’t lower its prices. LO-5

7-43 Diseconomies of Scale oEven though large size may result in greater efficiencies, there is no assurance that it actually will. oMonopolies may generate diseconomies of scale, producing at higher cost than a competitive industry. LO-5

7-44 Natural Monopoly oA natural monopoly is an industry in which one firm can achieve economies of scale over the entire range of market supply. oExamples include local telephone, cable, and utility services. LO-1

7-45 Natural Monopoly oEconomies of scale are a natural barrier to entry. oThere exists a potential for abuse in a natural monopoly. oGovernment regulation may be necessary to ensure that the benefits of increased efficiency are shared with consumers. LO-1

7-46 Contestable Markets oPotential competition is a threat even to monopolies. oThis may cause them to behave more competitively. LO-5

7-47 Contestable Markets oA contestable market is an imperfectly competitive industry subject to potential entry if prices or profits increase. oHow contestable a market is depends not so much on its structure as on entry barriers. LO-5

7-48 Structure versus Behavior oIf potential rivals force a monopolist to behave like a competitive firm, then monopoly imposes no cost on consumers or on society at large. oThe experience with the Model T suggests that potential competition can force a monopoly to change its ways. LO-5

7-49 Structure versus Behavior oCritics argue that even if markets are contestable, there will always exist a gap between a monopoly and a competitive outcome. oThis gap can be very costly to consumers. LO-5

7-50 Flying Monopoly Air oMarket structure explains why it is cheap to fly to one place and expensive to fly somewhere else of equal distance. LO-5

7-51 Industry Structure oFrom a national perspective, the airline industry looks pretty competitive. oHowever, all of these companies do not fly to the same place. LO-5

7-52 Industry Structure oWhen assessing market structure, it is essential to specify the relevant market. oIn many markets, there is only one or two air carriers, thus the firms in this market act like duopolies or monopolies. LO-5

7-53 Industry Behavior oAir fares from airports dominated by one or two carriers are percent higher than at more competitive airports. LO-5

7-54 Entry Effects oHow fares change when airlines enter or exit a specific market can be used to assess the impact of market structure on prices. oAmerican Airlines cut its fares when low- cost carriers entered a market it dominated – then raised them when they left. LO-5

7-55 Entry Effects oPredatory pricing – temporary price reductions designed to drive out competition. LO-5

7-56 Barriers to Entry oOne of the most formidable entry barriers to the airline industry is the ownership of landing rights and gates. oAt Washington, D.C.’s National Airport, the six largest carriers owned 97 percent of available takeoff/landing slots in LO-5

7-57 Barriers to Entry oTo offer service from that airport, a new entrant would have to buy or lease a slot from one of these firms. oIf existing firms are unwilling to sell or lease their slots, then competition is thwarted. LO-5

Monopoly End of Chapter