Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Chapter 22 MONOPOLY

22-2 Learning Objectives After this chapter, you should be able to: 1. Analyze and discuss the graph of the monopolist. 2. Calculate the profit or loss of the monopolist. 3. Differentiate between the short run and long run for the monopolist. 4. List and discuss the barriers to entry in a monopolized industry. 5. List and discuss the limits to monopoly power. 6. Explain how economies of scale and natural monopoly affect control of an industry 7. Identify and discuss the factors that make bigness bad. 8. List the pros and cons of allowing a Wal-Mart Supercenter to open in your community.

22-3 Monopoly Defined A monopoly is the ONLY firm in an industry.  No one produces the output nor sells the monopolist’s product.  There are local monopolies. Examples: local hardware store, dry cleaners, drugstore.  There are national/regional monopolies. Some examples are diamonds dealers, gas and electric companies, and local phone companies. A monopoly produces ALL the output in an industry. There are no close substitutes available for the product or service.

22-4 The Graph of the Monopolist Monopoly is the first of three types of imperfect competition.  The other two are monopolistic competition and oligopoly. The distinguishing characteristic of imperfect competition is that the firm’s demand curve slopes downward to the right.  This means the imperfect competitor has to lower price to sell more.

22-5 The Graph of the Monopolist The imperfect competitor has to lower price to sell more.

22-6 Hypothetical Demand and Cost Schedule for a Monopoly Try completing the columns for TR, MR, ATC and MC.

22-7 Hypothetical Demand and Cost Schedule for a Monopoly Remember: TR = P x Q MR = change in TR/change in Q ATC = TC/Q; and MC = change in TC/change in Q Profit = (P – ATC) x Q* where Q* is set where MC = MR Profit also = (TR – TC)

22-8 The Monopolist Making a Profit Here is a graph of the previous table: The monopolist earns a profit if for some range of output. ATC lies below the D curve.

22-9 Questions for Further Discussion Let’s review the monopolist’s economic analysis. Use the table below to find TR, MR, ATC, and MC. Then find Q* (where MC=MR) and calculate profit. You can answer these questions by using the table.

22-10 Questions for Further Discussion Q* is where MC = MR, or 5 Profit = (P – ATC) x Q* Profit = ($17 - $14) x 5 = $3 x $5 = $15 Now let’s graph this.

22-11 Questions for Further Discussion MC = MR  Q* of 5 Price = $17 ATC = $14 Profit = ($17 – $14) x 5 or $15

22-12 The Monopolist Losing Money If costs are too high relative to the price, the monopolist can lose money. What would that graph look like?

22-13 The Monopolist Losing Money The calculation of the loss is still the same. MC = MR  Q* = 200 Loss = (P – ATC) x Q* or ($18 – $21) x 5 = $ -15

22-14 The Monopolist in the Short Run and the Long Run There is no distinction between the short run and the long run for the monopolist.  If there is enough demand for their product or service, they make a profit (economic profits).  If there is not enough demand for their product for them to make a profit, they go out of business.

22-15 Are All Monopolies Big Companies? No. Many monopolies are tiny firms operating in a very small market.  What matters is size relative to the market—the proverbial big fish in a small pond.  Chances are there is only one bookstore on your campus. It is not nearly as big as Barnes and Noble.  The only grocery store in a very small community would be a monopoly. There are tens of thousands of gas stations, convenience stores, restaurants, cleaners, and repair shops that have monopolies in their communities.

22-16 Barriers to Entry Monopolies are created and/or maintained through barriers to entry. How? 1. Control over an essential resource.  Examples: DeBeers’ land (diamond mines); NFL’s skilled labor/talent. 2. Economies of scale 3. Legal barriers  Examples: licensing, franchises (including government franchises), and patents.  Is there BOTH Cola-Cola and Pepsi on your campus? 4. Required scale for innovation  Large firms tend to buy ideas and sell them! 5. Economies of being established

22-17 Economies of Scale: Refers to the cost advantages that a business obtains due to expansion. Typically, industries with high start-up costs enjoy economies of scale because once the plant and equipment are in place they can take advantage with high volumes of output.

22-18 Limits to Monopoly Power The ultimate limit to monopoly power may come from the government or from the market itself.  If a firm gets “too big or too bad”, or both, the government may decide to step in using antitrust laws.  The market limits monopoly power basically through the development of substitutes.

22-19 Economies of Scale and Natural Monopoly There are only two justifications for monopoly.  Economies of Scale justify bigness because sometimes only a firm with the capability of very large output can produce anywhere close to the minimum point of its ATC.  A Natural Monopoly is a situation where one firm is able to provide a service at a lower cost than could several competing firms. Examples: Local utilities such as gas and electric companies; local phone companies (though they are becoming fewer and fewer); local cable company.

22-20 Panel A shows a single electric transmission feeder cable serving all the homes in 1 block. Panel B shows 4 cables serving that same block. It is a lot more efficient (and cheaper) to have one cable than four. One Electric Company is Better than Four! But what would be wrong with 1 cable shared by 4 companies?

22-21 Today’s Rationale for Natural Monopoly? The rationale for natural monopoly is disappearing.  In more than half of the United States, the electric power industry has been deregulated, so that local electric monopolies are getting a great deal of competition.  Once the transmission cables were laid, it became possible under deregulation for competition to develop, and the rationale for monopoly no longer was valid.  The original local phone or electric company was a natural monopoly, but once we’re all connected, then let the competition begin—as long as enough firms stay in the market to ensure competition.

22-22 Two Policy Alternatives Two ways to prevent public utilities from charging outrageous prices: 1. Government Regulation 2. Government Ownership

22-23 Is Bigness Good or Bad? When Is Bigness Bad? Monopolies tend to be inefficient because they do not produce at the minimum point on their ATC.  This prevents resources from being allocated in the most efficient manner. Big business always has great political power.  Economic power is easily converted into political power. The monopolist may engage in price discrimination.

22-24 The Corporate Hierarchy Bigness can lead to inefficiency and exorbitant CEO pay.

22-25 Is Bigness Good or Bad? When Is Bigness Good? Natural monopolies can take advantage of economies of scale and deliver services much more cheaply than a multitude of competing firms. It is probably OK if a firm is big because that means it is very good. If a firm is big because it is bad, that is another story.

22-26 The Economic Case Against Bigness Because there is no competition, there is no great incentive to control cost or to use resources efficiently. There is no need to spend much money on research and development, to improve processes, to develop new products, or to be responsive to customer needs. A monopolist can charge higher prices and provide poorer quality and service.

22-27 Conclusion Natural Monopolies are probably OK, but only if they do not abuse their power. Monopolies based on other factors must be looked on with suspicion.  They may be up to no good.  They may even be illegal. Any monopoly must pass the test of whether or not there are close substitutes.  Who decides this? The buyers do!

22-28 Chapter Issue: Would You Allow Wal-Mart to Open a Supercenter in Your Community? Pros:  Wal-Mart charges very low prices. Who can resist the bargains?  Wal-Mart runs an efficient, lean and mean organization. Low income customers save about $1,000 a year with higher income customers saving even more. Wal-Mart saves consumers over a $100 billion a year. Every new store is flooded with applicants, even with the low wages they offer. Wal-Mart kept stores open during hurricane Katrina and didn’t gouge but continued their policy of lowest prices.

22-29 Chapter Issue: Would You Allow Wal-Mart to Open a Supercenter in Your Community? Cons:  Wal-Mart’s full-time employees’ wages average only $10 an hour, 30% less than its competitors.  Wal-Mart imports $20 billion a year in goods from China, adding to our trade deficit and putting Americans out of work.  Wal-Mart runs a ruthless, lean and mean organization. Less than half have any kind of health insurance. Wal-Mart has been accused of discrimination against women employees and mistreatment of employees in some instances. Wal-Mart has been accused of numerous labor violations involving worker hours and breaks. Wal-Mart has driven smaller retailers out of business.

22-30 Chapter Issue: Would You Allow Wal-Mart to Open a Supercenter in Your Community? Many communities oppose Wal-Mart opening new stores because of the cons. Other communities welcome Wal-Mart opening a store because of their pros. Like always, it’s you (through local planning boards) who decides one way or the other.