1. Chapter 22
Monopoly
22-1
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Objectives The graph of the monopolist
How monopolist’s profits are calculated
The monopolist in the short run and long run
Barriers to entry
Limits to monopoly power
Economies of scale and natural monopoly
What makes bigness bad?
22-2
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

3. Monopoly Defined A monopoly is the ONLY firm in an industry
No one else sells what the monopolist is producing
There are local monopolies
Some examples are a hardware store, a dry cleaners, and a 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
22-3
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

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
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Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

5. The Graph of the Monopolist
The imperfect competitor has to lower price to sell more P1 P2 D Q1 Q2
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Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

6. Hypothetical Demand and Cost Schedule for a Monopoly
Output Price TR MR TC ATC MC
$16
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Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

7. Hypothetical Demand and Cost Schedule for a Monopoly
Output Price TR MR TC ATC MC
$ $16
22-7
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

8. Hypothetical Demand and Cost Schedule for a Monopoly
Output Price TR MR TC ATC MC
$ $ $16
22-8
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

9. Hypothetical Demand and Cost Schedule for a Monopoly
Output Price TR MR TC ATC MC
$ $ $ $20
22-9
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

10. Hypothetical Demand and Cost Schedule for a Monopoly
Output Price TR MR TC ATC MC
$ $ $ $ $20
22-10
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

11. Hypothetical Demand and Cost Schedule for a Monopoly
Output Price TR MR TC ATC MC
$ $ $ $ $
$10
Marginal cost is the additional cost of producing one more unit of output
22-11
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

12. Hypothetical Demand and Cost Schedule for a Monopoly
Output Price TR MR TC ATC MC Total Profit
$ $ $ $ $ $
Marginal cost is the additional cost of producing one more unit of output
22-12
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

13. The Monopolist Making a Profit
(This is the graph of the previous schedule)
The monopolist will make a profit if for some range of output her ATC lies below the demand curve
22-13
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

14. The Monopolist Making a Profit
(This is the graph of the previous schedule)
In this instance, the monopolist maximizes her profit at five units of output charging a price of $12
22-14
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

15. The Monopolist Making a Profit (Calculating the Monopolist’s Profit)
In this instance, the monopolist maximizes her profit at five units of output charging a price of $12
This is where MC=MR
22-15
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

16. The Monopolist Making a Profit (Calculating the Monopolist’s Profit)
Price
ATC
The ATC at five units of output is about $10
22-16
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

17. The Monopolist Making a Profit
(Calculating the Monopolist’s Profit)
Price
ATC
Total Profit = (Price – ATC) X Output
= ($12 - $10) X 5 = ($2 X 5)
= $10
22-17
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

18. The Monopolist Making a Profit (Calculating the Monopolist’s Profit)
Price
ATC
Every firm produces where MC=MR. The perfect competitor produced at the most profitable output, which in the long run always happened to be the most efficient output
22-18
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

19. The Monopolist Making a Profit (Calculating the Monopolist’s Profit)
Price
ATC
The monopolist has no competition and does not have to produce where output is at its most efficient level (the minimum point on the ATC).
22-19
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

20. The Monopolist Making a Profit (Calculating the Monopolist’s Profit)
Price
ATC
The perfect competitor will produce at the most efficient output level which is the minimum point on the ATC
22-20
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

21. The Monopolist Making a Profit (Calculating the Monopolist’s Profit)
Price
ATC
The perfect competitor’s P = MR = D = $9.80 and its ATC is equal to price.
22-21
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

22. The Monopolist Making a Profit (Calculating the Monopolist’s Profit)
Price
ATC
Perfect competitor Monopoly Price $ Price $ Output $5.45 units Output 5 units ATC $ ATC 9.90
22-22
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

23. The Monopolist Making a Profit
Price is $17
ATC is $14
TP = (P – ATC) X Output
TP = ($17 – $14) X 5
TP = ($3) X 5
TP = $15
Output is 5
22-23
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

24. The Monopolist Making a Profit
Price is $17
ATC is $14
The perfect competitor would charge
TP = (P – ATC) X Output
TP = ($17 – $14) X 5
TP = ($3) X 5
TP = $15
The output at which the firm would produce most efficiently is 5.1
Output is 5
The perfect competitor would produce at an output of 5.1
22-24
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

25. The Monopolist in the Short Run and the Long Run
There is no distinction between the short run and the long run for monopolists
If there is a 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
22-25
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

26. Demand and Supply under Monopoly
The monopolist’s supply curve is its MC curve. Its supply curve begins at the break-even point (that is, the minimum point of the ATC)
Break-even point
Because the monopolist is the ONLY seller in the industry, its individual demand curve is also the Market Demand curve. Likewise its supply curve is the Market Supply curve.
22-26
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

27. Monopolist Taking a Loss 22-27
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28. 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 book store on your campus
It is not nearly as big as Barnes and Noble
The only video 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
22-28
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

29. Barriers to Entry Control over an essential resource
Economies of scale
Legal barriers
Required scale for innovation
Economies of being established
22-29
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

30. Control Over an Essential Resource
In economics the basic resources are land, labor, and capital
Some examples are
The Metropolitan Opera has most of the world’s top opera stars under contract
The NFL had virtually all the top football stars under contract until the early 1960s
DeBeers Diamonds own four-fifths of the world’s diamond mines
The International Nickel Company of Canada owns ninety percent of the world’s nickel reserves
22-30
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

31. Economies of Scale
Typically, heavy industry - iron, steel, copper, aluminum, and automobiles - has high start-up costs
Once the plant and equipment are in place, you can take advantage of economies of scale with high volumes of output
22-31
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

32. Legal Barriers
Legal barriers include licensing, franchises, and patents
Licensing prevents just anybody from driving a taxi, cutting hair, peddling on the street, practicing medicine, burying bodies, etc.
Often the licensing procedure is designed to hold down the number of people going into a field
This tends to keep prices high in that field
22-32
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

33. Legal Barriers
Legal barriers include licensing, franchises, and patents
Government franchises are the most important legal barrier
When the number is large, for example radio stations, usually there is no big problem
However, government franchises can be, (illegally) obtained through bribes
The most important form of local franchise is the public utility gas and electric companies
22-33
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

34. Legal Barriers
Legal barriers include licensing, franchises, and patents
Patents are granted to investors so they can have a chance to get rich before some one else can use their ideas (Patents are granted for 17 years.)
Some times firms buy up patents to prevent competition
Sometimes, just before the 17 years are up, a firm makes a slight improvement and gets a patent for another 17 years
22-34
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

35. Required Scale for Innovation
Most inventors don’t have the wherewithal to produce and market their ideas
Most inventors would probably be quite happy to hand their ideas and innovations over to one of the big guys for a share of the profits
While individuals come up with all the great ideas, only large firms have the money and know-how to bring them to the marketplace
22-35
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

36. Economies of Being Established
Companies that have been in business for a number of years have certain advantages
Recognizable brand names
The sales reps have established territories
The sellers and buyers have long-standing relationships
Sometimes these companies can set the standard for the industry
Microsoft in software, Matsushita-VCR format
22-36
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

37. 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
22-37
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

38. 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
22-38
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

39. One Electric Company Is Better than Four
Panel A shows a single electric transmission feeder cable serving all the homes in one block. Panel B shows four cables serving that same block. It is a lot more efficient (and cheaper) to have one cable than four.
22-39
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

40. One Electric Company Is Better than Four
Panel A shows a single electric transmission feeder cable serving all the homes in one block. Panel B shows four cables serving that same block. It is a lot more efficient (and cheaper) to have one cable than four. What would be wrong with one cable that is shared by four companies?
22-40
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

41. The Rationale for Natural Monopoly
Today, the rationale for natural monopoly is disappearing
In more than half the states the electric power industry has been deregulated, so that local electric monopolies are getting a great deal of competition
Once the transmission cables had been 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
22-41
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

42. 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
22-42
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

43. 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 all right if a firm is big because it is very good
If a firm is big because it is bad, that is another story
22-43
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

44. When Is Bigness Good?
22-44
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

45. The Corporate Hierarchy
22-45
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46. 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
22-46
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

47. Two Policy Alternatives
Two ways to prevent public utilities from charging outrageous prices
government regulation
government ownership
22-47
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

48. Conclusion
Natural Monopolies are probably all right, 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!
22-48
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

49. Chapter Issue: Would You Allow Wal-Mart to Open a Supercenter in Your Community?
Pro:
Wal-Mart charges very low prices. Who can resist the bargains?
Wal-Mart imports $20 billion a year in goods from China
Wal-Mart runs a ruthlessly efficient mean and lean 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 attained its finest hour by keeping stores open during hurricane Katrina
They didn’t gouge but continued their policy of lowest prices
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Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

50. Chapter Issue: Would You Allow Wal-Mart to Open a Supercenter in Your Community?
Con:
Wal-Mart’s full-time employees average hourly wages are around $10 an hour, 30 percent less than its competitors
Wal-Mart imports $20 billion a year in goods from China all to our trade deficit and puts some Americans out of work
Wal-Mart runs a ruthlessly efficient mean and lean organization
Every new store is flooded with applicants, even with the low wages they offer. This may indicate that Wal-Mart’s low wages are more governed by supply and demand that to exploit their hired help
Less than half of Wal-Mart’s workers have any kind of health insurance
Wall-Mart seems to have some problems with discrimination against women employees and mistreatment of employees in some instances
Wal-Mart has driven smaller retailers out of business
22-50
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

51. Would you want Wal-Mart to open a supercenter in your community?
Chapter Issue: Would You Allow Wal-Mart to Open a Supercenter in Your Community?
Would you want 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, its you who decides one way or the other
22-51
Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.