1. Understanding Monopoly14
Understanding Monopoly

2. Contrasting Competition and Monopoly
Competitive Markets
Monopoly
Many firms
One firm
Produces efficient level of output
(since P = MC)
Produces less than the efficient level of output (since P > MC)
Cannot earn long run economic profits
May earn long run economic profits
Has no market power
(is a price taker)
Has significant market power
(is a price maker)
Lecture notes:
Really, you can just point out that perfect competition and monopoly are on polar opposite ends of the market structure spectrum.
You may have realized that in real life, we don’t often see perfect competition or pure monopoly. Much of our economy lies somewhere between these two extremes. We call this “imperfect competition,” and we can discuss the market structures of oligopoly and monopolistic competition.

3. Monopoly MR and Demand Image: Animated Figure 10.2 Lecture notes:
Two separate effects that determine marginal revenue.
First, there is a price effect, which refers to the impact that lower prices have on revenue. If the price drops from $70 to $60, each of the 3,000 existing customers will save $10. This represents a drop of $10 x 3,000, or $30,000 in lost revenue (the yellow shaded area).
Second, dropping the price also has an output effect, which refers to the impact of lower prices on the quantity sold. Since 1,000 new customers buy the product when the price is lowered to $60, this represents $60 x 1,000, or $60,000 in additional revenue (the blue shaded area).
Therefore, the output effect (gain from selling more) is greater ($60,000) than the price effect (loss from selling units at lower prices) ($30,000). As a consequence, marginal revenue is positive ($30,000) at an output level between 3,000 and 4,000 units.
Since the lost revenues associated with the price effect are always subtracted from the revenue gains created by the output effect, the marginal revenue per customer can never exceed price.

4. The Monopolist’s Profit
Image: Animated Figure 10.3
Lecture notes:
Remember that the demand function represents willingness to pay (WTP) of consumers. At the quantity q, the monopolist charges a price equal to the height of the demand, or equal to the WTP of the consumers at that quantity.
Recall the area of a rectangle is length * height.
Here, the length of the green profit rectangle is the number of units the monopoly sells.
The height of the rectangle is average profit per unit.
Thus, we get the following formula from the graph:
Total profit = (number of units sold) * (average profit per unit)

5. PC: In the long-run In the long run,
the firm will make only normal (accounting) profit (zero economic profit).
Its horizontal demand curve will touch its average total cost curve at its lowest point

6. The Problems with Monopoly
Monopolies can make societies worse off
Restricting output and charging higher prices compared to competitive markets
Operate inefficiently (deadweight loss). This is referred to as market failure.
Less choices for consumers
Unhealthy competition called “rent seeking”
Lecture notes:
The word “monopoly” often has a negative connotation. With a bad economy, we often hear people complaining about “greedy companies,” “Wall Street,” “banks”, etc.
However, these entities are often not monopolies. Monopolies are often economically inefficient. This comes from the fact that P > MC and that output is restricted compared to competitive markets.

7. Deadweight Loss of Monopoly
Image: Animated Figure 10.5
Lecture notes:
From text:
The monopolist charges too high a price and produces too little of the product, so some consumers who would benefit from a competitive market lose out. Since the demand curve, or the willingness to pay, is greater than the marginal cost between output levels QM and QC, society would be better off if output was expanded to QC. But a profit-maximizing monopolist will limit output to QM. The result, a deadweight loss equal to the area of the yellow triangle, is inefficient for society.

8. Monopoly versus Competition
Output (quantity)
QMonopoly < QCompetition
Price
PCompetition < PMonopoly
Deadweight loss
Monopoly DWL > 0
Competition DWL = 0
Lecture notes:
In one sentence:
A monopolist produces less output and charges a higher price than competitive markets.

9. Monopoly Problems Few choices
Restricts consumer ability to put downward pressure on prices. No substitutes.
Cable companies and bundling. Monopolies can force you to buy more.
And not necessarily the channels you want
Lecture notes:
With fewer choices (no substitutes), consumers may be “forced” to pay higher prices for goods and services since they have no option to buy cheaper substitutes. In addition, multiproduct monopolies (cable companies, for example) may bundle other goods together that you must also buy. This raises prices and profits for the firm and may make consumers buy more goods than they want to.
Rent seeking: think about this as spending time, effort, and resources in ways that attempt to gain monopoly or keep your existing monopoly. Rather than spending money on making a better product or improving production, you spend money on lobbyists and lawyers, and spend resources defending your monopoly. This is an economically inefficient use of resources in this market. The firm is attempting to eliminate competition, but this act doesn’t benefit consumers.

10. What’s So Bad About Monopolies?
Compared to Perfect Competition
Higher Price for Fewer Goods
Economic Considerations
P > MC
Consumer’s value (MV) of Q* > Cost (MC) of resources used
Thus -> Deadweight Loss (Economic Inefficiency)
Allocatively Inefficient
Q* not produced at lowest cost (ATC > min(ATC))
Productively Inefficient
Little Incentive to Adopt New Technology
No competition -> no incentive to adopt new tech & reduce cost

11. How Did It Happen? Monopoly
Firm that is the sole seller of a product without close substitutes
Barriers to entry – prevent firms from entering this market when there are + economic profits
Legal and Cost Barriers
NBA, Medical, Patents (pharmaceutical)
Monopoly resources
Oil, Diamonds, Professional Sports
Government regulation
Comcast
High Cost Barriers to Enter the Market – Aerospace

12. Barriers to Entry
Monopolist needs a “barrier” (or obstacle) to entry so that potential competitors can’t get into the Monopolist’s market
Monopolies earn + long-run and short-run profits that would “normally” attract new entrants (i.e. potential competitors)
Long-run profits = 0 in competitive firms where any one can enter the market (no barriers)

13. Types Barriers That Exist and Can Explain Why a Monopoly Continues to Persist
Limiting entry by legally granting “entry” authorization to people already in the industry
AMA, Professional Sports
New entrants would increase competition -> driving prices (and salaries) down
Incentive to restrict entry
Revenue sharing – more revenue shared over more firms -> lower average revenue per team

14. Types Barriers That Exist and Can Explain Why a Monopoly Continues to Persist
Legal
Patent – exclusive (property) right to the particular ingredients (e.g., Big Pharma)
Trademark – exclusive right to product name (brand loyalty)
Granted/protected by the government
Meant to encourage investment in research and development of new products/drugs
Shkreli claims that the Turing Pharm. is increasing the price for its prescription drug to conduct R&D for new drugs
Shkreli was able to get a new patent for this drug by showing it could be used to treat a new disease – no new development; just a new application

15. Big Pharma Big Pharma Is America’s New Mafia
Pharmaceutical companies have more power than ever, and the American people are paying the price—too often with our lives.

16. What’s So Bad About Monopolies
Martin Shkreli In September 2015, Shkreli received widespread criticism when Turing obtained the manufacturing license for the antiparasitic drug Daraprim and raised its price by 5,556 percent (from US$13.50 to US$750 per tablet) leading him to be referred to by media as the "most hated man in America".[4]

17. Types Barriers That Exist and Can Explain Why a Monopoly Continues to Persist
Cost Barrier (High Fixed Costs)
Large Initial Costs for Plant, Equipment (i.e., Capital Structures) can prevent entry
Aerospace
Has both economies of scale and
High Fixed (Plant) Cost to enter market
Market currently dominated by 2 large manufacturers (Airbus and Boeing)
Nearly 100% market share (Europe, US and Asia)

18. Aerospace
Boeing and Airbus – Market Share

19. Types Barriers That Exist and Can Explain Why a Monopoly Continues to Persist
Limited/Scarce Natural Resource
Entry is limited by “limited” access to the resource
Oil, Diamonds, Lithium Ion batteries
Very few places to access the resource
Once property rights are established – only owner has access to the resource
Oil – appox 14 major oil producers (really only 3 or 4 are major producers)
Prior to off-shore drilling and fracking
Requires cooperation among members to “fix” prices above competitive market price

20. Economies of Scale “Natural” Monopoly
Having 1 firm produce the good, rather than several smaller firms, reduces the average cost of production
“economies of scale” are present
However, having the government “license” the market to 1 provider can result in “monopoly” like pricing unless they also regulate its price
Most require firm to set price at ATC + 10% (assumes a normal ROR is ~ 10%)
“cost plus” pricing

21. How A Firm Could Limit/Reduce Competition
Mergers
Merging with a competitor can
Reduce competition
Possible to increase price without worrying about competitor’s offering a lowering price
Rational for DOJ, FCC, FTC being involved and having to approve mergers

22. Solutions to Monopoly “Divestiture” (Sherman Act (1890)
Breaking one big company into a smaller number of “competing” companies
AT&T (1982), Standard Oil (1911)
Telecomm Act (1996)
Allows competitors to access/rent current Telecomm companies network at “forward-looking” costs (best, most efficient technology)
Ignored that: (1) local phone company’s costs based on historical costs to be recovered over 20 years
(2) Residential rates subsidized (below costs)for universal service – higher costs business rates
Lecture notes:
1982:
AT&T was split up into eight smaller companies after spending over $300 million defending itself from lawsuits and antitrust legislation.
1911:
Standard Oil controlled 91% of production and 85% of final sales of oil in the United States in In 1909, the Department of Justice sued the company for violating the Sherman Act. In 1911, the company was forced to break up into 34 independent companies with different boards of directors. The biggest two companies were Exxon and Mobil.
Reducing trade barriers:
Text: The Constitution reads, “No State shall, without the consent of Congress, lay any imposts or duties on imports or exports.” Rarely have so few words been more profound. With this simple law in place, states must compete on equal terms.
In addition, if we eliminate trade quotas and tariffs, international firms may force domestic producers to become more competitive, which will reduce monopoly power.

23. Professional Sports
At the federal level, antitrust legislation serves as one culprit in the city-switching games played by teams.
Pro sports leagues have been classified by government officials as monopolies, and are therefore subject to antitrust regulation.
The exception to this has been Major League Baseball, which operates under an antitrust exemption, and indeed, baseball teams remain far less mobile than, for example, NFL teams.

24. Solutions to Monopoly Preventing anti-competitive mergers
Sherman Act (1890) – FCC, FTC and SEC
AT&T and T-Mobile
Reduce competition
Lecture notes:
1982:
AT&T was split up into eight smaller companies after spending over $300 million defending itself from lawsuits and antitrust legislation.
1911:
Standard Oil controlled 91% of production and 85% of final sales of oil in the United States in In 1909, the Department of Justice sued the company for violating the Sherman Act. In 1911, the company was forced to break up into 34 independent companies with different boards of directors. The biggest two companies were Exxon and Mobil.
Reducing trade barriers:
Text: The Constitution reads, “No State shall, without the consent of Congress, lay any imposts or duties on imports or exports.” Rarely have so few words been more profound. With this simple law in place, states must compete on equal terms.
In addition, if we eliminate trade quotas and tariffs, international firms may force domestic producers to become more competitive, which will reduce monopoly power.

25. AT&T – A Short History
Alexander Graham Bell patented the telephone in 1876,
formed Bell Telephone which licensed local telephone exchanges in major US cities. AT&T was formed in 1885
In 1913 AT&T became a regulated monopoly.
had to connect competing local companies
And let the Federal Communication Commission (FCC) approve their prices and policies.
All customers rented phones from AT&T, and no other equipment could be attached to the network for fear of "breaking" it.

26. AT&T – A Short History
On January 1, 1984, a court forced AT&T to give up its 22 local Bell companies (Divestiture)
This established seven Regional Bell Operating Companies (RBOC).
Since that time, mergers have reduced the number of RBOCs to four: Verizon (originally Bell Atlantic and Nynex), Qwest (Qwest Communications International took over US West), BellSouth and SBC (originally Southwestern Bell and Pacific Telesys).

27. How Do We “Fix” Monopolies
Lower Barriers to Entry
Goal is to increase competition by allowing more firms to enter the market and compete against each other
AT&T Divestiture (1980)
DOJ and FCC sought to introduce competition into the local phone markets (dominated by 7 RBOCs, “bab y bells”)
Required AT&T/RBOCs to lease local wirelines, switching networks, transmission satellites and local household connections at “forward” looking economic costs (which were below historical costs)

28. How Do We “Fix” Monopolies

29. AT&T Before and After the Break-up

30. After the Break Up

31. Colbert on the AT&T Break-Up

32. Natural Monopoly – Avg Cost Decrease with Increasing Size/Scale of the Firm – Divestiture Raises Avg Cost 6
Average
Total
Cost
ATC in short
run with
small factory
ATC in short
run with
medium factory
ATC in short
run with
large factory
ATC in long run
Economies
of scale
Diseconomies
of scale
$12,000
1,200
10,000
Constant returns to scale
1,000
Quantity of Cars per Day
Because fixed costs are variable in the long run, the average-total-cost curve in the short run differs from the average-total-cost curve in the long run.

33. Why Monopolies Arise The production process Natural monopoly
A single firm can produce output at a lower cost than can a larger number of producers
Natural monopoly
Arises because a single firm can supply a good or service to an entire market
At a smaller cost than could two or more firms
Economies of scale over the relevant range of output

34. Solutions to Monopoly For Natural Monopolies Price regulation
Often, we don’t want to break up firms due to large economies of scale
Don’t need to have redundant water pipes, power lines
In this case, a monopoly may be desirable, but we may still need to regulate the firm to prevent market power abuse
Lecture notes:
Breakup of a natural monopoly would actually be a bad idea. Due to economies of scale, there are some firms in which bigger really is better. If the ATC curve is downward-sloping over a large range of output, it means that a bigger firm can produce output at a lower cost than many smaller firms.
While this monopoly may be desirable (compared to competition), we still want to make sure that the firm doesn’t abuse its monopoly power by charging exorbitantly high prices. This is where price regulation comes in.

35. Economies of scale as a cause of monopoly1
Economies of scale as a cause of monopoly
Costs
Average total cost
Quantity of output
When a firm’s average-total-cost curve continually declines, the firm has what is called a natural monopoly. In this case, when production is divided among more firms, each firm produces less, and average total cost rises. As a result, a single firm can produce any given amount at the smallest cost

36. Regulatory Solution for Natural Monopoly
Image: Animated Figure 10.6
Lecture notes:
No regulation:
Unregulated monopolist sets MR = MC and produces QM at a price of PM. Since PM is greater than the average cost of producing QM units, or CM, the monopolist earns the profit shown in the green rectangle.
Regulation:
If the firm is regulated, and the price is set at marginal cost, regulators can set P = MC and the output expands to QR. In this example, since the cost of production is subject to economies of scale, the cost falls from CM to CR. This is a large improvement in efficiency. The regulated price, PR, is lower than the monopolist’s price, PM, and production increases. As a result, consumers are better off. But what happens to the monopoly? It loses profits in the amount of the red rectangle. This occurs since the average costs under the marginal-cost pricing solution, CR, are higher than the price charged by regulators, PR.

37. Marginal Cost Pricing At P = MC Solutions? French approach
The monopolist experiences a loss
MC < ATC, so P < ATC (results in losses)
Solutions?
Government subsidies given to the firm
Set P = ATC at the P = MC output level
Government ownership of the firm
French approach
Set P=MC => subsidize ∆ (ATC-MC) from taxes
Lecture notes:
Why is this bad?
Subsidies come from the government, which taxes YOU! So you now have lower prices, but now have to pay higher taxes to subsidize the firm!
Government ownership creates many more problems, which we will see next.

38. Government Failure Government intervention Free market
Can eliminate the profit motive and the necessity to innovate and improve efficiency
Free market
Firms under MC pricing have no incentive to lower costs.
Price Caps:
Set maximum price to recover costs (P+ATC)
Adjust price over time for efficiency
P(next year) = P(today) – Average Industry Productivity
Often better than government intervention and changing incentives for a firm
Lecture notes:
It all comes down to incentives. The government can always “bail itself out,” so it has no incentive to be efficient, keep costs down, or fire bad employees. A private firm has to take care of its own expenses and has the incentive to find and eliminate inefficiencies.

39. Conclusion
While competitive markets generally bring about welfare-enhancing outcomes for society, monopolies often do the opposite
Government seeks to limit monopoly outcomes and promote competitive markets
Perfectly competitive markets and monopoly are market structures at opposite extremes
Most economic activity takes place between these two alternatives
Lecture notes:
You can think that we often talk about perfect competition (PC) and pure monopoly in the theoretical sense because they are very rare (by strict definition and assumptions) in real life. Many firms have some competitive characteristics and some monopolistic characteristics. This will be studied in the upcoming chapters.

40. Natural Barriers to Entry
Economies of scale
“Bigger is better” (more cost-efficient)
This is due to the ATC being downward- sloping over a large range of output
Lower costs  lower prices
Car production, electricity production, mail delivery
Natural monopoly
A monopoly exists because a single large firm has lower costs than any potential competitor
In addition, breaking up the firm into multiple competitors may increase costs as well
Lecture notes:
Economies of scale
Recall this definition from Chapter 8. Average costs fall as output increases. Which do you think can be done at an OVERALL lower cost? One hundred car producers making 10 cars each or two car producers making 500 cars each? A total of 1,000 cars is made in each case, but due to the nature of the cost structure of car production which exhibits economies of scale, average costs fall with output increases and two firms producing more cars will have overall lower costs.
Natural monopoly
It’s just “natural” to have a monopoly since it provides the lowest (most efficient) costs. Realize however, that a monopoly (natural or not) will enjoy significant market power and may not pass cost savings to consumers in the form of lower prices. Natural monopolies (such as electric companies) are often regulated by the government to prevent abuse of market power.

41. Summary
Monopolies
Market structure characterized by a single seller who produces a well-defined product with few good substitutes
Operate in a market with high barriers to entry, the chief source of market power.
May earn long run profits
Perfectly competitive firms are price takers. Monopolists are price makers.

42. Summary
Like perfectly competitive firms, a monopoly tries to maximize its profits.
Same profit maximizing rule of MR = MC is used.
From an efficiency standpoint, the monopolist charges too much and produces too little.
Since the output of the monopolist is smaller than would exist in a competitive market, the outcome also results in deadweight loss.

43. Summary Government grants of monopoly power encourage rent seeking
There are four potential solutions to the problem of monopoly
First, the government may break up firms to restore a competitive market
Second, government can promote open markets by reducing trade barriers
Third, the government can regulate a monopolist’s ability to charge excessive prices
Finally, there are circumstances in which it is better to leave the monopolist alone
Lecture notes:
The government may want to leave a monopoly alone if the costs of intervention are greater than the benefits of intervention.

44. Practice What You Know
Which of the following firms will most likely be a natural monopoly?
A grocery store
A cable TV company
A gas station
A barbershop
Clicker Question
Correct answer: B
Town utilities (cable, gas, electricity, water) usually are natural monopolies due to their cost structure.

45. Practice What You Know
Which of the following most accurately describes a patent?
An incentive to innovate
A profit-sharing mechanism
A redistribution of wealth
An original invention
Clicker Question
Correct answer: A
Be careful. The patent is not the invention itself. The patent protects your invention and allows you to gain temporary monopoly status on your invention.

46. Practice What You Know What is true for a profit-maximizing monopoly?
P = MR = MC
P = MR > MC
P > MR = MC
P > MR > MC
Clicker Question
Correct answer: C
Any firm wants to sell output where MR = MC.
However, in monopoly, P > MR.
In competition, we have P = MR = MC.

47. Practice What You Know
What is the reason for monopoly deadweight loss (relative to perfect competition)?
The monopolist faces a downward sloping demand curve
People boycott monopolies more often
The monopolist sells less output at a higher price
The monopolist has no competitors
Clicker Question
Correct answer: C
With monopoly, we don’t maximize gains from trade by reaching the same equilibrium that a competitive market reaches.

48. Practice What You Know
A monopolist will have negative profits and exit the industry in the long run if:
A new competitor enters the industry
Demand becomes more elastic
Price < ATC
A monopolist never has negative profits
Clicker Question
Correct answer: C
A monopolist can still earn negative profits. Maybe demand for the product is low, or the firm’s costs are too high.