chapter 23 monopoly 23-1 copyright 2002 by the mcgraw-hill companies, inc. all rights reserved

Chapter 23

Monopoly

23-1Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 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?


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 for the product or service


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


The Graph of the Monopolist

• The imperfect competitor has to lower price to sell more


D

Q2Q1

P2

P1


Hypothetical Demand & Cost Schedule for a Monopoly

Output Price TR MR TC ATC MC

1 $16

2 15

3 14

4 13

5 12

6 11

7 10




1 $16 $16

2 15 30

3 14 42

4 13 52

5 12 60

6 11 66

7 10 70




1 $16 $16 $16

2 15 30 14

3 14 42 12

4 13 52 10

5 12 60 8

6 11 66 6

7 10 70 4




1 $16 $16 $16 $20 $20

2 15 30 14 30 15

3 14 42 12 36 12

4 13 52 10 42 10.50

5 12 60 8 50 10

6 11 66 6 63 10.50

7 10 70 4 84 12




1 $16 $16 $16 $20 $20 ----

2 15 30 14 30 15 $10

3 14 42 12 36 12 6

4 13 52 10 42 10.50 6

5 12 60 8 50 10 8

6 11 66 6 63 10.50 13

7 10 70 4 84 12 21


Output

20

18

16

14

12

10

8

6

4

2

0

ATC

D

MR

0 1 2 3 4 5 6 7

MC

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


Output

20

18

16

14

12

10

8

6

4

2

0

ATC

D

MR

0 1 2 3 4 5 6 7

MC

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


Output

20

18

16

14

12

10

8

6

4

2

0

ATC

D

MR

0 1 2 3 4 5 6 7

MC

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


Output

20

18

16

14

12

10

8

6

4

2

0

ATC

D

MR

0 1 2 3 4 5 6 7

MC


Price

The ATC at five units of output is about $9.90

ATC


Output

20

18

16

14

12

10

8

6

4

2

0

ATC

D

MR

0 1 2 3 4 5 6 7

MC


Price

ATC

Total Profit = (Price – ATC) X Output= ($12 - $9.90) X 5 ($2.10 X 5)

= $10.50


Output

20

18

16

14

12

10

8

6

4

2

0

ATC

D

MR

0 1 2 3 4 5 6 7

MC


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


Output

20

18

16

14

12

10

8

6

4

2

0

ATC

D

MR

0 1 2 3 4 5 6 7

MC


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).


Output

20

18

16

14

12

10

8

6

4

2

0

ATC

D

MR

0 1 2 3 4 5 6 7

MC


Price

ATC

The perfect competitor will produce at the most efficient output level which is the minimum point on the ATC


Output

20

18

16

14

12

10

8

6

4

2

0

ATC

D

MR

0 1 2 3 4 5 6 7

MC


Price

ATC

The perfect competitor’s P=MR=D=$9.80 and its ATC is equal to price.


Output

20

18

16

14

12

10

8

6

4

2

0

ATC

D

MR

0 1 2 3 4 5 6 7

MC


Price

ATC

Perfect competitor Monopoly Price $9.80 Price $12.00 Output $5.45 units Output 5 units ATC $9.80 ATC 9.90

Summary

• The monopolist makes a profit (economic), whereas in the long run the perfect competitor makes no profit (economic)

• The monopolist operates at less than peak efficiency, while the perfect competitor operates at peak efficiency (the lowest point on the ATC)

• The perfect competitor(s) charges a lower price and produces a larger output than the monopolist



Output

ATC

MC

D

MR

0 1 2 3 4 5 6

8

10

12

14

16

18

20

22

24

The Monopolist Making a Profit

Output is 5

Price is $17

ATC is $14

TP = (P – ATC) X OutputTP = ($17 – $14) X 5TP = ($3) X 5TP = $15


Output

ATC

MC

D

MR

0 1 2 3 4 5 6

8

10

12

14

16

18

20

22

24

The Monopolist Making a Profit

Output is 5

Price is $17

ATC is $14

TP = (P – ATC) X OutputTP = ($17 – $14) X 5TP = ($3) X 5TP = $15

The output at which the firm would produce most efficiently is 5.1 The perfect competitor would produce at an output of 5.1

The perfect competitor would charge


The Monopolist in the Short Run and the Long Run

• There is no distinction between the short run and the long run for the 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

–


Output

ATC

MC

D

MR

0 1 2 3 4 5 6

8

10

12

14

16

18

20

22

24

Demand and Supply under Monopoly

Because the monopolist is the ONLY seller in the industry, her individual demand curve is also the Market Demand curve. Likewise her supply curve is the Market Supply curve.

The monopolist’s supply curve is her MC curve. Her supply curve begins at the break-even point (that is, the minimum point of the ATC)

Break even point


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


Barriers to Entry

• Control over an essential resource

• Economies of scale• Legal barriers• Required scale for innovation• Economies of being established


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

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


Economies of Scale

• Typically, heavy industry - iron, steel, copper, aluminum, and automobiles - has high start up cost– Once the plant and equipment are in place, you can take

advantage of economies of scale with high volumes of output

Output (in hundred thousands)

ATC5

10

15

20

25

30

35

40

45

50

55

60

65

70

75

1 2 3 4 5 6 7


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 the field

• This tends to keep prices high in that field


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


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

• Some times, just before the 17 years are up, a firm makes a slight improvement and gets a patent for another 17 years

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



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, i.e.,– Microsoft in software, Matsushita-VCR format


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


Economies of Scale and Natural Monopoly

• There are only two justifications for monopoly– Economies of Scale justify bigness because

sometime only a firm with the capability of a very large output can produce anywhere close to the minimum point of its ATC

– Natural Monopoly is a situation where one firm is able to provide a service at a lower cost than could several competing firms


A B

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.

23-37

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


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


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 is another story



Chief executivesÕ payAs a multiple of manufacturing employeesÕ pay, 1999

475

40

50

30

20

10

0

The Corporate Hierarchy

• 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


The Economic Case Against Bigness


Two Policy Alternatives

• Two ways to prevent public utilities from charging outrageous prices– government regulation

– government ownership


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

chapter 23 monopoly 23-1 copyright 2002 by the mcgraw-hill companies, inc. all rights reserved

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