ECO 204
Chapter 9
MONOPOLY
Monopoly is the extreme example of a market with
no competition. The monopolist is the only producer of a product with no
close substitutes. Hence characteristics of a monopoly are opposite those
described for the perfectly competitive firm. Instead of many firms, there
is only one. Instead of a perfectly substitutable product, the monopolist's
product is unique. Rather than conditions of free entry and exit prevailing,
the monopolist is able to erect and hold onto barriers to entry.
The basic decision rule for the monopolist is
the same as for the perfect competitor; that is, the profit-maximizing
monopolist chooses output such that marginal revenue equals marginal cost.
However, since the monopolist is the market, it bases its decisions on
the market demand curve and must lower market price in order to sell marginl
units of output. Because of this, the marginal revenue curve is downward-
sloping and marginal revenue is less than price. Although monopolists must
earn at least a normal profit in order to stay in business in the long
run, in the short run they may earn losses. The monopolist is in a favorable
position due to its ability to affect price, but the demand curve and consumer
tastes and preferences serve as a check on the ability of the firm to exploit
this position. Due to the existence of barriers to entry, a monopolist
can earn economic profits indefinitely, but this happens only if the barriers
to entry remain in place and if consumer demand remains strong enough to
justify a price greater than average total cost.
Price discrimination occurs when a company charges
different prices to different buyers and when these price differences are
not due to differences in cost. Price discrimination can be employed by
a firm that has a great deal of monopoly power, ability to separate buyers
into groups based on willingness to pay higher prices, and ability to prevent
resale among buyers. Price discrimination is illegal in some cases, but
it is difficult to prove and very profitable for the producer.
In many cases, monopolists have earned a bad
name in the minds of most consumers. However, there are some advantages
to big business. These pros and cons will be discussed carefully in this
chapter in the context of the theoretical model of monopoly behavior.
Outline
I. The Meaning of Monopoly
A. A firm is a monopolist if it is the sole producer of a unique product
B. Any firm that faces a downward-sloping demand curve has some monopoly power
II. Maintaining Monopoly Through Barriers to Entry
A. If a firm has control of an essential raw material, it can keep competitors from the market
B. If minimum costs can be achieved only through production of very high levels of , then it is more difficult for rivals to enter a market
C. Patents and copyrights can enable a monopolist to eliminate the possibility of competitors
D. A monopolist that obtains from a government exclusive permission to operate will have to worry about the entry of competitors
III. The Basic Model of Monopoly
A. The monopolistic firm is the market; therefore, the firm faces downward-sloping market demand and marginal revenue curves
1. To sell additional units of output, the monopolist must lower its market price on all units sold
2. Marginal revenue is less than price; as the firm expands output, market price falls and the addition to total revenue gets smaller and smaller
3. Thus, the monopolist never produces in the inelastic region of the demand curve
B. The profit-maximizing output level for the monopolist is found where marginal revenue is equal to marginal cost
C. The profit-maximizing price for the monopolist is found by looking to the demand curve, which shows the maximum price that buyers are willing to pay for each level of output.
D. Monopoly power does not guarantee short-run profits
1. Revenues depend on the strength of the demand for output
2. Like the perfect competitor, the monopolist goes out of business if P less than AVC in order to lessen the loss
E. A monopolist can earn economic profits in the long run
1. Due to the existence of barriers, the entry of rivals does not necessarily eliminate economic profits
2. A monopolist will not continue to earn losses in the long run; instead, resources will be shifted into an alternative that yields at least normal profits
IV. Price Discrimination
A. Price discrimination occurs when a company charges different prices to different buyers and these price differences are not attributable to differences in costs of production or sales
B. Three conditions must hold in order for a firm to effectively engage in price discrimination
1. The company must have some monopoly power--that is, some ability to control price
2. The company must be able to segment buyers into groups based on price of demand
3. The company must be able to prevent the resale of its product
V. An Evaluation of Monopoly
A. The Evils of Monopoly
1. Higher prices and lower output than would be produced in a perfectly market
2. Inefficient allocation of resources (the existence of barriers to entry additional resources out of this industry, even when demand-side would warrant their entry)
3. Rent-seeking behavior
a. Resources are used by the monopolist not to produce output, but to maintain monopoly power
b. Thus some output is forgone in order to maintain market control
4. Delayed innovation in the absence of any competition to innovate
5. Inequities in income distribution may be magnified by the existence of monopolies
B. Potential Advantages of Monopoly
1. Reduction of current costs of production through the existence of monopolies
2. Reduction of future costs of production through promotion of progress enables firms to spend more money on research development