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Topic 3 Monopoly

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Ahmed Said
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© © All Rights Reserved
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Managerial Economics

Topic 3: Monopoly and Antitrust Policy


Chapter Outline
15.1 Is Any Firm Ever Really a Monopoly?

15.2 Where Do Monopolies Come From?

15.3 How Does a Monopoly Choose Price and Output?

15.5 Government Policy Toward Monopoly


15.1 Is Any Firm Ever Really a Monopoly?
Define monopoly.

Monopoly is a market structure consisting of a firm that is the only seller of a good or service
that does not have a close substitute.

Monopoly exists at the opposite end of the competition spectrum to perfect competition.

We study monopolies for two reasons:


1. Some firms truly are monopolists, so it is important to understand how they behave.
2. Firms might collude in order to act like a monopolist; knowing how monopolies act
helps us to identify these firms.
Do Monopolies Really Exist?
Suppose you live in a small town with only one pizzeria. Is
that pizzeria a monopoly?
1. It has competition from other fast-food restaurants
2. It has competition from grocery stores that provide pizzas for
you to cook at home

If you consider these alternatives to be close substitutes for


pizzeria pizza, then the pizza restaurant is not a monopoly.

If you do not consider these alternatives to be close


substitutes for pizzeria pizza, then the pizza restaurant is a
monopoly.

Regardless, the pizzeria’s unique position may afford it some


monopoly power to raise prices and obtain economic profit.
15.2 Where Do Monopolies Come From?
Explain the four main reasons monopolies arise.

For a firm to exist as a monopoly, there must be barriers to entry preventing other firms
coming in and competing with it.
The four main reasons for these barriers to entry are:
1. Government restrictions on entry
2. Control of a key resource
3. Network externalities
4. Natural monopoly
The next few slides will examine these in detail.
1. Government Restrictions on Entry (1 of 2)
In the U.S., governments block entry in two main ways:

a. Patents, copyrights, and trademarks


Newly developed products like drugs are frequently granted patents, the exclusive
right to produce a product for a period of 20 years from the date the patent is filed
with the government.

Similarly, copyrights provide the exclusive right to produce and sell creative works
like books and films, and trademarks offer protection for brand names, symbols,
and some characteristics.

These intellectual property protections encourage innovation and creativity, since


without them, firms would have a harder time covering high fixed costs.
1. Government Restrictions on Entry (2 of 2)
In the U.S., governments block entry in two main ways:

b. Public franchises
A government designation that a firm is the only legal provider of a
good or service is known as a public franchise. These might exist, for
example, in electricity or water markets.

Sometimes (more commonly in Europe than the U.S.) governments


even operate these firms as a public enterprise.
• A U.S. example of this is the U.S. Postal Service.
2. Control of a Key Resource
For many years, the Aluminum Company of America (Alcoa) either
owned or had long-term contracts for almost all the world’s supply of
bauxite, the mineral from which we obtain aluminum.
• Such control over a key resource served as a substantial barrier to
entry for additional firms.

The National Football League (NFL) acts as a monopoly in this manner


too: it ensures that the majority of the world’s best football players are
under contract to the NFL and unable to be used for another potential
league.
3. Network Externalities
Economists refer to network externalities as a product characteristic whereby the
usefulness of a product increases with the number of consumers who use it.

Examples: Auction sites (like eBay)


Computer operating systems (like Windows)
Social networking sites (like Facebook)

These network externalities can set off a virtuous cycle for a firm, allowing the
value of its product to continue to increase, along with the price it can charge.

But consumers may be locked into an inferior product.


4. Natural Monopoly
A natural monopoly occurs when one firm can supply the entire
market at a lower average total cost than can two or more firms.

Natural monopolies are most likely when fixed costs are high.
• Example: A firm producing electricity must make a substantial
investment in production and distribution infrastructure; the marginal
cost of producing another hour of electricity is low.
15.3 How Does a Monopoly Choose Price and Output?
Explain how a monopoly chooses price and output.

In our study of oligopoly, we abandoned the idea of marginal cost and marginal revenue,
because the strategic interaction between firms overrode these concepts.

But monopolists have no competitors and hence no concern about strategic interactions.
• They seek to maximize profit by choosing a quantity to produce, just like perfect and
monopolistic competitors.

In fact, monopolists act very much like monopolistic competitors: they face a downward
sloping demand curve.
• The difference is that barriers to entry will prevent other firms from competing away their
economic profit.
Figure 15.2 Calculating a Monopoly’s Revenue (1 of 2)

Comcast is a monopolist in a local


market for cable television services. Subscribers per Month Price Total Revenue Average Revenue Marginal Revenue
(Q) (P) (TR = P × Q) (AR = TR/Q) (MR = ∆TR/∆Q)
0 $ 60 $0 – –
1 57 57 $ 57 $ 57
The first two columns of the table 2 54 108 54 51
show the market demand curve, 3 51 153 51 45
which is also Comcast’s demand 4 48 192 48 39
curve. 5 45 225 45 33
6 42 252 42 27
7 39 273 39 21
8 36 288 36 15
Total, average, and marginal revenue 9 33 297 33 9
are all calculated in the usual 10 30 300 30 3
manner.
Figure 15.2 Calculating a Monopoly’s Revenue (2 of 2)

As the monopolist decreases price to expand


output, two effects occur:
1. Revenue increases from selling an extra
unit of output.
Marginal
2. *Revenue decreases, because the price
reduction is shared with existing
customers.
So marginal revenue is always below demand
for a monopolist.

Copyright © 2019, 2017, 2015 Pearson Education, Inc. All Rights Reserved.
Figure 15.3 Profit-Maximizing Price and Output for a Monopoly (1 of 2)

The monopolist maximizes profit by producing the quantity where the additional revenue from the
last unit (marginal revenue) just equals the additional cost incurred from its production (marginal
cost).
MC = MR determines quantity for a monopolist.
Copyright © 2019, 2017, 2015 Pearson Education, Inc. All Rights Reserved.
Figure 15.3 Profit-Maximizing Price and Output for a Monopoly (2
of 2)

At this quantity,
• The demand curve determines price, and
• The average total cost (ATC) curve determines average cost.
Profit is the difference between these (P−ATC), times quantity (Q).
Copyright © 2019, 2017, 2015 Pearson Education, Inc. All Rights Reserved.
15.5 Government Policy Toward Monopoly
Explain how the government regulates monopoly.

Because monopolies reduce consumer surplus and economic efficiency, governments regulate
their behavior.
• Many governments try to stop firms colluding and seek to prevent mergers and acquisitions
creating large firms, through antitrust laws.

Collusion: An agreement among firms to charge the same price or otherwise not to compete.

Antitrust laws: Laws aimed at eliminating collusion and promoting competition among firms.
Apply the Concept: Have Generic Drug Firms Been
Colluding to Raise Prices? (1 of 2)
Drugs for which the patent has
expired are called generic drugs;
these constitute about 88% of all
U.S. prescriptions.

Intense competition in the


generic drug market commonly
results in low prices for generic
drugs.

But this means firms have a


strong incentive to break antitrust
laws and collude to raise prices.
Apply the Concept: Have Generic Drug Firms Been
Colluding to Raise Prices? (2 of 2)
In early 2017, two executives at
Heritage Pharmaceuticals Inc.
pleaded guilty to colluding with
other firms to fix the prices of an
antibiotic and a diabetes drug.

The Department of Justice is


investigating other firms to
determine how widespread
collusion has become.

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