ECON 251: Chapter 11 - Pure Monopoly

What are the five main characteristics of Pure Monopoly?

1. Single Seller: One firm is the sole producer [LO12.1, 275].

2. No Close Substitutes: The product is unique [LO12.1, 275].

3. Price Maker: The monopolist controls total quantity supplied and has considerable control over price, facing a downward-sloping product demand curve [LO12.1, 275].

4. Blocked Entry: Barriers prevent competitors from entering [LO12.1, 275].

5. Nonprice Competition: May involve public relations for standardized products or advertising for differentiated products [LO12.1, 275].

Provide an example of a pure monopoly or near-monopoly.

While pure monopolies are rare, near-monopolies like Intel, Illumina, or Google's Android are common [LO12.1, 229]. Government-owned or regulated public utilities often function as monopolies [LO12.1, 229].

What is the primary barrier to entry that can lead to a natural monopoly?

Economies of Scale [LO12.2, 229, 343]. This occurs when declining average total cost (ATC) over a wide range of output allows a single firm to satisfy demand at the lowest average total cost, making it difficult for new, smaller firms to compete on cost [LO12.2, 229].

List two types of legal barriers to entry for a monopoly.

1. Patents: Exclusive right for inventors to produce and sell a new product for 20 years, incentivizing innovation [LO12.2, 230, 437].

2. Licenses: Government limits entry into an industry or occupation (e.g., FCC licenses, state lotteries) [LO12.2, 230].

Besides economies of scale and legal barriers, what are two other types of barriers to entry for a pure monopoly?

1. Ownership or Control of Essential Resources: A firm owning or controlling a vital resource can block rivals (e.g., International Nickel Company) [LO12.2, 231].

2. Pricing and Other Strategic Barriers to Entry: Monopolists may slash prices or increase advertising to deter new entrants (e.g., Dentsply, American Express) [LO12.2, 231].

How does a monopolist's demand curve differ from that of a purely competitive firm?

A monopolist's demand curve is the market demand curve and is downward sloping [LO12.3, 231]. In contrast, a purely competitive firm faces a perfectly elastic (horizontal) demand curve [LO10.3, 341].

Why is a monopolist's marginal revenue (MR) less than its price (P)?

To sell more output, a monopolist must lower the price on all units sold, not just the additional unit [LO12.3, 232]. This causes the MR curve to lie below the demand curve [LO12.3, 232].

In which region of its demand curve will a profit-maximizing monopolist operate, and why?

A profit-maximizing monopolist will always operate in the elastic region of demand [LO12.3, 233]. This is because total revenue increases when demand is elastic (MR is positive), and decreases when inelastic (MR is negative) [LO6.2, 121, LO12.3, 233]. A monopolist will never operate in the inelastic segment as that would reduce total revenue [LO12.3, 233].

What is the profit-maximizing rule for a pure monopolist regarding output and price?

A pure monopolist maximizes profit by producing the output where marginal revenue (MR) equals marginal cost (MC) [LO12.4, 234, 345]. The corresponding price (Pm) is then found by extending a vertical line from this output level up to the demand curve [LO12.4, 234].

Why is there no unique supply curve for a pure monopolist?

There is no unique relationship between price and quantity supplied for a monopolist because its marginal revenue is less than its price, and the monopolist is a price maker, not a price taker [LO12.4, 237].

What are two common misconceptions about monopoly pricing?

1. Monopolists do not seek the highest possible price; they seek maximum total profit [LO12.4, 236].

2. Monopolists do not seek maximum per-unit profit; they seek maximum total profit [LO12.4, 237].

Can a monopolist experience losses? Explain.

Yes, monopolists can incur short-run losses if demand is weak or costs are high [LO12.4, 237]. However, they will continue to operate as long as their price (Pm) exceeds their average variable cost (AVC) [LO12.4, 237].

Compare the price and output of a pure monopoly to that of a purely competitive industry.

A pure monopolist will produce a smaller output (Qm) and charge a higher price (Pm) than a purely competitive industry would (Qc, Pc) [LO12.5, 237].

How does pure monopoly lead to productive inefficiency?

A pure monopolist's output (Qm) is typically less than the output for minimum Average Total Cost (ATC), and its price (Pm) is higher than minimum ATC [LO12.5, 238]. Thus, the monopolist does not produce in the least costly way [LO12.5, 238].

How does pure monopoly lead to allocative inefficiency?

The monopolist's price (Pm) exceeds marginal cost (MC) [LO12.5, 238]. This means that resources are underallocated to the monopolized product [LO12.5, 238]. For units between the monopoly output (Qm) and the socially optimal output (Qc), the marginal benefit (price) exceeds the marginal cost, resulting in an efficiency loss (deadweight loss) [LO12.5, 238, 400].

Beyond efficiency losses, what is another economic effect of monopoly concerning income?

Monopoly results in an income transfer from consumers to monopoly owners through higher prices, effectively acting as a "private tax" [LO12.5, 239].

What is X-inefficiency and how does it relate to monopoly?

X-inefficiency occurs when a firm produces at a higher cost than necessary [LO12.5, 239]. Monopolies, lacking competitive pressure, may exhibit this, leading to higher costs than a competitive firm with the same technology [LO12.5, 239].

What are rent-seeking expenditures in the context of monopoly?

These are costs incurred by monopolists to acquire or maintain monopoly power, such as lobbying or legal fees [LO12.5, 240]. They add to the firm's costs but do not increase output [LO12.5, 240].

What are the three main policy options for addressing the economic effects of monopoly?

1. Antitrust Laws: Break up monopolies or prohibit anticompetitive actions [LO12.5, 240, LO21.1, 408].

2. Public Regulation: Regulate prices and operations, especially for natural monopolies [LO12.5, 240, LO21.3, 415]. 3. Ignore: If the monopoly is unsustainable due to emerging technology, let creative destruction work [LO12.5, 240, LO11.5, 223].

Define price discrimination.

Price discrimination is the practice of selling a product at more than one price when the differences are not justified by cost differences [LO12.6, 241, 347].

What are the three conditions necessary for a monopolist to engage in price discrimination?

1. Monopoly Power: The firm must have some control over output price [LO12.6, 241].

2. Market Segregation: Must be able to separate buyers into classes with different elasticities of demand (e.g., business vs. students) [LO12.6, 241, 358].

3. No Resale: The product cannot be easily transferred or resold between markets [LO12.6, 241].

Provide two examples of price discrimination.

Airlines (different prices for business vs. leisure travelers), movie theaters (student/senior discounts), coupons, and international trade [LO12.6, 241, 358].

What is the goal of regulating a natural monopoly by imposing a socially optimal price? What is a potential problem with this price?

The socially optimal price is set where Price (P) equals Marginal Cost (MC) (P=MC) [LO12.7, 351], aiming for allocative efficiency [LO12.7, 351]. The problem is that this price may be so low that average total costs are not covered, leading to losses for the monopoly [LO12.7, 351, Figure 12.8].

What is the goal of regulating a natural monopoly by imposing a fair-return price? How does this compare to the socially optimal price?

The fair-return price is set where Price (P) equals Average Total Cost (ATC) (P=ATC) [LO12.7, 351], allowing the monopolist to earn a normal profit and cover all costs [LO12.7, 351]. This price is higher than the socially optimal price (P=MC), meaning output is less than socially optimal, but more than an unregulated monopoly would produce [LO12.7, 351, Figure 12.8].

What is the "dilemma of regulation" for natural monopolies?

The dilemma is that forcing a socially optimal price (P=MC) ensures allocative efficiency but may cause the monopolist to incur losses [LO12.7, 351]. Allowing a fair-return price (P=ATC) avoids losses but does not fully achieve allocative efficiency [LO12.7, 351].