Monopoly Notes

Monopoly

A monopoly firm is the sole seller of its product, which has no close substitutes.
Microsoft's Windows operating system is an example of a monopoly.
A monopoly firm is a price maker, unlike a competitive firm, which is a price taker.
This chapter examines the implications of market power held by monopolies.

The fundamental cause of monopoly is barriers to entry, preventing other firms from competing.
Three main sources of barriers to entry:
- A key resource is owned by a single firm.
- The government gives a single firm the exclusive right to produce a good or service.
- The costs of production make a single producer more efficient than a large number of producers.

A single firm owning a key resource can lead to a monopoly.
Example: a single well in a town with no other water source.
In practice, monopolies rarely arise solely from the ownership of a key resource due to the size of economies and the global trade of resources.

Governments grant exclusive rights to firms to sell certain goods or services.
This may arise from political influence or when it's deemed in the public interest.
Examples:
- Network Solutions, Inc., which maintains the database of internet addresses.
- Patent and copyright laws.

Patent laws give a company the exclusive right to manufacture and sell a drug for 20 years.
Copyright laws guarantee that no one can print and sell an author's work without permission.
These laws lead to higher prices but encourage desirable behavior like pharmaceutical research and writing.
The benefits of patents and copyrights are the increased incentive for creative activity.
These benefits are offset, to some extent, by the costs of monopoly pricing.

A natural monopoly occurs when a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms.
This arises when there are economies of scale over the relevant range of output.
Example: the distribution of water, where a firm must build a network of pipes throughout the town.
The average total cost is lowest if a single firm serves the entire market.
Bridges are excludable because a toll collector can prevent someone from using them.
Bridges are not rival because use of the bridge by one person does not diminish the ability of others to use it.
Fixed cost of building a bridge and a negligible marginal cost of additional users, the average total cost of a trip across the bridge falls as the number of trips rises.

A key difference between a competitive firm and a monopoly is the monopoly’s ability to influence the price of its output.
A competitive firm takes the price as given by market conditions, while a monopoly can alter the price by adjusting the quantity supplied.
Demand curve:
- Competitive firm: faces a horizontal demand curve because it can sell as much or as little as it wants at the market price.
- Monopoly: faces the downward-sloping market demand curve.

Total revenue is calculated as price P times quantity Q.
Average revenue is the revenue per unit sold, which equals the price of the good.
Marginal revenue is the change in total revenue from selling one more unit.
Marginal revenue is always less than the price for a monopoly.
When a monopoly increases the amount it sells, it has two effects on total revenue (P Imes Q).
- Output effect: More output is sold, so Q is higher.
- Price effect: The price falls, so P is lower.
For a competitive firm, marginal revenue equals the price of its good because there is no price effect.

Monopolies maximize profit by producing the quantity where marginal revenue equals marginal cost.
For a competitive firm: P = MR = MC.
For a monopoly firm: P > MR = MC.
To find the profit-maximizing price, the monopoly uses the demand curve to determine the amount customers are willing to pay for that quantity.
A monopoly does not have a supply curve because it is a price maker, not a price taker.
The shape of the demand curve determines the shape of the marginal-revenue curve which in turn determines the monopolist’s profit-maximizing quantity.

Profit equals total revenue (TR) minus total costs (TC): Profit = TR - TC.
Rewrite as: Profit = (TR/Q - TC/Q) Imes Q.
TR/Q is average revenue, which equals the price P, and TC/Q is average total cost ATC.
Therefore, Profit = (P - ATC) Imes Q.

Monopolies charge a price above marginal cost, which is undesirable for consumers.
However, the monopoly earns profit from this high price, which is desirable for the firm's owners.

A benevolent social planner would maximize total surplus, which equals producer surplus (profit) plus consumer surplus.
The socially efficient quantity is found where the demand curve and the marginal-cost curve intersect.
A social planner would charge a price equal to marginal cost.
The monopolist produces less than the socially efficient quantity of output.
The inefficiency of monopoly can be viewed in terms of the monopolist’s price.
Monopoly pricing prevents some mutually beneficial trades from taking place causing a deadweight loss.
The deadweight loss caused by monopoly is similar to the deadweight loss caused by a tax.
A monopolist is like a private tax collector.

The firm’s profit is not in itself necessarily a problem for society.
The monopoly profit itself does not represent a shrinkage in the size of the economic pie.
The problem stems from the inefficiently low quantity of output.

Policymakers can respond to the problem of monopoly in four ways:
- Trying to make monopolized industries more competitive with antitrust laws.
- Regulating the behavior of the monopolies.
- Turning some private monopolies into public enterprises.
- Doing nothing at all.

If regulators are to set price equal to marginal cost, that price will be less than the firm’s average total cost, and the firm will lose money.
Regulators can respond to this problem in various ways, none of which is perfect.
One way is to subsidize the monopolist.

Rather than regulating a natural monopoly that is run by a private firm, the government can run the monopoly itself.

Some economists argue that it is often best for the government not to try to remedy the inefficiencies of monopoly pricing.

Price discrimination is the business practice of selling the same good at different prices to different customers.
Price discrimination is not possible when a good is sold in a competitive market.

Perfect price discrimination describes a situation in which the monopolist knows exactly the willingness to pay of each customer and can charge each customer a different price.
Perfect price discrimination raises profit, raises total surplus, and lowers consumer surplus.