15-1 Why Monopolies Arise

• Monopoly: a firm that is the sole seller of a product without any close substitutes.

• Barriers to entry are the main cause of monopolies. They include monopoly resources, government regulations, and a production process.

Monopoly Resources

• For a monopoly to arise, a single firm must own a key resource. Exclusive ownership of a key resource could also cause a monopoly but this is rare.

• Monopolists acquire more market power than any single firm in a competitive market.

Government-Created Monopolies

• Patents can be used by pharmaceutical companies when a new drug is discovered but they must first apply to the government for a said patent. When the government approves the drug and deems it to be original, the patent is approved and the company is granted exclusive right to manufacture and sell the drug for 20 years.

• Copyrighting can be used by novelists seeking to finalize their novels. This will allow them to ask the government for permission to keep others from printing and selling the author's work without their permission. Copyrighting a novel makes the novelist a monopolist.

Natural Monopolies

• Natural monopoly: a type of monopoly that arises because a single firm can supply a good or service to an entire market at a lower cost than could two or more firms.

• The distribution of water is an example of a natural monopoly.

• As the market expands, natural monopolies have the opportunity to expand into a competitive market.

15-2 How Monopolies Make Production and Pricing Decisions

Monopoly versus Competition

• A competitive firm is small relative to the market that it operates in

• The market demand curve slopes downward in a competitive market but this curve is horizontal at the market price.

A Monopoly's Revenue

• The average revenue is the amount of revenue the firm receives per unit sold.

• The output effect shows that if more output is sold, Q will be higher, causing the total revenue to increase.

• The price effect shows the prices falling, meaning P is lower, so the total revenue decreases.

Profit Maximization

• If the monopoly increases in production, the price on all units sold will fall. The marginal revenue will end up less than the price.

• Competitive firm: P = MR = MC.

• Monopoly firm: P > MR = MC.

• Competitive market prices are equal to the marginal cost, while in monopolized markets, prices exceed the marginal costs.

A Monopoly's Profit

• Profit = TR - TC or (TR/Q - TC/Q) Q or (P-ATC) Q.

• These equations allow us to measure a monopolist's profit.

• When a firm is given a monopoly by a patent over the sale of a drug, the firm charges the monopoly a price that exceeds the marginal cost of making the drug. After the patent on the drug expires, new firms can enter the market, making it a competitive market, resulting in a price drop from the monopoly price to marginal cost.

15-3 The Welfare Cost of Monopolies

The Deadweight Loss

• Social planners focus on the profit earned by the firm's owners, as well as the benefits received by the firm's consumers.

• The socially efficient quantity can be found where the demand curve and the marginal-cost curve intersect.

• The deadweight losses caused due to a monopoly are similar to the deadweight losses that are caused due to taxes.

The Monopoly's Profit: A Social Cost?

• Welfare in monopolized markets includes the welfare of both consumers and producers.

15-4 Price Discrimination

• Price discrimination: the business practice of selling the same good at different prices to different customers.

A Parable about Pricing

• A publisher with a new novel will publish a more expensive hardcover version of the novel and then a cheaper paperback version. The difference in price exceeds the difference in printing costs, allowing the publisher to profit off of this discrimination.

The Moral of the Story

• Price discrimination benefits profit-maximizing monopolists in a rational way, through charging different prices to different customers. This allows the monopolist to earn more profit.

• Price discrimination divides customers based upon who is willing to pay what price.

• Arbitrage is a process where good is bought in one market at a low price but sold to another market at an even higher price to profit off the price difference.

The Analytics of Price Discrimination

• An ideal price discriminatory situation would be when the monopolist is aware of how much each customer is willing to pay and can charge each customer differently.

Examples of Price Discrimination

• Children and senior citizens are charged lower prices in movie theaters.

• Airplane seats are sold at different prices to separate business travelers from leisure ones.

• Discount coupons are offered in newspapers, magazines, or online to the public.

• Colleges and Universities give financial aid to students in need. Wealthy students often have better access to financial resources.

15-5 Public Policy toward Monopolies

Increasing Competition with Antitrust Laws

• Horizontal mergers are mergers between two firms in the same market.

  • Ex. Coca-Cola and PepsiCo.

• Vertical mergers are mergers between firms at different stages of the production process.

• The Sherman Antitrust Act was passed by Congress in 1890, reducing the market power of dominating trusts at that time.

• The Clayton Antitrust Act was passed in 1914, causing the government's powers to grow and authorizing private lawsuits.

Regulation

• Regulating a monopolist's behavior allows the government to deal with problems that come with monopolies.

• One problem with marginal-cost pricing arises from the logic of cost curves, while the other issue is that monopolists receive no incentive to reduce costs.

Public Ownership

• The government uses public ownership to handle monopolies, allowing them to publicly run the monopoly themselves.

• Economists typically prefer private ownership of natural monopolies over the public, as private owners have an incentive to minimize costs.

Doing Nothing

• A competitive enterprise economy will produce the largest possible income from a given stock of resources.

15-6 Conclusion: The Prevalence of Monopolies

• Firms usually can control the prices they charge and are not forced to change them. These goods in firms form a downward-sloping demand curve, giving each producer some sort of monopoly power.