Monopoly Notes

Monopoly

Monopoly Characteristics

  • One Supplier: A single firm controls the entire supply of a good or service.
  • No Close Substitutes: There are no readily available alternatives for consumers.
  • Barriers to Entry: Significant obstacles prevent other firms from entering the market if economic profits exist.
  • Imperfect Information: Not all market participants have the same information.

Barriers to Entry

A constraint that stops other firms from entering the market to compete.

Three Types of Barriers to Entry

  1. Natural: Rare occurrence where one firm can supply the entire market at the lowest possible cost.
  2. Ownership: Rare situation where one firm owns "all" of a key resource.
  3. Legal: Most common, where government regulations restrict competition.

Natural Monopoly

A market where economies of scale allow one firm to supply the entire market at the lowest possible cost. The Long Run Average Cost (LRAC) curve is still sloping downward when it meets the demand curve.

  • Example: One firm can produce 6 million units at 5 cents per unit, while two firms producing 3 million units each would incur a cost of 10 cents per unit.

Ownership Monopoly

Occurs when one firm owns a significant portion of a key resource.

*De Beers Example:

  • At one point, De Beers controlled 90% of the world's diamond supply.
  • New discoveries in Russia, Australia, and Canada made it harder to maintain control.
  • Currently, De Beers controls ≈27% of the market.

Recent trends indicate the rise of lab-grown diamonds are impacting the demand for natural diamonds reducing prices by >40% (Thomas Biesheuvel and Bloomberg, September 3, 2023).

Rare Earth Metals

  • China was the primary source since the late 1990s, but production is diversifying.
  • Rare earth elements are 17 minerals essential for modern technologies.

Production data:

  • In 2010, China produced 92% of the world's rare earth oxides.
  • By 2020, China's share decreased to 58%.
  • The U.S. Mountain Pass Mine ceased large-scale operations in 1998 and shut down completely in 2002 due to environmental concerns and Chinese competition.

Legal Monopoly

Competition is restricted by government law.

  • Public Franchise: e.g., U.S. Postal Service for first-class mail.
  • Government License: e.g., license to practice law or medicine.
  • Patent or Copyright

Monopoly Price Strategies

A monopoly determines both the quantity it sells and the price (price setter, not a price taker).

Two Price-Setting Strategies

  • Single-Price Monopoly: Sells each unit of output for the same price to all customers.
  • Price Discrimination: Selling different units of a good/service for different prices.

Monopoly Output & Price

  • If a firm cuts the price from 16 to 14, sales increase from 2 to 3 units.
  • The firm loses 4 of total revenue on the initial 2 units and gains 14 on the 3rd unit.
  • Total revenue increases by 10 (marginal revenue = 10).
  • The marginal revenue curve (MR) is below the demand curve (MR < P at each quantity).

Profit Maximization

A monopoly selects the profit-maximizing quantity where Marginal Revenue (MR) equals Marginal Cost (MC) and sets the price accordingly.

  • Process: Produce where MR = MC, then set the price at the highest level for which that quantity can be sold.

*A firm produces an output where MR = MC, then sets the price at the highest price for which it can sell that quantity. This combination of output (3) and price (22) maximizes economic profit (30).

Economic Profit

  • The monopoly produces the quantity that maximizes profit, where total revenue minus total cost is the greatest.
  • A monopoly can sustain economic profit in the long run due to barriers to entry.

Monopoly vs. Perfect Competition

  • Perfect Competition: Equilibrium where quantity demanded equals quantity supplied.
    • Example: Quantity = 5, Price = 12, EP = 0
  • Monopoly: Equilibrium where marginal revenue equals marginal cost.
    • Example: Quantity = 3, Price = 22, EP = 30
  • Comparison: Monopoly results in a higher price and lower output compared to perfect competition.

Efficiency & Deadweight Loss

  • Perfect Competition is Efficient
    • The market demand curve is the marginal social benefit curve.
    • The market supply curve the marginal social cost curve.
    • Equilibrium occurs where Marginal Social Benefit (MSB) equals Marginal Social Cost (MSC).
    • Gains from trade are maximized, and resources are used efficiently.
  • Monopoly is Inefficient:
    • Produces a smaller output at a higher price.
    • Causes a deadweight loss because some output that could be produced efficiently is not.
    • A deadweight loss arises, lost consumer surplus. Some consumer surplus is converted to producer surplus - economic profit.

Price Discrimination

Selling the same product at different prices to different people.

  • Firms identify and separate different buyers and sell a product that cannot be resold.
  • Examples:
    • Groups of buyers (students, seniors, early birds).
    • Quantity discounts.

Effects of Price Discrimination

  • Monopolies charge some customers a higher price, as some will pay more than others.
  • Price discrimination allows a monopoly to convert consumer surplus into economic profit.
  • The more perfectly a monopoly can price discriminate, the closer its output is to the competitive output (P = MC), eliminating deadweight loss, but it converts consumer surplus to economic profit.

Rent Seeking

Any surplus—consumer surplus, producer surplus, or economic profit—is called an economic rent, and rent-seeking is the pursuit of monopoly as a way to capture economic rent (long-run economic profit).

  • Rent-seekers try to create a monopoly by using resources in political activity to establish barriers to entry.
  • Examples:
    • Only Automobile Dealers can sell cars.
    • Only Real Estate Agents can sell houses.
  • Rent-seekers make political contributions, hire lobbyists, trade favors, and campaign for/against legislation.

Inefficiency of Rent Seeking

  • Resources used in rent-seeking can eliminate the monopoly’s economic profits.
  • Rent-seeking increases the average total costs.

Natural Monopoly Regulation

  • Problem: Determining the price a regulator should set (marginal cost, average cost, or something else).
  • Most natural monopolies are regulated with rate-of-return regulations (price = costs + %profit).
  • Firms have an incentive to inflate costs.
  • Monopoly regulation is complex, difficult, and often fails.

Antitrust Laws

  • In the United States, it is against the law to be a monopoly or engage in anti-competitive practices.

Key Antitrust Laws

  • 1890: Sherman Antitrust Act
  • 1914: Clayton Act
  • 1936: Robinson-Patman Act
  • 1950: Celler-Kefauver Act

Measures of Market Concentration

  • Four-Firm Concentration Ratio: Percentage of total industry sales by the four largest firms.
  • Herfindahl-Hirschman Index (HHI): Sum of the squares of percentage market shares of the largest 50 firms.

Assumption: More concentration = less competition

  • Sellers cannot collude, agree not to compete, or set prices together.

Google Antitrust Case

The government argues that Google's conduct has created an uneven playing field, and its quality reflects illegally acquired advantages.

The remedy should close this gap and deprive Google of these advantages.

  • Judge Mehta asked the Justice Department and the states that brought the antitrust case to submit solutions to correct the search monopoly.
  • Suggested remedies include:
    • Selling Chrome.
    • Selling Android.
    • Banning Google from making its services mandatory on phones that use Android.
    • Stopping Google from entering paid agreements with Apple to be the default search engine.
    • Requiring Google to allow rival search engines to display the company’s results and access its data for a decade.

Monopoly Summary

  1. One Seller
  2. No Substitutes
  3. Barriers to Entry Exist
  4. Imperfect Info
    • Types/Barriers Natural, Ownership, Legal (most common)
    • Firm Demand Curve is Downward Sloping (MR < Demand)
    • Monopoly Firms decide Output + PRICE
    • OUTPUT is where MC = MR; PRICE is Highest that people will pay for that quantity
    • In the Long Run, there are ECONOMIC PROFITS because barriers to entry block entry of competition
    • Monopoly is Inefficient, because it creates a lesser output and higher prices than competition
    • Firms “Rent Seek” - spend money to obtain legal monopoly
    • Antitrust - Laws against monopoly and anti-competitive practices
    • Regulating monopolies is difficult, and often fails