Pure Monopoly Study Notes

Pure Monopoly Characteristics

Pure monopoly exists when a single firm is the sole producer of a product with no close substitutes.

  • Single Seller: A single firm is the sole producer, making the firm and industry synonymous.
  • No Close Substitutes: The product is unique with no close alternatives.
  • Pricemaker: The monopolist controls the quantity supplied and has considerable control over price, unlike a price taker in pure competition.
  • Blocked Entry: Barriers prevent potential competitors from entering the industry.
  • Nonprice Competition: Products can be standardized or differentiated. Standardized products rely on public relations advertising, while differentiated products advertise specific attributes.

Examples of Monopoly

Pure monopolies are rare, but near-monopolies exist where a single firm dominates a market.

  • Public Utilities: Government-owned or regulated utilities like natural gas, electricity, water, and cable TV companies.
  • Near-Monopolies: Firms with a large market share, e.g., Intel (microprocessors), Illumina (gene-sequencing machines), and Google (Android OS).
  • Professional Sports Teams: Sole suppliers of specific services in large geographic areas.
  • Geographic Monopolies: Single providers in small towns (e.g., airlines, barber shops).
  • Competition: Substitutes exist, but they are often more costly or less appealing (e.g., Starlink for internet, Linux for Windows, amateur softball for professional baseball).

Barriers to Entry

Barriers to entry prevent firms from entering an industry.

  • Strong barriers lead to pure monopoly.
  • Weaker barriers may lead to oligopoly (few firms).
  • Still weaker barriers may lead to monopolistic competition (many firms).
  • Absence of barriers leads to pure competition (very large number of firms).

Five Prominent Barriers to Entry

Economies of Scale

Modern technology allows extensive economies of scale, where average total cost (ATC) declines with added firm size.

  • Only a few large firms or a single large firm can achieve low average total costs.
    ATC=TotalCostQuantityATC = \frac{Total Cost}{Quantity}
  • Example: A monopolist produces 200 units at a per-unit cost of $10, totaling $2,000. Two firms producing 100 units each have a unit cost of $15 and a total cost of $3,000. Four firms producing 50 units each have a unit cost of $20 and a total cost of $4,000.
  • Conclusion: When long-run ATC is declining, a monopolist can produce at the lowest total cost per unit.
Natural Monopoly

A monopoly firm is a natural monopoly if the market demand curve intersects the long-run ATC curve at a point where average total costs are declining.

  • A natural monopoly may set prices higher than if the industry were competitive, potentially leading to government regulation.
Network Effects

Network effects occur when the value of a product increases as more people use it.

  • Example: Social networking apps like Snapchat. The value of the network increases as more people interact with it.
  • Industries with network effects tend toward monopoly because customers join networks with the most users, leaving smaller networks to decline.
  • Network effects create barriers to entry because startups struggle to compete with established firms that have billions of users.
  • First-mover advantage: Early firms in industries with network effects gain substantial monopoly power.
Legal Barriers to Entry: Patents and Licenses

Government creates legal barriers through patents and licenses.

  • Patents: Exclusive right to use an invention, protecting the inventor from rivals.
    PatentLength=20 years from applicationPatent Length = 20 \text{ years from application}
  • Patents encourage R&D and can lead to self-sustaining monopoly power.
  • Licenses: Government limits entry into industries or occupations through licensing (e.g., radio and TV stations).
Ownership or Control of Essential Resources

A firm that controls a resource essential to production can prevent rival firms from entering.

Pricing and Other Strategic Barriers to Entry

Monopolists may deter entry by:

  • Slashing prices.
  • Increasing advertising.
  • Other strategic actions.

Examples

  • American Express was found guilty of unlawful restraint of trade for prohibiting merchants from promoting rival credit cards.
  • Endo Pharmaceuticals bribed Impax Laboratories to prevent the production of a generic rival for Opana ER.

Monopoly Demand

Model assumptions for analyzing monopoly price and output decisions:

  • Patents, economies of scale, network effects, or resource ownership secure the firm's monopoly.
  • No government regulation.
  • The firm is a single-price monopolist, charging the same price for all units of output.

Demand Curve

The pure monopolist's demand curve is the market demand curve, which is downward sloping.

  • Quantity demanded increases as price decreases (Table 11.1).
  • Unlike purely competitive seller who is a price taker.

Marginal Revenue Is Less Than Price

  • The monopolist can increase sales only by charging a lower price.
  • Marginal revenue (MR) is less than price (average revenue) for every unit except the first.

Monopolist as Pricemaker

Imperfect competitors, including monopolists, oligopolists, and monopolistic competitors, face downward-sloping demand curves.

  • They are pricemakers who control output and