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Monopoly
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- 2. The Four MarketStructures
- 3. Monopolies • One firmproduces all of the output in a market • We study monopolies for two reasons: 1. Some firms truly are monopolists • Important to understand their behavior 2. Firms might collude in order to act like a monopolist • Helps us to identify these firms
- 4. Monopolies • Do theyexist? • Suppose you live in a town with only one coffee shop. • Is that coffee shop a monopoly? • Competition from grocery stores • (sell coffee you make at home) • Competition from other stores that sale coffee • (e.g., gas stations, donut shop) • Close substitutes? • Yes is not a monopoly • No is a monopoly • The coffee shop may have some monopoly power • Raise prices • Earn economic profit
- 5. Monopolies: Barriers toEntry • Barriers to entry lead to monopolies • Legal, technological, or market forces that discourage/prevent potential competitors from entering a market • Some reasons for barriers to entry 1. Government restrictions on entry a) Patents & copyrights b) Public franchises 2. Control of a key resource 3. Natural monopolies
- 6. Government Restrictions onEntry • Exclusive production rights for a period of time • Patents • Newly developed products (e.g., drugs) • 20 years from date patent filed with government • Copyrights • Creative works (e.g., books and films) • Encourage innovation and creativity • Allows firms to profit from their endeavors • Without these rights, other producers will profit • Greatly reduces incentive to innovate/create
- 7. Government Restrictions onEntry • Public franchise • Government designates the firm is only legal provider of a good/service • Example: electricity or water markets • Government may operate these firms as a public enterprise • Example: US Postal Service
- 8. Control of aKey Resource • National Football League (NFL) acts as a monopoly • Majority of world’s best football players under contract to the NFL • Unable to be used for another (potential) league • Control over key resource is a substantial barrier to entry for competitors
- 9. Natural Monopoly • Economiesof scale large enough that 1 firm can supply market at lower ATC than 2+ firms • Most likely when FC are high • Examples • Electricity • Water
- 10. Monopoly Decisions • Maximizeprofit • Choose Q • How much does a monopolist produce? • 𝑀𝑅 = 𝑀𝐶 • What price will a monopolist charge? • Monopolists can set the price • Market demand constrains the price • Charge price corresponding to market demand at profit-maximizingQ
- 11. Monopoly Decisions Subscribers per Month (Q) Price (P) TR ARMR 0 $60 $0 --- --- 1 57 57 $57 $57 2 54 108 54 51 3 51 153 51 45 4 48 192 48 39 5 45 225 45 33 6 42 252 42 27 7 39 273 39 21 8 36 288 36 15 9 33 297 33 9 10 30 300 30 3 ConsiderTimeWarner Cable • Monopolist in a local, cable television market • First two columns represent market demand (…andTWC’s demand) • 𝑇𝑅, 𝐴𝑅, and 𝑀𝑅 calculated as usual Notice, 𝑃 = 𝐴𝑅 ≠ 𝑀𝑅 • Furthermore, MR is always below demand for a monopolist
- 12. Monopoly Decisions Monopolist maximizesprofit by producing the quantity where 𝑀𝐶 = 𝑀𝑅
- 13. Monopoly Decisions At thisquantity, the demand curve determines price Profit = 𝑃 − 𝐴𝑇𝐶 × 𝑄
- 14. Monopoly: LR Profits •Barriers to entry additional firms cannot enter the market • Thus, no distinction between the SR and LR for a monopoly • Expect monopolists to continue earning profits in the LR
- 15. Monopoly Decisions: PracticeProblem • A monopolist has the costs and faces the demand provided in this table. • At what level of output will the monopolist maximize profits? • What is the monopolist’s profit at that level of output? P ($) Q TC ($) TR ($) MC ($) MR ($) 10.00 0 8.00 0.00 --- --- 9.00 1 13.00 9.00 5.00 9.00 8.00 2 16.00 16.00 3.00 7.00 7.00 3 18.00 21.00 2.00 5.00 6.00 4 19.00 24.00 1.00 3.00 5.00 5 21.00 25.00 2.00 1.00 4.00 6 24.00 24.00 3.00 -1.00 3.00 7 28.00 21.00 4.00 -3.00 2.00 8 33.00 16.00 5.00 -5.00
- 16. Monopoly & Efficiency •Thought experiment • Suppose the smartphone market is perfectly competitive • Now, one firm buys up all of the smartphones in the country • What would happen to: • Price of smartphones? • Quantity of smartphones traded? • The net benefit of consumers? (i.e. consumer surplus) • The net benefit of producers? (i.e. producer surplus) • The net benefit of all of society? (i.e. economic surplus)
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- 19. Monopoly & Efficiency •What would happen to: • Price of smartphones? • Increases • Quantity of smartphones traded? • Decreases • Fewer smartphones will be traded at a higher price. • What would happen to: • Consumer surplus? • Higher price CS will fall • Producer surplus? • Must increase • Economic surplus? • Fewer trades ES must fall Suppose the smartphone market is perfectly competitive. Now, one firm buys up all of the smartphones in the country
- 20. Monopoly & Efficiency •At 𝑃𝑀… • CS decreases by the areas A+B • PS falls by C, but rises by A; an overall increase • Area A is simply a transfer of surplus • Neither inherently good nor bad • But areas B and C are lost surpluses • DWL inefficiency
- 21. Monopoly & Efficiency •How large are the efficiency losses? • Relatively few monopolies • Efficiency losses must be relatively small • Many firms have market power • Ability to charge 𝑃 > 𝑀𝐶 • Only perfectly competitive firms do not • Estimates: • Efficiency loss in US due to market power likely less than 1% of total US production • About $500/person annual • Why so small? • Most firms face relatively large degree of competition • 𝑃 closer to 𝑀𝐶 than with monopolies • DWL due to market power relatively small
- 22. Monopoly & Efficiency •Market power may produce some benefit for an economy • Prospect of market power (and resulting economic profits) innovation • New goods/services • Incentive affects both… • Large firms: reinvest profits in the hope of making larger future profits • Small firms: hope to obtain profits for themselves • Austrian economist Joseph Schumpeter claimed… • This drive would create “gale of creative destruction” that would eventually benefit consumers more than increased price competition • Helps explain governmental ambivalence regarding large firms with market power