ECON 202 Chapter 22 Pure Monopoly Pure Monopoly Exists when a single firm is the sole producer of a product for which there are no close substitutes. There are a number of products where the producers have a substantial amount of monopoly power and are called near monopolies. Pure Monopoly Characteristics Single seller One firm is the sole producer of a specific good or service. Firm and industry are synonymous. No close substitutes for the firm s product. Those who don t buy do without. Firm is a price maker, that is, the firm has control over the price because it controls quantity supplied. 1
Pure Monopoly More Characteristics Blocked Entry into the industry. (economic, technical, legal, barriers, etc.) Non Price Competition A monopolist may or may not engage in non price competition. Depending on the nature of its product, a monopolist may advertise. Examples of pure monopolies and near monopolies : Public utilities gas, electric, water, cable TV, and local telephone service companies are pure monopolies. First Data Resources (Western Union), and the DeBeers diamond syndicate are examples of near monopolies. (See Last Word.) More Examples Professional sports leagues are sole providers of specific service in large area (Braves in the South). Monopolies may be geographic. g A small town may have only one airline, bank, etc. Manufacturing monopolies are virtually nonexistent in nationwide U.S. manufacturing industries. 2
Barriers to Entry Limiting Competition Barriers to entry factors that prohibit firms from entering an industry. Economies of scale constitute one major barrier. This occurs where the lowest unit costs and, therefore, lowest unit prices for consumers depend on the existence of a small number of large firms or, in the case of a pure monopoly, only one firm. Economies of Scale Because a very large firm with a large market share is most efficient, new firms can t afford to start up in industries with economies of scale. The explanation of why more than one firm would be inefficient involves the description of the maze of pipes or wires that would result if there were competition among water companies, electric utility companies, etc. Economies of Scale Government usually gives one firm the right to operate a public utility industry in exchange for government regulation of its power. Public utilities are often natural monopolies because they have economies of scale in the extreme case where one firm is most efficient in satisfying existing demand. 3
Legal Barriers to Entry Patents grant the inventor the exclusive right to produce or license a product (20 years); this exclusive right can earn profits for future research, which results in more patents and monopoly profits. Licenses Radio and TV stations (issued by: FCC), taxi companies are examples of government granting licenses where only one or a few firms are allowed to offer the service. Ownership or control of essential resources is another barrier to entry. International Nickel Co. of Canada (now called Inco) controlled about 90 percent of the world s nickel reserves, and DeBeers of South Africa controls most of the world s diamond supplies (see Last Word). Ownership Barrier to entry Aluminum Co. of America once controlled all basic sources of bauxite, the ore used in aluminum fabrication. Professional sports leagues control player contracts and leases on major city stadiums. 4
Monopolists use pricing or other strategic barriers such as selective price cutting and advertising. Dentsply, manufacturer of false teeth, controlled about 70 percent of the market. In 2005 Dentsply was found to have illegally prevented distributors from carrying competing brands. Microsoft charged higher prices for its Windows operating system to computer manufacturers featuring Netscape Navigator instead of Microsoft s Internet Explorer. U.S. courts ruled this action illegal. Monopoly demand is the industry (market) demand and is therefore downward sloping. Analysis of monopoly demand makes three assumptions: 1. The monopoly is secured by patents, economies of scale, or resource ownership. 2. The firm is not regulated by any unit of government. 3. The firm is a single price monopolist; it charges the same price for all units of output. The monopolist is a price maker. The firm controls output and price but is not free of market forces, since the combination of output and price that can be sold depends on demand. Firms with downward sloping demand curves are Price Makers. 5
So can they sell too much?? Every time they sell 1 more unit, the extra profit they make goes down. So increasing output means their total cost goes up, and their profits go down. To maximize their profit, they need to find the point where their marginal revenue (MR) is equal to their marginal cost (MC). Or, compare TR to TC at every level of production and pick the level that gives the most profit. Output and Price Determination The pure monopolist has no supply curve. There is no unique relationship between price and quantity supplied for a monopolist. Misconceptions about monopoly prices Monopolist cannot charge the highest price it can get, because it will maximize profits where total revenue minus total cost is greatest. This depends on quantity sold as well as on price and will never be the highest price possible. Total, not unit, profits is the goal of the monopolist. Unlike the purely competitive firm, the pure monopolist can continue to receive economic profits in the long run. 6
Misconceptions about monopoly prices Although Monopolists likely make greater profits than they would in pure competition, they are not guaranteed a profit. They are not immune to changes in tastes, economic effects, escalating resource prices, etc. Faced with continuing loses, monopolists will choose to do something else with their resources. Economic effects of monopolies Monopolies don t operate at maximum efficiency in regard to resources and production. They pick the level where they can make the most money. So usually monopolies result in an underallocation of resources. Restricting output and charging higher prices than society would expect is what usually makes people upset. Economic effects of monopolies Income distribution is more unequal than it would be under a more competitive situation. The effect of the monopoly power is to transfer income from the consumers to the business owners. This will result in a redistribution of income in favor of higherincome business owners, unless the buyers of monopoly products are wealthier than the monopoly owners. 7
Cost complications may lead to other conclusions. Economies of scale Where there are huge economies of scale, market demand may not be big enough to support a large number of companies, so a monopoly might be the only way to provide the product to consumers. Inefficiency may occur in monopoly since there is no competitive pressure to produce at the minimum possible costs. Cost complications may lead to other conclusions. Rent seeking behavior often occurs as monopolies seek to acquire or maintain government granted monopoly privileges. There is a great desire by firms to obtain these privileges because of the long term profits available. Technological progress and dynamic efficiency may occur in some monopolistic industries but not in others. Some monopolies show little interest in technological progress. On the other hand, research can lead to lower unit costs, which help monopolies as much as any other type of firm. Also, research can help the monopoly maintain its barriers to entry against new firms. 8
Assessment and Policy Options: Monopoly power is not widespread, although there are legitimate concerns of the effects of monopoly power on the economy. While research and technology may strengthen monopoly power, overtime it is likely to destroy monopoly position. When monopoly power is resulting in an adverse effect upon the economy, the government may choose to intervene on a case by case basis. Price Discrimination Can Take 3 forms: 1.Charging each customer in a single market the maximum price he or she is willing to pay. 2.Charging each customer one price for the first set of units purchased, and a lower price for subsequent units. 3.Charging one group of customers one price, and another group a different price. Conditions needed for successful price discrimination: Monopoly power is needed with the ability to control output and price. The firm must have the ability to segregate the market, to divide buyers into separate classes that have a different willingness or ability to pay for the product (usually based on differing elasticities of demand). Buyers must be unable to resell the original product or service. 9
Examples of price discrimination: Airlines charge high fares to executive travelers (inelastic demand) than vacation travelers (elastic demand). Electric utilities frequently segment their markets by end uses, such as lighting and heating. (Lack of substitutes for lighting makes this demand inelastic). More examples Price Discrimination Long distance phone service has higher rates during the day, when businesses must make their calls (inelastic demand), and lower rates at night and on week ends, when less important calls are made. Movie theaters and golf courses vary their charges on the basis of time and age. International trade has examples of firms selling at different prices to customers in different countries. Legal? Price discrimination is common, and only illegal when the firm is using it to lessen or eliminate competition. 10
Regulated Monopoly Occurs where a natural monopoly or economies of scale make one firm desirable. As a result of changes in technology and deregulation in the local telephone and the electricity providers industry, some states are allowingnew new entrants to compete in previously regulated markets (pg 439) In those markets that are still regulated, a regulatory commission may attempt to establish the legal price for the monopolist that is equal to marginal cost at the quantity of output chosen. This is called the socially optimal price. (See Figure 22.9) End Chapter 22 11