Chapter24 puremonopoly

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 substantial amount
of monopoly power, and they are called
“near” monopolies.

CHARACTERISTICS OF
PURE MONOPOLY
1. There is a single seller so that firm and
industry are synonymous.
2. There are no close substitutes for the
firm’s product.
3. The firm is a “price maker” (it has
considerable control over the price
because it can control the quantity
supplied.

CHARACTERISTICS OF
PURE MONOPOLY
4. Entry into the industry by other firms is
blocked.
5. A monopolist may or may not engage in
non-price competition. Depending on
the nature of its product, a monopolist
may advertise to increase demand.

EXAMPLES OF
MONOPOLIES AND “NEAR”
MONOPOLIES
1. Public utilities – gas, electric, water,
cable TV, and telephone companies –
are pure monopolies.
2. Western Union, Frisbees, and DeBeers
diamond syndicate are examples of
“near” monopolies.
3. Professional sports leagues grant team
monopolies to cities.

EXAMPLES OF
MONOPOLIES AND “NEAR”
MONOPOLIES
4. Manufacturing monopolies are virtually
non-existent in the U.S. manufacturing
industries.
5. Monopolies may be geographic. If a
town is small, it may have only one
bank, airline, etc.

USING THE MONOPOLY
MODEL

As with pure competition, analysis of
monopolies helps us understand
monopolistic competition and oligopoly, the
more common types of market situations.

BARRIERS TO ENTRY
1. Economies of Scale
2. Legal barriers
3. Ownership or control of essential
resources
4. Pricing, selective price-cutting, and
advertising.

ECONOMIES OF SCALE
 Economies of scale are one major
barrier. This occurs where the lowest
unit costs, and therefore, the lowest unit
prices for consumers, depend on the
existence of a small number of large
firms, or in the case of a monopoly, only
one firm. Because a large firm with a
large market share is most efficient, new
firms cannot afford to start up in
industries with economies of scale.

ECONOMIES OF SCALE
1. Public utilities are know as natural
monopolies because they have
economies of scale in the extreme case
where one firm is most efficient in
satisfying existent demand.
2. Government usually gives one firm the
right to operate a public utility industry
in exchange for government regulation
of its power.

ECONOMIES OF SCALE
3. The explanation of why more than one
firm would be inefficient involves the
description of the maze of wires or
pipes that would result if there were
competition among water companies,
electricity utility companies, etc.

LEGAL BARRIERS
 Legal barriers to entry into a monopolist
industry also exist in the form of patents or
licenses.
1. Patents grant the inventor the exclusive
right to produce or license a product for 20
years; this exclusive right can earn profits
for future research, which results in more
patents and monopoly profits.
2. Licenses are another form of barrier.
Radio and TV stations, taxi companies are
examples of government granting a set
number of licenses to allow only a set
number of firms to offer the service.

OWNERSHIP OF
RESOURCES
 Ownership or control of essential
resources is another barrier to entry.
1. A monopoly may control mineral
reserves, such as nickel or diamonds.
2. Alcoa once controlled all basic
resources of bauxite, the ore used to
produce aluminum.
3. Professional sports leagues control
player contracts and leases on city
stadiums.

PRICING
 Monopolists may use pricing or other
strategic barriers, such as selective
price-cutting and adverstising.

3 ASSUMPTIONS OF
MONOPOLY DEMAND
 3 assumptions in monopoly demand:
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 price will exceed marginal revenue.

WHY DOES PRICE EXCEED
MARGINAL REVENUE?
 The price exceeds marginal revenue
because the monopolist must lower the
price to sell the additional unit. The added
revenue will be the price of the last unit
minus the sum of the price cuts which must
be taken on all prior units of output.
 The marginal-revenue curve is below the
demand curve, and when it becomes
negative, the total-revenue curve turns
downward as total-revenue falls.

MONOPOLIST IS A PRICE
MAKER
 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.

MONOPOLY DEMAND
AND ELASTICITY
 Price elasticity also plays a role in
monopoly price setting.
 The total revenue test shows that the
monopolists will avoid the inelastic
segment of its demand schedule. As long
as demand is elastic, total revenue will rise
when the monopoly lowers its price, but
this will not be true when demand becomes
inelastic.
 Therefore, the monopolist will expand
output only in the elastic portion of its
demand curve.

MONOPOLY DEMAND
AND ELASTICITY
 At the point when demand becomes
inelastic, total revenue falls as output
expands, and since total costs rise with
output, profits will decline as demand
becomes inelastic.
 Therefore, the monopolist will expand
output only in the elastic portion of its
demand curve.

OUTPUT AND PRICE
DETERMINATION
 Cost data is based on hiring resources
in competitive markets.
 The MR = MC rule will tell the
monopolist where to find its profit-
maximizing output level. The same
outcome can be determined by
comparing total revenue and total costs
incurred at each level of production.

OUTPUT AND PRICE
DETERMINATION
 The pure monopolist has no supply
curve because there is no unique
relationship between price and quantity
supplied. The price and quantity
supplied will always depend on location
of the demand curve.

MISCONCEPTIONS ABOUT
MONOPOLY PRICES
1. Monopolists cannot charge the highest
price it can get, because it will
maximize profits where total revenue
minus total cost is the greatest. This
depends on quantity sold as well as on
price and will never be the highest price
possible.

MISCONCEPTIONS ABOUT
MONOPOLY PRICES
2. Total, not units, profits is the goal of the
monopolist. Quantity must be
considered as well as unit profit.
3. Unlike the purely competitive firm, the
pure monopolist can continue to receive
economic profits in the long run.
Although losses can occur in a pure
monopoly in the short run (P ATC), the
less-than-profitable monopolist will shut
down in the long run.

ECONOMIC EFFECTS
OF A MONOPOLY
2. Monopoly price will exceed marginal
cost, because it exceeds marginal
revenue and the monopolist produces
where marginal revenue and marginal
cost are equal. The monopolist
charges the price that consumers will
pay for that output level.

ECONOMIC EFFECTS
OF A MONOPOLY
3. Allocative efficiency is not achieved
because price (what the product is
worth to consumers) is above marginal
cost (opportunity cost of the product).
Ideally, output should expand to a level
where price = marginal revenue =
marginal cost, but this will occur only
under pure competitive conditions
where price = marginal revenue.

ECONOMIC EFFECTS
OF A MONOPOLY
4. Productive efficiency is not achieved
because the monopolist’s output is less
than the output at which average total
cost is minimum.

ECONOMIC EFFECTS
OF A MONOPOLY
 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 higher-income
business owners, unless the buyers of
monopoly products are wealthier than
the monopoly owners.

COST IMPLICATIONS
1. Economies of scale may result in one
or two firms operating in an industry
experiencing lower ATC than many
competitive firms. These economies of
scale may be the result of spreading
large initial capital cost over a large
number of units of output (natural
monopoly) or spreading product
development costs over units of output,
and a greater specialization of inputs.

COST IMPLICATIONS
2. X-inefficiency may occur in monopoly
since there is no competitive pressure to
produce at the minimum possible costs.
3. Rent-seeking behavior often occurs as
monopolies seek to acquire or maintain
government-granted monopoly privileges.
Such rent-seeking may entail substantial
costs (lobbying, legal fees, public relations
advertising, etc.) which are inefficient.

TECHNOLOGICAL
PROGRESS AND DYNAMIC
EFFICIENCY
 Technological progress and dynamic
efficiency may occur in some monopolistic
industries but not in others.
1. Some monopolies have shown little
interest in technological progress.
2. 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.

ASSESSMENT AND
POLICY OPTIONS
1. Although there are legitimate concerns of
the effects of monopoly power on the
economy, monopoly power is not
widespread. While research and
technology may strengthen monopoly
power, over time it is likely to destroy
monopoly position.
2. When monopoly power is resulting in an
adverse effect on the economy, the
government may choose to intervene on a
case-by-case basis.

PRICE DISCRIMINATION
 Conditions needed for a successful price
discrimination:
1. Monopoly power is needed with the ability
to control output and price.
2. 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 elasticities of demand)
3. Buyers must be unable to resell the
original product or service.

EXAMPLES OF
1. Airlines charge high fares to executive
travelers (inelastic demand) then
vacation travelers (elastic demand).
2. Electric utilities frequently segment their
markets by end uses, such as lighting
and heating (lack of substitutes for
lighting makes this demand inelastic).

EXAMPLES OF
3. 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 weekends, when less
important calls are made (elastic
demand).
4. Movie theaters and golf courses vary
their charges on the basis of time and
age.

EXAMPLES OF
5. Discount coupons are a form of price
discrimination, allowing firms to offer a
discount to price-sensitive customers.
6. International trade has examples of
firms selling at different prices to
customers in different countries.

CONSEQUENCES OF
1. More profits can be earned by the
seller, since the price charged is what
each buyer is willing to pay in perfect
discrimination. The marginal revenue
will be equal to price in the perfect
discrimination.

CONSEQUENCES OF
2. More production will occur with
discrimination because as output
expands, the reduced price applies to
the additional unit sold and not to prior
units. Marginal revenue can now be
equated to marginal cost to find the
profit-maximizing level of output, and
price of the last unit sold will equal that
marginal revenue.

REGULATED MONOPOLY
 This occurs where a natural monopoly
or economies of scale makes one firm
desirable.
 As a result of changes in technology and
deregulation in some utility providers
industry, some states are allowing new
entrants to compete in previously
regulated markets.

REGULATED MONOPOLY
 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”.

REGULATED MONOPOLY
 However, setting price to equal marginal
cost may cause losses, because public
utilities must invest in enough fixed plant
to handle peak loads. Much of this fixed
plant goes unused most of the time, and
a P=MC would be below ATC.
Regulators often choose a P=AC rather
than MC, so that the monopoly firm can
achieve a “fair return” (normal profit) and
avoid losses.

REGULATED MONOPOLY
 The dilemma for regulators is whether to
choose a socially optimal price, where
P=MC, or a fair return price, where
P=AC. P=MC may be more efficient,
but may result in losses for the
monopoly firm, and government would
then have to subsidize the firm for it to
survive. P=AC does not achieve
allocative efficiency, but it does insure a
fair return (normal profit) for the firm.

LAST WORD: De Beers’
Diamonds: Are Monopolies
Forever?
 De Beers Consolidated Mines of South
Africa has been one of the world’s
strongest and most enduring
monopolies. It produces about 50% of
all rough-cut diamonds in the world and
buys for resale many of the diamonds
produced elsewhere, for a total of about
80% of the world’s diamonds.

Forever?
 Its behavior and results fit the monopoly
model. It sells a limited quantity of
diamonds that yield an “appropriate”
monopoly price.
 The “appropriate” price is well over
production costs and has earned
substantial economic profits.

Forever?
 How has De Beers controlled the production of
mines it doesn’t own?
1. It convinces producers that “single channel”
monopoly marketing is in their best interests.
2. Mines that don’t use De Beers may find the
market flooded from De Beers stockpiles of
the particular kind of diamond they produce,
which causes price declines and loss of
profits.
3. Finally, De Beers purchases and stockpiles
diamonds produced by independents.

Forever?
 Threats and problems face De Beers
monopoly power.
1. New diamond discoveries have resulted
in more diamonds outside their control.
2. Russia, which has been a part of De
Beers’ monopoly, has been allowed to
sell a part of its stock directly into the
world market.

Forever?
 In mid 2000, De Beers abandoned its
attempt to control the supply of
diamonds.
 The company is transforming itself into a
company that sells “premium” diamonds
and luxury goods, under the De Beers
label.
 De Beers plans to reduce its stockpile of
diamonds and increase the demand for
diamonds through advertising.

Chapter24 puremonopoly

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