OUTLINE LESSONS 10 and 10b
Pure Monopoly

10a - Monopoly: Charcteristics and Short-Run Equilibrium

I. Introduction:

A. Four Product Market Models
1. Competitive Market (Lessons 8/9a, 8/9b)

2. Monopoly (Lessons 10a, 10b)

3. Monopolistic Competition (Lesson 11a)

4. Oligopoly (Lesson 11b)

B. General Outline for Each Model

1. Characteristics and Examples
2. Nature of the Demand Curve
3. Short Run Equilibrium (Profit Max.)
4. Long Run Equilibrium and Efficiency
5. Other Issues

II. MONOPOLY - Characteristics

A market structure in which one firm sells a unique product into which entry is blocked in which the single firm has considerable control over product price and in which nonprice competition may or may not be found.

A. NUMBER OF FIRMS: single firm
B. TYPE OF PRODUCT: unique product, no close substitutes
C. CONTROL OVER PRICE: "price makers"
D. EASE OF ENTRY: blocked entry
E. NONPRICE COMPETITION: public relations

III. Examples / Importance

1.

Public utilities: gas, electric, water, cable TV, and local telephone service companies, are often pure monopolies.

2.

Central Microprocessors (Intel), First Data Resources (Western Union), Wham-o (Frisbees), Brannock Device Company (shoe sizing devices), and the DeBeers diamond syndicate are examples of "near" monopolies. (See Last Word.)

3.

Manufacturing monopolies are virtually nonexistent in nationwide U.S. manufacturing industries.

4.

Professional sports leagues grant team monopolies to cities.

5.

Monopolies may be geographic. A small town may have only one airline, bank, etc.

Why Study Monoplies?

  • because they really do exist
  • and because most industries are a combination of pure competition and pure monoply
    • monopolistic competion
    • oligopoly

IV. Barriers to Entry

A. Definition
Anything which artificially prevents the entry of firms into an industry.

B. Importance of Barriers

C. Types of Barriers

1. economies of scale: costs
a) graphically
b) rationale

c) natural monopolies

3. legal barriers

a) patents
b) licenses

3. ownership or control of essential raw materials

4. pricing and other strategic barriers

V. Price and Output Determination: Benefit-Cost Analysis

A. Monopoly Demand
1. Assumptions
  • barriers to entry secure the firm's monoploy
  • no government regulation
  • a single-price monopoly - that is, it charges the same price to all of its customers (no price discrimination)

 

2. firm's demand = market demand (demand is downsloping)

  • P > MR
    • agraphically
    • why?
  • price maker
  • the monoplolist sets the price in the elastic region of demand
    • in the inelastic region a lower price (to sell more) would lower total revenue even though it costs more to produce more

 

B. Price and Output Determination

1. goal: profit maximization
2. benefit-cost analysis 2 steps (graphically)
a) find best quantity where MR = MC
b) product only if AR > AVC

C. Profits? (graphically)

1. profit maximizing case: economic profits ( profits/losses)

2. loss minimizing case( profits/losses) extra

3. shut down case ( profits/losses) extra

4. normal profit ( profits/losses)

D. Misconceptions Concerning Monopoly Pricing
1. not highest price
2. total, not unit, profits
3. losses
4. graph

 

VI. Price and Output Determination TC - TR Approach

 

10b - Monopoly: Long-Run, Efficiency, and Regulation

VII. Monopoly Firms and Long Run Equilibrium

Monopoly: Long-Run Equilibrium Graph

  

VIII. Monopoly Firms and Efficiency

A. Competitive Firms and Efficiency (review)
1. allocative efficiency: P = MC
2. productive efficiency: P = MC = ATC

B. Assume Identical Costs

C. Monopoly [GRAPH]

1. allocative inefficiency: P >MC
a) underallocation of resources smaller output than competitive markets
b) higher prices than competitive markets

2. productive inefficiency

a) not producing at minimum ATC
b) cost complications
1) natural monopoly
An industry in which economies of scale are so great the product can be produced by one firm at a lower average total cost than if the product were produced by more than one firm.

graphically

2) X-inefficiency

Failure to produce any specific output at the lowest average (and total) cost possible.

3) monopoly preserving expenditures

4) dynamic efficiency?

(a) competitive model
(b) monopoly model
(1) means
(2) incentives?
(3) a mixed picture
  • Some monopolies have shown 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.
  • MORE

(c) the inverted-U theory of R &D expenditures

 

3. inequities (income distribution)

  • 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 consumers to 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.

IX. Price Discrimination

A. Definition
The selling of a product to different buyers at different prices when the price differences are not justified by differences in cost.

B. Examples: Who pays more? / Who pays less?

1. ELECTRICITY: heating or lighting? homes or businesses?

2. DOCTORS: insured patients or uninsured?

3. AIR TRAVEL: business travellers or vacationers?

4. MOVIES / SKIING / GOLF: adults or children?

5. RAILROADS: expensive cargo or inexpensive cargo?

6. COUPONS

7. INTERNATIONAL TRADE

8. OTHERS ????

C. Conditions

1. Monopoly power ( price maker )

2. Market segregation: ability to segregate buyers according to their price elasticity of demand

3. No resale

D. Consequences (graphically)

1. more profits
2. more production = more efficient

 

 

 

X. Regulated Monopoly: Rate Regulation

A. Why rate regulation instead of antitrust?
1. definition: antitrust
The use of the antitrust laws to promote competition and economic efficiency.

2. natural monopoly

An industry in which economies of scale are so great the product can be produced by one firm at a lower average total cost than if the product were produced by more than one firm.

3. graphically: demand crosses ATC while ATC is still downward sloping

B. Why government gets involved

1. to improve allocative efficiency: "public interest "
The presumption that the purpose of the regulation of an industry is to protect the public (consumers) from abuse of the power possessed by natural monopolies.

2. political reasons: legal cartel theory

The hypothesis that some industries seek regulation or want to maintain regulation so they may form or maintain a legal cartel.

a. Proponents of this theory contend that regulators guarantee a return to the regulated firms while blocking entry and dividing up the market - activities that would be illegal in unregulated markets.

b. Occupational licensing is an example of this theory in certain labor markets.

 

C. How the government regulates rates (prices)

1. P = MC: socially optimum price (alloc. eff. price)
a. Definition

The price of a product which results in the most efficient allocation of an economy's resources and is equal to the marginal cost of the product.

Means the same thing as ALLOCATIVE EFFICIENCY

b. graphically

c. achieves allocative efficiency

The price of a product which results in the most efficient allocation of an economy’s resources and is equal to the marginal cost of the product.

c) but results in a loss for the firm

d) government could subsidize or use AC pricing

2. P = ATC: "fair" return price

a. definition
The price of a product which enables its producer to obtain a normal profit and which is equal to the average total cost of producing it.

b. graphically

c. some inefficiency

d. but normal profits earned no losses

3. Review: GRAPH

Unregulated Profit Maximizing Price and Quantity: P3 and Q3
(where MR = MC)

Allocatively Efficient Price and Quantity: P2 and Q2
(where P = MC)

Fair Return Price and Quantity: P1 and Q1
(where P = ATC)

 

D. Dilemma with Industrial Regulation

The tradeoff a regulatory agency faces in setting the maximum legal price a monopolist may charge:

The socially optimal price is below average total cost (and either bankrupts the firm or requires that it be subsidized) while the higher fair-return price does not produce allocative efficiency.

 

E. Deregulation in the United States

1. Deregulation came about in the 1970s and 1980s as a result of the greater acceptance of the legal cartel theory, increasing evidence of inefficiency in regulated industries, and the contention that government was regulating potentially competitive industries.

2. Industries that were deregulated included airlines, trucking, banking, railroads, natural gas, television broadcasting, electricity, and telecommunications.

3. Although some criticize deregulation, on balance it appears to have benefited consumers and the economy.

a. Benefits to society through lower prices, lower costs, and increased output are estimated at $50 billion annually. The gains come primarily from airlines, railroads, and trucking.

b. Deregulation has lead to technological advances in new and improved products.

4. Deregulation in the electricity industry has generated significant controversy.

a. The industry is most deregulated at the wholesale level. This allows wholesalers to build facilities and sell electricity to distributors at unregulated prices.

b. Some states have also deregulated retail electricity prices and, for the most part, electricity rates have fallen for consumers.

c. In California, where wholesalers are deregulated and retailers regulated, a dramatic increase in wholesale prices in 2001 resulted in substantial financial losses for retail providers, as they were legally prevented from raising retail prices to cover the higher costs. The problem was exacerbated by the fraudulent activities of energy-trader Enron.

 

XI.  De Beers' Diamonds: Are Monopolies Forever?

A. De Beers Consolidated Mines of South Africa has been one of the world's strongest and most enduring monopolies.
1. It produces about 50 percent of all rough-cut diamonds in the world

2. and buys for resale many of the diamonds produced elsewhere,

3. for a total of about 80 percent of the world's diamonds.

B. Its behavior and results fit the monopoly model portrayed in the figure below It sells a limited quantity of diamonds that will yield an "appropriate" monopoly price.

C. The "appropriate" price is well over production costs and has earned substantial economic profits.

D. 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.

E. 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.

F. In mid-2000, De Beers abandoned its attempt to control the supply of diamonds.

G. The company is transforming itself into one that sells "premium" diamonds and luxury goods under the De Beers label