1. Chapter 24 Monopoly

2. Introduction
States have various licensing requirements for individuals who wish to practice specific professions.
For example, Ohio requires a $100 license fee to become a kick boxer. Other states mandate specific education requirements for interior designers.
What are the economic effects of these and other legal requirements for entry into a profession?
Chapter 24 will explore the answer to this question.

3. Learning Objectives Identify situations that can give rise to monopoly
Describe the demand and marginal revenue conditions a monopolist faces
Discuss how a monopolist determines how much output to produce and what price to charge
Evaluate the profits earned by a monopolist
Understand price discrimination
Explain the social cost of monopolies

4. Chapter Outline Definition of a Monopolist Barriers to Entry
The Demand Curve a Monopolist Face
Elasticity and Monopoly
Cost and Monopoly Profit Maximization
Calculating Monopoly Profit
On Making Higher Profits: Price Discrimination
The Social Cost of Monopolies

5. Did You Know That ...
Private hospitals are among the most profitable companies in the U.S.?
A common characteristic among the most profitable private hospitals is that they are all the only large, full-service hospitals located within the regions surrounding the cities in which they are based.
In this chapter, you will learn the reasons for substantial profits earned by a monopoly, a business that is the only seller.

6. Definition of a Monopolist
A single supplier of a good or service for which there is no close substitute
The monopolist therefore constitutes the entire industry

7. Barriers to Entry Question Answer
How does a firm obtain monopoly power?
Answer
Barriers to entry that allow the firm to make long-run economic profits
Barriers to entry are restrictions on who can start as well as stay in business.

8. International Example: The Canadian Wheat Monopoly
In Canada, the Canadian Wheat Board is the only entity permitted by law to sell the wheat produced by the country’s farmers.
It purchases the harvest from all farmers and then acts as the sole supplier.
This is an example of monopoly.

9. Barriers to Entry (cont'd)
Barriers to entry include:
Ownership of resources without close substitutes
Economies of scale
Legal or governmental restrictions

10. Barriers to Entry (cont'd)
Ownership of resources without close substitutes
The Aluminum Company of America (ALCOA) at one time owned most of of the world’s bauxite

11. Barriers to Entry (cont'd)
Economies of scale
Low unit costs and prices drive out rivals
The largest firm can produce at the lowest average total cost

12. Barriers to Entry (cont'd)
Natural Monopoly
A monopoly that arises from the peculiar production characteristics in an industry
It usually arises when there are large economies of scale
One firm can produce at a lower average cost than can be achieved by multiple firms

13. Figure 24-1 The Cost Curves That Might Lead to a Natural Monopoly

14. Barriers to Entry (cont'd)
Legal or governmental restrictions
Licenses, franchises, and certificates of convenience
Examples include
Electrical utilities
Radio and television broadcasting

15. Policy Example: Waging Economic War on Children’s Lemonade Stands
Some children who become entrepreneurs by opening a neighborhood lemonade stand find themselves confronted with law-enforcement officials requiring payment of a license fee.
Typically, these children give up the lemonade business and search for other income-generating opportunities in the neighborhood.

16. Barriers to Entry (cont'd)
Legal or governmental restrictions
Patents
Intellectual property
Tariffs
Taxes on imported goods
Regulation
Government enforcement of safety and quality

17. The Demand Curve a Monopolist Faces
The monopolist faces the industry demand curve because the monopolist is the entire industry

18. The Demand Curve a Monopolist Faces (cont'd)
Recall that under perfect competition
Firm faces perfectly elastic demand curve, it is a price taker
The forces of supply and demand establish the price per unit
Marginal revenue, average revenue, and price are all the same

19. The Demand Curve a Monopolist Faces (cont'd)
Marginal revenue equals the change in total revenue due to a one-unit change in the quantity produced and sold

20. The Demand Curve a Monopolist Faces (cont'd)
Perfect competition versus monopoly
The perfect competitor doesn’t have to worry about lowering price to sell more
In a purely competitive situation, the firm accounts for a small part of the market
It can sell its entire output, whatever that may be, at the same price

21. The Demand Curve a Monopolist Faces (cont'd)
Perfect competition versus monopoly
The more the monopolist wants to sell, the lower the price it has to charge on the last unit sold
To sell the last unit, the monopolist has to lower the price because it is facing a downward sloping demand curve

22. Figure 24-2 Demand Curves for the Perfect Competitor and the Monopolist

23. The Demand Curve a Monopolist Faces (cont'd)
Monopoly
Perfect Competition
Single seller
Faces entire industry demand
Must lower price to sell more
Not all units sold for same price (MR < P)
Many sellers
Faces perfectly elastic demand
Must produce more to sell more
All units sold for same price (P = MR)

24. Elasticity and Monopoly
The monopolist faces a downward-sloping demand curve (its average revenue curve)
That means that it cannot charge just any price with no changes in quantity (a common misconception) because, depending on the price charged, a different quantity will be demanded

25. Figure 24-3 Marginal Revenue: Always Less Than Price

26. Elasticity and Monopoly (cont'd)
Question
If a monopoly raises price, what will happen to quantity demanded?
Hint
Remember how consumers respond to a change in price

27. Elasticity and Monopoly (cont'd)
Recall
A monopolist is a single seller of a well-defined good or service with no close substitute
Think of some imperfect substitutes.
The demand curve slopes downward because individuals compare marginal satisfaction to cost

28. Elasticity and Monopoly (cont'd)
After all, consumers have limited incomes and unlimited wants
The market demand curve, which the monopolist alone faces in this situation, slopes downward because individuals compare the marginal satisfaction they will receive to the cost of the commodity to be purchased

29. Costs and Monopoly Profit Maximization
We assume profit maximization is the goal of the pure monopolist, just as it is for the perfect competitor

30. Costs and Monopoly Profit Maximization (cont'd)
Perfect competitor has only to decide on the profit-maximizing output rate because price is given
The perfect competitor is a price taker
For the pure monopolist, we must seek a profit-maximizing price output combination
The monopolist is a price searcher

31. Costs and Monopoly Profit Maximization (cont'd)
Price Searcher
A firm that must determine the price-output combination that maximizes profit because it faces a downward-sloping demand curve

32. Costs and Monopoly Profit Maximization (cont'd)
We can determine the profit-maximizing price-output combination with either of two equivalent approaches:
By looking at total revenues and total costs or
By looking at marginal revenues and marginal costs

33. Costs and Monopoly Profit Maximization (cont'd)
Total revenues-total costs approach
Maximize the positive difference between total revenues and total costs
Marginal revenue-marginal cost approach
Profit maximization will also occur where marginal revenue equals marginal cost

34. Costs and Monopoly Profit Maximization (cont'd)
Question
Why produce where marginal revenue equals marginal cost?
Answer
This is where the greatest positive difference between total revenue and total cost occurs

35. Figure 24-4 Monopoly Costs, Revenues, and Profits, Panel (a)

36. Figure 24-4 Monopoly Costs, Revenues, and Profits, Panels (b) and (c)

37. Costs and Monopoly Profit Maximization (cont'd)
Producing past where MR = MC
Result is that incremental cost will exceed incremental revenue
Producing less than where MR = MC
The monopolist is not maximizing profits through this approach either

38. Figure 24-5 Maximizing Profits

39. Cost and Monopoly Profit Maximization (cont’d)
Real-World Informational Limitations
Price searching by a less-than perfect competitor is a process
A monopolist can only estimate the actual demand curve and make an educated guess when it sets its profit-maximizing profit
For the perfect competitor, price is given already by the intersection of market demand and supply

40. Example: Trial and Error Yields Profits from Monopoly Time in the Air
Since the late 2000s, airlines have been taking advantage of their position as monopoly sellers during the duration of flights.
In addition to charging for checked bags, snacks, and pillows, some airlines are now experimenting with fees for more comfortable seats.
Other airlines offer “travel concierge” services that assist passengers with booking items in their destination cities.
As monopoly providers, airlines are searching for prices that will maximize profits.

41. Calculating Monopoly Profit
Monopoly profit is given by the shaded area in Figure 24-6, which is equal to total revenues (P  Q) minus total costs (ATC  Q)

42. Figure 24-6 Monopoly Profit

43. Calculating Monopoly Profit (cont'd)
No guarantee of profits
The term monopoly conjures up the notion of a greedy firm ripping off the public
If ATC is everywhere above AR, or demand
No price-output combination allows the monopolist to cover costs

44. Figure 24-7 Monopolies: Not Always Profitable

45. Policy Example: The U.S. Rail Monopoly that Subsists on Taxpayer Handouts
Amtrak has a near-monopoly on U.S. intercity rail service. Nevertheless, it continues to suffer economic losses.
To keep passenger rail lines operating, the federal government provides a subsidy to cover Amtrak’s losses.
So even though Amtrak charges loss-minimizing prices, the revenues generated from passenger fares are less than total costs.

46. On Making Higher Profits: Price Discrimination
Selling a given product at more than one price, with the difference being unrelated to differences in cost

47. On Making Higher Profits: Price Discrimination (cont'd)
Price Differentiation
Establishing different prices for similar products to reflect differences in marginal cost in providing those commodities to different groups of buyers

48. On Making Higher Profits: Price Discrimination (cont'd)
Necessary conditions for price discrimination
The firm must face a downward-sloping demand curve
The firm must be able to readily (and cheaply) identify buyers or groups of buyers with predictably different elasticities of demand
The firm must be able to prevent resale of the product or service

49. Example: Why Students Pay Different Prices to Attend College
Out-of-pocket tuition rates for any two college students can differ by considerable amounts, even if the students happen to major in the same subjects and enroll in many of the same courses.
The reason for this is that colleges offer students diverse financial aid packages depending on their “financial need.”
To document their “need” for financial aid, students must provide detailed information about family income and wealth. This information helps the college determine the prices that different families are most likely to be willing and able to pay, so that it can engage in price discrimination.

50. Figure 24-8 Toward Perfect Price Discrimination in College Tuition Rates

51. The Social Cost of Monopolies
Comparing monopoly with perfect competition
Let’s assume a monopolist comes in and buys up every single perfect competitor
Notice the monopolist produces a smaller quantity and sells at a higher price

52. The Social Cost of Monopolies (cont'd)
Comparing monopoly with perfect competition
Monopolists raise the price and restrict production compared to a perfectly competitive situation
Consumers pay a price that exceeds the marginal cost of production and resources are misallocated in such a situation

53. What If Governments protect local retailers from “big-box” retailers such as Wal-Mart and Target?
When local activists succeed in opposing the opening of a new retailer, they also serve to protect local stores from competition.
This means that local sellers can charge prices higher than what would prevail under perfect competition.

54. Figure 24-9 The Effects of Monopolizing an Industry

55. You Are There: Seeking Higher Rents from Souvenir Vendors in Atlanta
For the past 20 years, Stanley Hambrick and Larry Miller have been paying an annual rent of $250 to operate a vending stand at Turner Field, where they sell baseball souvenirs and T-shirts.
Now, Atlanta has granted monopoly rights for the vending space to a property-management company. Rental rates now range from $500 per month to $1,600 per month, depending on the location of the vending stand.
Vendors now face monopoly rents as much as 77 times higher than what they used to pay.

56. Issues & Applications: The U.S. Occupational License Explosion
In states across the land, licensing rules have been expanding with each passing year.
Table 24-1 on the next slide lists some of the occupations that require licenses in at least a few U.S. states.

57. Table 24-1 Selected Occupations Requiring Licenses in Some U.S. States

58. Issues & Applications: The U. S
Issues & Applications: The U.S. Occupational License Explosion (cont’d)
To obtain an occupational license, people typically must pay a fee and engage in a period of study. These licenses create monopoly profits for incumbents already established in the profession.
After controlling for other determinants of incomes, economists have found licensing requirements can boost incomes by 15 percent.

59. Summary Discussion of Learning Objectives (cont'd)
Why a monopoly can occur
Barriers to entry
Demand and marginal revenue conditions faced by a monopolist
Because the monopolist constitutes the entire industry, it faces the entire market demand curve.
Marginal revenue is less than price.

60. Summary Discussion of Learning Objectives (cont'd)
How a monopolist determines how much output to produce and what price to charge
Seeks to maximize its economic profits
Produces where marginal revenue equals marginal cost
Charges maximum price for the amount of output where MR = MC

61. Summary Discussion of Learning Objectives (cont'd)
A monopolist’s profits
Profit earned by monopolist is equal to the difference between the price it charges and its average production cost times the amount of output it produces and sells.
Monopolist typically earns positive economic profits.

62. Summary Discussion of Learning Objectives (cont'd)
Price discrimination
Selling at more than one price with the price differences being unrelated to differences in production costs.
Monopolist sells some of its output at higher prices to consumers with less elastic demand.

63. Summary Discussion of Learning Objectives (cont'd)
Social cost of monopolies
Price exceeds marginal cost.
The price is higher and output is lower for a monopolist as compared to a perfectly competitive industry.

64. Appendix G: Consumer Surplus in a Perfectly Competitive Market
Given the market clearing price that prevails in the perfectly competitive market, consumer surplus is:
the difference between the total amount that consumers would have been willing to pay and the total amount that they actually pay

65. Figure G-1 Consumer Surplus in a Perfectly Competitive Market

66. Appendix G: How Society Loses from Monopoly
Deadweight Loss
The portion of consumer surplus that no one in society is able to obtain in a situation of monopoly
No one in society, not even the monopoly, can obtain this deadweight loss

67. Appendix G: How Society Loses from Monopoly (cont’d)
As a result of monopoly, consumers are worse off in two ways:
The monopoly profits that result constitute a transfer of a portion of consumer surplus away from consumers to the monopolist
The failure of the monopoly to produce as many units as would have been produced under perfect competition eliminates consumer surplus that otherwise would have been a benefit to consumers

68. Figure G-2 Losses Generated by Monopoly