1. Market Failure: Monopoly 2-9-09
Econ 100 Lecture 6-1
Market Failure:
Monopoly
2-9-09

2. Departures from Perfect Competition
Market structural problems
Monopoly: single supplier/seller
Monopsony: single buyer
Oligopoly: few sellers
Externalities
Public goods: positive externalities (free riders)
Negative Externalities

3. Departures from the Competitive Market Assumptions
No buyer or seller has market power
Information costs are minimal
Product quality is known and products are homogenous
No legal/cost barriers to entry
Close substitutes
No externalities – positive or negative

4. Monopoly Features Single seller, i.e., a “price-searcher”
May be the result of:
Legal barriers to entry, e.g., “med school”
Economies of scale, i.e., efficient for only 1 firm to operate (e.g., public utilities)
Information costs are high
determining product quality is costly

5. Wikipedia’s Definition
A monopoly (from Greek mono(μονό), alone or single + polο (πωλώ), to sell)
Only one provider of a product or service in a particular market.
Lack of economic competition for the good or service that they provide and a lack of viable substitute goods.
Distinguished from monopsony, in which there is only one buyer of a product or service;
Distinguished from a cartel (a form of oligopoly), in which several providers act together to coordinate services, prices or sale of goods.

6. What’s Different?
The profit maximizing rule for both a monopolist and a competitive firm is the same
Choose output level such that MRev = MCost
Difference is:
For a competitive firm: price = MRev
As it takes price as given
For a monopolist:
Each successive unit supplied/sold lowers the price (avg rev) and marginal revenue (MRev)

7. An Example

8. In Words For a price-searcher
Amount supplied has a negative effect on the price received, i.e., average (or per-unit) price falls with each additional unit sold
Therefore, if Average Revenue (Demand Curve) is falling, then Marginal Revenue is falling and is falling faster than AR
MR is below AR

9. What’s the Impact on Market Efficiency?
DWLoss as higher P; lower Q
Transfer from CS to PS

10. Monopolies and Market Efficiency
A monopoly will sell:
a lower quantity of goods
at a higher price than firms would in a purely competitive market.
Monopoly will secure monopoly profits by appropriating some or all of the consumer surplus:

11. A Couple of Questions
Is the monopolist earning an economic profit?

12. A Couple of Questions
What is the demand elasticity at the Monopolist’s Profit-Max?

13. Demand Elasticity
As long as the price elasticity of demand for most customers is less than one in absolute value,
firm increases its prices: it then receives more money for fewer goods.
With a price increase, price elasticity tends to rise, and
in the optimum case above it will be greater than one for most customers.

14. A Couple of Questions
Since the Monopolist is earning an economic profit, why aren’t other firms entering the market and dissipating the “economic rent”?

15. Possible Answers Barriers to entry
Legal barriers – entry is prohibited by legislation
Medical Profession
Accreditation – contrast to law schools/entry
Pharmaceuticals
Patents
Airline hubs
Regulated number of gates

16. Possible Answers Unique Costs High fixed costs
Generally industrial: e.g., automotive (“big 3” before globalization), airlines
Economies-of-scale are so large
“natural monopolies” – public utilities (telecomm, electricity, energy)

17. Possible Answers No/few close substitutes “unique” resources
diamonds, mining industries

18. Examples of Monopolies
Examples of alleged and legal monopolies
The salt commission, a legal monopoly in China formed in 758.
British East India Company; created as a legal trading monopoly in 1600.
Dutch East India Company; created as a legal trading monopoly in 1602.
U.S. Steel; anti-trust prosecution failed in 1911.
Standard Oil; broken up in 1911.
National Football League; survived anti-trust lawsuit in the 1960s, convicted of being an illegal monopoly in the 1980s.
Major League Baseball; survived U.S. anti-trust litigation in 1922, though its special status is still in dispute as of 2007.
United Aircraft and Transport Corporation; aircraft manufacturer holding company forced to divest itself of airlines in 1934.
American Telephone & Telegraph; telecommunications giant broken up in 1982.
Microsoft; settled anti-trust litigation in the U.S. in 2001; fined by the European Commission in 2004, which was upheld for the most part by the Court of First Instance of the European Communities in 2007.
De Beers; settled charges of price fixing in the diamond trade in the 2000s.
Apple Inc., Accused of forming a Vertical Monopoly, with iPod, iTunes, iTunes Music Store, and the FairPlay DRM System.

19. The Downside to Monopolies
Negative aspects
tend to become less efficient and innovative over time,
"complacent giants", do not have to be efficient or innovative to compete in the marketplace.
On the Other Hand
Loss of efficiency can raise a potential competitor's value enough to overcome market entry barriers, or provide incentive for research and investment into new alternatives.
The theory of contestable markets argues that in some circumstances (private) monopolies are forced to behave as if there were competition because of the risk of losing their monopoly to new entrants.
This is likely to happen where a market's barriers to entry are low.
Availability in the longer term of substitutes in other markets. For example, a canal monopoly, while worth a great deal in the late eighteenth century United Kingdom, was worth much less in the late nineteenth century because of the introduction of railways as a substitute.

20. Upside to Monopolies? Positive aspects
Some argue that it can be good to allow a firm to attempt to monopolize a market, since practices such as dumping can benefit consumers in the short term; and once the firm grows too big, it can be dealt with via regulation. When monopolies are not broken through the open market, often a government will step in, either to regulate the monopoly, turn it into a publicly owned monopoly, or forcibly break it up (see Antitrust law). Public utilities, often being natural monopolies and less susceptible to efficient breakup, are often strongly regulated or publicly owned. AT&T and Standard Oil are debatable examples of the breakup of a private monopoly. When AT&T was broken up into the "Baby Bell" components, MCI, Sprint, and other companies were able to compete effectively in the long distance phone market and began to take phone traffic from the less efficient AT&T.