1. Lecture 12 The Causes of Monopoly
Microeconomics 1000
Lecture 12 The Causes of Monopoly

2. PUBLIC POLICY TOWARD MONOPOLIES
Since monopoly is socially costly, there is room for policy
Government may respond to the problem of monopoly in various ways.
Through competition policy.
Regulating the behavior of monopolies.
Turning some private monopolies into public enterprises.

3. Competition policy Competition policy does not prohibit monopoly
In general, competition policy deals with
Cartels
Mergers
Abuses of dominant position
Thus, holding a dominant position is not prohibited; only the abuse is illegal
To understand why competition policy does not prohibit monopoly, we must understand why monopolies arise

4. WHY MONOPOLIES ARISE
The fundamental cause of monopoly is barriers to entry.

5. WHY MONOPOLIES ARISE Barriers to entry have various sources:
Ownership of a key resource.
The government gives a single firm the exclusive right to produce some good.
A producer may be much more efficient than any other firm
Costs of production make a single producer more efficient than a large number of producers.

6. Monopoly Resources
Exclusive ownership of a key resource is a potential source of monopoly
Placido Domingo has a monopoly over his own voice
Lionel Messi has a monopoly over his special football talent
A firm may own the only spring of a certain kind of mineral water

7. Government-Created Monopolies
Governments may restrict entry by giving a single firm the exclusive right to sell a particular good in certain markets.
Patent and copyright laws are two important examples of how government creates a monopoly to serve the public interest.
In other cases, the government’s grant of a monopoly is a source of revenue (e.g., spectrum auctions – although this has often resulted in oligopoly rather than monopoly)

8. Natural Monopolies
An industry is a natural monopoly when the fixed costs are so high that there is not enough room for two or more firms.
Let 𝜋 ∗ be the monopoly profit, gross of fixed cost
If 𝜋 ∗ >𝐹 then a monopolist would cover its fixed costs and still make a positive profit
However, if 𝐹> 𝜋 ∗ 2 , two competing firms could not survive

9. Natural Monopolies
More generally, a natural monopoly arises when there are economies of scale over the relevant range of output.
Large fixed costs are the more common source of economies of scale, but not necessarily the only one
Other possible sources are learning curve effects or positive network externalities

10. Figure 1 Economies of Scale as a Cause of Monopoly
Cost
Average
total
cost
Quantity of Output
Copyright © South-Western

11. Competitive advantages
A firm may be so much more efficient than its competitors that it is effectively unconstrained by outside competition

12. Figure 2 Large Competitive Advantage
Costs and
Revenue
Demand
Marginal revenue
All other firms’
unit cost
Monopoly
price
QMAX B
Efficient firm’s unit cost A
Quantity
Copyright © South-Western

13. Prohibiting monopoly is not a good idea after all
When the monopoly is created by the government, policy would be self-defeating
When the market is a natural monopoly, monopoly is the only possible market outcome
When the source of monopoly is a large competitive advantage, competitors would survive only if the price was greater than the monopoly price – but then the deadweight loss would be even greater.

14. Antitrust Laws US Antitrust Laws Sherman Act (1890) Clayton Act (1914)
§1 prohibits cartels
§ 2 prohibits “unfair monopolization”.
Clayton Act (1914)
Regulates mergers and authorizes private lawsuits.

15. Antitrust laws EU competition law
Art. 81 of the Treaty or Rome prohibits agreements between firms (i.e., cartels; but also certain kind of vertical restraints)
Art. 82 prohibits abuses of dominant position.
In addition, a special regulation (which is not part of the Treaty of Rome) deals with mergers
Neelie Kroes

16. Antitrust laws UK competition law
Chapter 1 of the 1998 Competition Act: similar to Art. 81, prohibits agreements among firms
Chapter 2 of the 1998 Competition Act: similar to Art. 82, prohibits abuses of dominant position.
Implemented by the Office of Fair Trading (current Chairman is Philip Collins)

17. Abuse of dominant position
Various strategies can be regarded as abusive if adopted by dominant firms
Predatory pricing
Bundling and tying
Exclusionary contracts
Refusal to license intellectual property
Loyalty discounts
The problem is that these strategies may also have innocent rationales, and it is hard to distinguish

18. Government may regulate the prices that the monopoly charges.
Regulation
Government may regulate the prices that the monopoly charges.
The allocation of resources will be efficient if price is set to equal marginal cost.

19. Figure 3 Marginal-Cost Pricing for a Natural Monopoly
Price
Demand
Average total cost
Average total
cost
Loss
Regulated
price
Marginal cost
Quantity
Copyright © South-Western

20. Regulation
In practice, regulators will allow some departure from marginal-cost pricing
To allow monopolists to cover large fixed costs
To allow monopolists to keep some of the benefits from lower costs in the form of higher profit, thus encouraging innovation and technical progress
Because they may be uncertain about the level of the marginal cost and fear that if the price is set too low, the monopolist may exit the market (which is even worst than a monopoly price).

21. Public Ownership
Rather than regulating a natural monopoly that is run by a private firm, the government can run the monopoly itself
Rare in the United States (Postal Service).
In UK very common pre-privatisation;
Still a lot in continental Europe.

22. Doing Nothing
Government can do nothing at all if the market failure is deemed small compared to the imperfections of public policies.

23. CONCLUSION: THE PREVALENCE OF MONOPOLY
How prevalent are the problems of monopolies?
Monopolies are common.
Most firms have some control over their prices because of differentiated products.
Firms with substantial monopoly power are rare.
Few goods are truly unique.

24. Summary
Policymakers can respond to the inefficiencies of monopoly behavior with antitrust laws, regulation of prices, or by turning the monopoly into a government-run enterprise.
If the market failure is deemed small, policymakers may decide to do nothing at all.