1. 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)Greek Only one provider of a product or service in a particular market. market Lack of economic competition for the good or service that they provide and a lack of viable substitute goods.competitiongoodservicesubstitute goods Distinguished from monopsony, in which there is only one buyer of a product or service;monopsony Distinguished from a cartel (a form of oligopoly), in which several providers act together to coordinate services, prices or sale of goods.carteloligopoly

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.purely competitive Monopoly will secure monopoly profits by appropriating some or all of the consumer surplus:monopoly profitsconsumer surplus

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

12. 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”?

13. 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

14. 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)

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

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

17. 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.contestable markets This is likely to happen where a market's barriers to entry are low.barriers to entry 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. canal United Kingdomrailways