Monopoly

Imperfect Competitionand Market PowerAn imperfectly competitive industry is an industry in which single firms have some control over the price of their output.Market power is the imperfectly competitive firm’s ability to raise price without losing all demand for its product.

Defining Industry BoundariesThe ease with which consumers can substitute for a product limits the extent to which a monopolist can exercise market power.The more broadly a market is defined, the more difficult it becomes to find substitutes.

Pure MonopolyA pure monopoly is an industry with a single firm that produces a product for which there are no close substitutes and in which significant barriers to entry prevent other firms from entering the industry to compete for profits.

Barriers to EntryThings that prevent new firms from entering and competing in imperfectly competitive industries include:Government franchises, or firms that become monopolies by virtue of a government directive.Barriers to EntryThings that prevent new firms from entering and competing in imperfectly competitive industries include:Patents or barriers that grant the exclusive use of the patented product or process to the inventor.Barriers to EntryThings that prevent new firms from entering and competing in imperfectly competitive industries include:Economies of scale and other cost advantages enjoyed by industries that have large capital requirements. A large initial investment, or the need to embark in an expensive advertising campaign, deter would-be entrants to the industry.Barriers to EntryThings that prevent new firms from entering and competing in imperfectly competitive industries include:Ownership of a scarce factor of production: If production requires a particular input, and one firm owns the entire supply of that input, that firm will control the industry.Price: The Fourth Decision VariableFirms with market power must decide:how much to produce,how to produce it,how much to demand in each input market, andwhat price to charge for their output.

Price and Output Decisions in Pure Monopoly MarketsTo analyze monopoly behavior we assume that:Entry to the market is blockedFirms act to maximize profitThe pure monopolist buys in competitive input marketsThe monopolistic firm cannot price discriminateThe monopoly faces a known demand curve

Price and Output Decisions in Pure Monopoly MarketsWith one firm in a monopoly market, there is no distinction between the firm and the industry. In a monopoly, the firm is the industry.The market demand curve is the demand curve facing the firm, and total quantity supplied in the market is what the firm decides to produce.

Price and Output Decisions in Pure Monopoly MarketsThe demand curve facing a perfectly competitive firm is perfectly elastic; in a monopoly, the market demand curve is the demand curve facing the firm.

Marginal Revenue Facing a Monopolist

Marginal Revenue CurveFacing a MonopolistFor a monopolist, an increase in output involves not just producing more and selling it, but also reducing the price of its output to sell it.At every level of output except one unit, a monopolist’s marginal revenue is below price.

Marginal Revenue and Total RevenueA monopolist’s marginal revenue curve shows the change in total revenue that results as a firm moves along the segment of the demand curve that lies exactly above it.

Price and Output Choice for a Profit-Maximizing MonopolistA profit-maximizing monopolist will raise output as long as marginal revenue exceeds marginal cost (like any other firm).The profit-maximizing level of output is the one at which MR = MC.

The Absence of a SupplyCurve in MonopolyA monopoly firm has no supply curve that is independent of the demand curve for its product.A monopolist sets both price and quantity, and the amount of output supplied depends on both its marginal cost curve and the demand curve that it faces.

Price and Output Choices for a Monopolist Suffering Losses in the Short-RunIt is possible for a profit-maximizing monopolist to suffer short-run losses.If the firm cannot generate enough revenue to cover total costs, it will go out of business in the long-run.

Perfect Competition andMonopoly ComparedIn a perfectly competitive industry in the long-run, price will be equal to long-run average cost. The market supply is the sum of all the short-run marginal cost curves of the firms in the industry.

Perfect Competition andMonopoly ComparedRelative to a competitively organized industry, a monopolist restricts output, charges higher prices, and earns positive profits.

Collusion and Monopoly ComparedCollusion is the act of working with other producers in an effort to limit competition and increase joint profits.When firms collude, the outcome would be exactly the same as the outcome of a monopoly in the industry.

The Social Costs of MonopolyMonopoly leads to an inefficient mix of output.Price is above marginal cost, which means that the firm is underproducing from society’s point of view.

The Social Costs of MonopolyThe triangle ABC measures the net social gain of moving from 2,000 units to 4,000 units (or welfare loss from monopoly).

Rent-Seeking BehaviorRent-seeking behavior refers to actions taken by households or firms to preserve positive profits.A rational owner would be willing to pay any amount less than the entire rectangle PmACPc to prevent those positive profits from being eliminated as a result of entry.

Government FailureThe idea of rent-seeking behavior introduces the notion of government failure, in which the government becomes the tool of the rent-seeker, and the allocation of resources is made even less efficient than before.

Public Choice TheoryThe idea of government failure is at the center of public choice theory, which holds that public officials who set economic policies and regulate the players act in their own self-interest, just as firms do.

Remedies for Monopoly:Antitrust PolicyA trust is an arrangement in which shareholders of independent firms agree to give up their stock in exchange for trust certificates that entitle them to a share of the trust’s common profits. A group of trustees then operates the trust as a monopoly, controlling output and setting price.

Landmark Antitrust LegislationCongress began to formulate antitrust legislation in 1887, when it created the Interstate Commerce Commission (ICC) to oversee and correct abuses in the railroad industry.In 1890, Congress passed the Sherman Act, which declared every contract or conspiracy to restrain trade among states or nations illegal; and any attempt at monopoly, successful or not, a misdemeanor.

Landmark Antitrust LegislationThe rule of reason is a criterion introduced by the Supreme Court in 1911 to determine whether a particular action was illegal (“unreasonable”) or legal (“reasonable”) within the terms of the Sherman Act.

Landmark Antitrust LegislationThe Clayton Act, passed by Congress in 1914, strengthened the Sherman Act and clarified the rule of reason. The act outlawed specific monopolistic behaviors such as tying contracts, price discrimination, and unlimited mergers.

Landmark Antitrust LegislationThe Federal Trade Commission (FTC), created by Congress in 1914, was established to investigate the structure and behavior of firms engaging in interstate commerce, to determine what constitutes unlawful “unfair” behavior , and to issue cease-and-desist orders to those found in violation of antitrust law.

The Enforcement of Antitrust LawThe Wheeler-Lea Act (1938) extended the language of the Federal Trade Commission Act to include “deceptive” as well as “unfair” methods of competition.The Antirust Division (of the Department of Justice) is one of two federal agencies empowered to act against those in violation of antitrust laws. It initiates action against those who violate antitrust laws and decides which cases to prosecute and against whom to bring criminal charges.

The Enforcement of Antitrust LawThe courts are empowered to impose a number of remedies if they find that antitrust law has been violated.Consent decrees are formal agreements on remedies between all the parties to an antitrust case that must be approved by the courts. Consent decrees can be signed before, during, or after a trial.

Natural MonopolyA natural monopoly is an industry that realizes such large economies of scale in producing its product that single-firm production of that good or service is most efficient.

Natural MonopolyWith one firm producing 500,000 units, average cost is $1 per unit. With five firms each producing 100,000 units, average cost is $5 per unit.

Monopoly

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