MonopolyMonopoly

What is a Monopoly?What is a Monopoly?

A market dominated by a single A market dominated by a single seller seller

What is a Monopoly?What is a Monopoly?

A monopoly forms when barriers A monopoly forms when barriers prevent firms from entering a prevent firms from entering a market that has a single supplier. market that has a single supplier.

What is a Monopoly?What is a Monopoly?

A firm has a monopoly when it A firm has a monopoly when it controls an entire market. Because controls an entire market. Because a monopolist controls the price of its a monopolist controls the price of its product, a monopoly produces less product, a monopoly produces less and charges higher prices than and charges higher prices than would a perfectly competitive would a perfectly competitive market. market.

Problems with Problems with monopolies monopolies

Charge higher pricesCharge higher prices Less supply than demandedLess supply than demanded Only one seller Only one seller

Different types of Different types of Monopolies Monopolies

Economies of ScaleEconomies of Scale Natural MonopoliesNatural Monopolies Government MonopoliesGovernment Monopolies

Economies of ScaleEconomies of Scale

If a firm’s start up costs are high, If a firm’s start up costs are high, and it’s average costs fall for each and it’s average costs fall for each additional unit it produces, we say it additional unit it produces, we say it enjoys what economists call: enjoys what economists call: economies of scale.economies of scale.

As production increases, the firm As production increases, the firm becomes more efficient.becomes more efficient.

In a market with economies of scale, In a market with economies of scale, bigger is better – such a market can bigger is better – such a market can easily become a natural monopoly.easily become a natural monopoly.

Natural MonopoliesNatural Monopolies

A natural monopoly is a market that runs A natural monopoly is a market that runs most efficiently when one large firm most efficiently when one large firm provides all of the output. provides all of the output.

If a second firm enters the market, If a second firm enters the market, competition will drive down the market competition will drive down the market price charged to customers and decrease price charged to customers and decrease the quantity each firm can sell. the quantity each firm can sell.

The government usually steps in and allows The government usually steps in and allows this so that resources are not wasted. In this so that resources are not wasted. In return, the government usually sets prices.return, the government usually sets prices.

Natural MonopoliesNatural Monopolies

New technologies can sometimes New technologies can sometimes destroy natural monopolies.destroy natural monopolies.

Example: Phone industry. Used to be a Example: Phone industry. Used to be a natural monopoly – one phone company natural monopoly – one phone company usually monopolized a region. They usually monopolized a region. They owned the phone poles, lines, hardware, owned the phone poles, lines, hardware, etc.etc.

With the advent of wireless and cable With the advent of wireless and cable phone services, the natural monopoly phone services, the natural monopoly disappeared. disappeared.

Government Monopolies Government Monopolies

A government monopoly is a A government monopoly is a monopoly created by the monopoly created by the government. government.

Types:Types: PatentPatent FranchiseFranchise LicenseLicense

PatentsPatents

A A patent – patent – gives a company gives a company exclusive rights to sell a new good or exclusive rights to sell a new good or service for a specific period of time.service for a specific period of time.

Encourages research and Encourages research and developmentdevelopment of new products that of new products that benefit society. benefit society.

FranchisesFranchises

A A franchise – franchise – is a contract issued by a is a contract issued by a local authority that gives a firm a local authority that gives a firm a single firm the right to sell its goods single firm the right to sell its goods within an exclusive market.within an exclusive market.

Examples?: Single companies get Examples?: Single companies get exclusive rights to sell food and goods exclusive rights to sell food and goods within national parks.within national parks. Soda machines in schoolsSoda machines in schools Used to keep small markets under control. Used to keep small markets under control.

LicensesLicenses A A license license – the government grants firms – the government grants firms

the right to operate a business. the right to operate a business. Examples: radio frequencies (FCC) and land Examples: radio frequencies (FCC) and land

(some cities license a single firm to manage (some cities license a single firm to manage their public parking lots).their public parking lots).

In other cases, the government allows In other cases, the government allows companies in an industry to restrict the companies in an industry to restrict the number of firms in an industry.number of firms in an industry.

Examples: Major professional sports. MLB, Examples: Major professional sports. MLB, NFL, NHL, NBANFL, NHL, NBA They’re allowed to restrict markets and They’re allowed to restrict markets and

locations of teamslocations of teams Exempt from anti-trust laws. Exempt from anti-trust laws.

The Monopolist’s The Monopolist’s Dilemma Dilemma

Even a monopolist faces a limited choice: it Even a monopolist faces a limited choice: it can choose either output or price, but not can choose either output or price, but not both. both.

The monopolist looks at the big picture and The monopolist looks at the big picture and tries to maximize profits. This means the tries to maximize profits. This means the monopolist will produce fewer goods at a monopolist will produce fewer goods at a higher price.higher price.

The law of demand means that when the The law of demand means that when the monopolist increases the price, it will sell monopolist increases the price, it will sell less, and when it lowers the price, it will sell less, and when it lowers the price, it will sell more. more.

So where does the So where does the monopoly set prices? monopoly set prices?

Remember, to maximize profits, a Remember, to maximize profits, a seller should set its marginal revenue, seller should set its marginal revenue, or the amount it earns from the last or the amount it earns from the last unit sold, equal to its marginal cost, or unit sold, equal to its marginal cost, or the extra cost from producing that unit.the extra cost from producing that unit.

In a perfectly competitive market, In a perfectly competitive market, marginal revenue = pricemarginal revenue = price

When a firm has some control over When a firm has some control over price—and can cut price to sell more – price—and can cut price to sell more – marginal revenue is less than price. marginal revenue is less than price.

Price Discrimination Price Discrimination

Monopolists may divide consumers Monopolists may divide consumers into to two or more groups and into to two or more groups and charge different prices to each charge different prices to each group.group.

Price discrimination is based on the Price discrimination is based on the idea that each customer has his or idea that each customer has his or her own maximum price she will pay her own maximum price she will pay for a good or service. for a good or service.

Market PowerMarket Power Price discrimination is a is a feature of a Price discrimination is a is a feature of a

monopoly but can be practiced by any monopoly but can be practiced by any company with company with Market powerMarket power, which is , which is the ability to control prices and total the ability to control prices and total market output.market output.

Companies divide customers into large Companies divide customers into large groups and design pricing policies for groups and design pricing policies for each group. Price discrimination means each group. Price discrimination means that some customers might be offered a that some customers might be offered a discount while others are charged discount while others are charged higher prices. higher prices.

Price DiscriminationPrice Discrimination

Discounted air faresDiscounted air fares Manufacturers rebate offersManufacturers rebate offers Senior citizen, student, or military Senior citizen, student, or military

discountsdiscounts Children fly or stay freeChildren fly or stay free

Firms would rather have their business Firms would rather have their business and earn lower profits than earn no and earn lower profits than earn no profits at all so they offer discounts. profits at all so they offer discounts.

Limits of Price Limits of Price Discrimination Discrimination

For price discrimination to work, a market For price discrimination to work, a market must meet three conditions:must meet three conditions:

1. Firms must have some market power – 1. Firms must have some market power – some control over price (this is rare in highly some control over price (this is rare in highly

competitive markets)competitive markets)

2. Customers must be divided into distinct groups2. Customers must be divided into distinct groups based on sensitivity of pricebased on sensitivity of price monopolists must be able to guess the demand monopolists must be able to guess the demand

curves of different groups and which ones are more curves of different groups and which ones are more elastic than otherselastic than others

3. Buyers must not be in a position in which they 3. Buyers must not be in a position in which they can easily resell the good or service can easily resell the good or service