Econ 102
Spring 2010
Market Failure:
Monopoly
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
• Asymmetric Information
– Buyer/seller have different information about quality
• E.g., Goldman-Sachs/Paulson and buyers of CDOs
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
• No close substitutes
• No externalities – positive or negative
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
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. [1]
• A monopoly should be distinguished from a cartel (a form of
oligopoly), in which several providers act together to coordinate
services, prices or sale of goods.
• A government-granted monopoly or legal monopoly is sanctioned by
the state, often to provide an incentive to invest in a risky venture.
The government may also reserve the venture for itself, thus forming
a government monopoly.
– E.g., drug patents
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)
An Example
Monopoly
Price
Marg Rev
Quantity
19
16
13
10
Tot Rev
7
$120
$100
$80
$60
$40
$20
$0
($20)
($40)
4
Rev Marg Rev
$20
$20
$38
$18
$54
$16
$68
$14
$80
$12
$90
$10
$98
$8
$104
$6
$108
$4
$110
$2
$110
$0
$108
($2)
$104
($4)
$98
($6)
$90
($8)
$80
($10)
$68
($12)
$54
($14)
$38
($16)
$20
($18)
1
$20
$19
$18
$17
$16
$15
$14
$13
$12
$11
$10
$9
$8
$7
$6
$5
$4
$3
$2
$1
Qty Dem Tot
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Price
Price
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
What’s the Impact on
Market Efficiency?
• DWLoss as higher P; lower Q
• Transfer from CS to PS
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:
A Couple of Questions
• Is the monopolist earning an economic
profit?
A Couple of Questions
• What is the demand elasticity at the
Monopolist’s Profit-Max?
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.
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”?
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
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)
Possible Answers
• No/few close substitutes
– “unique” resources
• diamonds, mining industries
Examples of Monopolies
•
•
•
•
•
•
•
•
•
•
•
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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.
The Downside to Monopolies
• Negative aspects
– monopolies tend to become less efficient and innovative over time,
• "complacent giants", do not have to be efficient or innovative to compete in
the marketplace.
– 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.
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.