Monopoly
Outline
•Pure monopoly
•Barriers to entry
•Monopoly compared to competition
•Natural monopoly
•The regulatory dilemma
•Monopolistic competition
Pure monopoly
A “pure” monopoly
is a market structure
in which a single
seller accounts for
100 percent of
market sales.
Pure monopolies are hard to
find in the real world.
Economists and judges as a
rule believe a 90 percent
market share is sufficient to
constitute an “effective”
monopoly.
Figure 9.1
Cost and Revenue per Unit
AC
Industry
demand
Pm
AC
MR
Qm
MC
AC
Notice the monopolist earns
an economic profit equal to
the shaded are. Question is:
Should this situation not be
ripe for entry of new firms?
Not if there are factors
which impede entry of new
firms.
Barriers to entry: 2 definitions
1. “[A]nything which creates a disadvantage for potential
entrants vis à vis established firms. The height of the
barriers is measured by the extent to which, in the long
run, established firms can elevate their selling prices above
minimal average cost . . . without inducing potential
entrants to enter” [Joe Bain, Industrial Organization, 2nd
ed., p. 252].
2. Barriers to entry into a market . . . can be defined to be
socially undesirable limitations to entry of resources which
are due to protection of resource owners already in the
market” [Christian von Weizsäcker, Barriers to Entry, p.
13].
Examples of barriers to entry
Absolute cost advantages
Examples: Alcoa had access to low cost hydroelectric power
in Pacific NW; Weyerhauser procured extraction rights to
tracts of Douglas fir in 1901; International petroleum majors
(Texaco, SOCAL, BP, et al) formed a pipeline consortium in
California.
Economies of scale: Dominant firm may enjoy cost
advantages due to realization of scale economies in
production, distribution, capital raising, or sales promotion.
Barriers due to control of wholesale, retail distribution
systems
Examples: Control of wholesale diamond distribution by
DeBeers; Control of advantageous retail shelf space by
Proctor and Gamble, Kellogs.
Barriers due to patents, copyrights, trademarks, and
other legal barriers
Examples: Xerox’s patent on xerography; Polaroid’s patent
on instamatic photography
Barriers due to product differentiation/brand power
Examples: Cigarettes, pain relievers, designer jeans, athletic
wear, batteries, soft drinks
Strategic Barriers
Alcoa’s restrictive covenants with hydroelectric suppliers.
Standard Oil’s “secret rebate” policy with the railroad
companies.
“Lease-only” policy of IBM, United Shoe Machinery,
International Salt
IBM’s continual design modification was designed to
forestall entry of firms such as Calcomp that marketed plugcompatible peripherals—e.g.,tapes and line printers.
Microsoft charges PC makers a royalty for every computer
shipped—regardless of whether the machine has a Windows
operating system installed.
Microsoft requires that Explorer icon appear on desktop in
initial boot up sequence.
The Microsoft case
Microsoft Corporation v. U.S. 530 U.S. 1301 (2000)
The Antitrust Division of the
DOJ won Sherman section 1
and section 2 convictions
against the software giant. The
key element in the case was
the so-called “applications
barrier to entry.”
The applications barrier in
the Microsoft case
Hear audio explanation (wav)
Judge Jackson stated in his Finding of Fact:
“[T]he applications barrier would prevent an
aspiring entrant into the relevant market from
drawing a significant number of customers away
from a dominant incumbent even if the
incumbent priced its products substantially
above competitive levels for a significant period
of time.”
Proprietary control of “application program
interfaces” keeps software developers in the
Microsoft tent.
“These are synapses at which the developer of an
application can connect to invoke pre-fabricated
blocks of code in the operating system. These blocks
of code in turn perform crucial tasks, such as
displaying text on the computer screen. Because it
supports applications while interacting more closely
with the PC system's hardware, the operating system
is said to serve as a ‘platform.’” Judge Jackson’s
Finding of Fact
The middleware threat
Mr. Gates viewed middleware (the
Java programming language and
Netscape browser software) as rival
platforms for ISV’s. Gates feared
middleware would bring down the
applications barrier.
Hear Brown’s comments (wav)
Evidence of ‘willful acquisition and
maintenance . . . “
The government alleged that Microsoft
designed its licensing agreements with
OEM’s and IAP’s so as to preserve the
applications barrier. This was also its
objective in giving away Internet
Explorer for free.
The OEM Channel
•Licensing agreements with Original Equipment Makers
(OEM’s) stipulated pre-installation of Internet explorer.
• Internet Explorer icon must appear on the desktop after the
initial boot-up sequence.
•OEM’s prohibited from pre-installing Netscape browser
software.
The IAP Channel
•
Microsoft offered IAP’s valuable “real estate” on the Windows
desktop in exchange for their agreement to distribute Internet
Explorer exclusively. Hear audio explanation (wav)
•
If an IAP was already under contract to pay Netscape a certain
amount for browser licenses, Microsoft offered to compensate
the IAP the amount it owed Netscape.
•
Microsoft also reduced the referral fees that IAPs paid when
users signed up for their services using the Internet Referral
Server in Windows in exchange for the IAPs' efforts to convert
their installed bases of subscribers from Navigator to Internet
Explorer.
Price, Cost
Monopoly compared to
Competition
A
Market
Demand
PM
B
H
PC
Notice that for each additional
unit produced between QM and
QC, Demand (marginal benefit)
is higher than marginal cost.
E
MC = AC
MR
0
QM
QC
Output
Results summarized
Price
Quantity
Econ

Consumer
Dead
Surplus
Weight
Competition
PC
QC
zero
PCAE
zero
Monopoly
PM
QM
PCPMBH
PMAB
BHE
Dead weight is a
measure of loss due to
resource
misallocation—it is
equal to the surplus
lost to consumers
which is not captured
by the producer.
q is the hypothetical output of a
single sellers in a competitive
market (100 sellers).
*Price that yields a normal profit to the
competitive firm exceed MC by vertical
distance AB
LMC
A
LAC
PC
PM
B
D = AR
MR
0
q = 1/100Qc
QM
Quantity
Professor,
What do you
mean by
the term
“regulatory
dilemma”
I refer to the dilemma
confronting regulators
(e.g., public service
commissioners) as they
go about the task of
subjecting firms covered
by their legislative
mandate to rate-ofreturn regulation.
Horns of the Dilemma
The socially efficient regulatory regime
does not provide the regulated firm a “fair”
return to shareholder equity.
We will use some simple graphs to
illustrate that marginal cost pricing
will, in the case of sustainable natural
monopoly, saddle the regulated firm
with losses. The Courts have ruled that
the regulated firm must receive a
return on shareholder equity that is
“fair.”
$
Case 1: Unregulated Monopoly

PM
CM

D = AR


LMC
MR
0
QM
LAC
QC
MWHs
$
Case 2: Marginal Cost Pricing
D = AR

C1

PC
LMC
MR
0
LAC
QC
MWHs
Recall the necessary
condition
for socially efficient
resource
allocation:
P = MC
Hence:
•Option 2 is optimal on social efficiency
criteria.
•Why not select option 2 and subsidize the
regulated firm by amount C1PC?
Subsidies give rise to problems of
distributional equity. For example, suppose
that gas companies were subsidized from
general tax revenues—does this not amount
to an income transfer from taxpayers to gas
users?
$
Option 3: Average Cost Pricing

PA


LMC
MR
0
LAC
QA
MWHs
Comparing the results
Option
Dead
Weight
Loss
Price Quantity given by
area
Econ
Profit given by
area
1
PM
QM

PMCM
2
PC
QC
0
(C1PC)
3
PA
QA

0
Monopolistic Competition
A market structure
featuring a relatively
large number of sellers
and a differentiated
product/service
Examples: Women’s shoes, snack foods,
furniture, carpet, bathroom fixtures, men’s
suits, cold cuts.
The monopolistic
competitor faces a
downward sloping, but
very elastic, demand
curve.
Short run equilibrium in monopolistic competition
Dollars per Unit of Output
MC AC
P
AC
MRF
Q
DF
Output
(a) The Firm Earns Excess Profit
Long Run Equilibrium in Monopolistic Competition
Dollars per Unit of Output
MC
AC
PE
MRF
QE
DF
Output
(b) Long-Run Equilibrium:
the Firm Earns Zero Economic Profit