Lesson Objectives:
By the end of this lesson you will be able to:
*Describe characteristics and give examples of a monopoly.
*Describe how monopolies, including government monopolies are formed.
*Explain how a firm with a monopoly makes output decisions.
*Explain why monopolists sometimes practice price discrimination.

Monopoly example: Prescribed medication
Sally is diagnosed with a rare infection. The doctor prescribes her a ten day supply of a new medication. At the pharmacy, she learns that the medicine costs $97.00 (nearly ten dollars a pill).
The pharmacist tells her that only one company has the right to produce the drug. There are no substitutes so Sally has no other option.
While there are different types of monopolies, all are characterized by a single seller that controls an entire market. This arrangement allows monopolies to control output and charge higher pries.

Describing Monopoly
A monopoly forms when barriers prevent firms from entering a market that has a single supplier. While a perfectly competitive market has many buyers and sellers, monopoly markets have only one seller.
Requirements of a monopoly:
*A single seller
*Barriers to market entry
*Supplying a unique product
*There is no substitute for the good/service
The problem with monopolies is that they an take advantage of their market power and charge high prices. For this reason the
United States has outlawed some monopolistic practices.

Forming a Monopoly
All monopolies have one trait in common: a single seller in a market. However, different market conditions can create different types of monopolies.
Economies of Scale
If a firm’s start up costs are high and its average costs fall for each additional unit produced, then it enjoys economies of scale.
Economies of scale are characteristics that cause a producer’s average cost to drop as production rises.
Example of an economy of scale: Hydroelectric plant
A hydroelectric plant generates electricity from a dam on a river.
A large dam could be expensive to build. However, once the dam is built the plant can produce energy at a very low additional cost simply by letting water flow through the dam.

Natural Monopolies
A natural monopoly is a market that runs most efficiently when one large firm provides all of the output. If a second firm enters the market, competition will drive down the market price charged to customers and decrease the quantity each firm can sell. One or both of the firms will not be able to cover their costs and will go out of business.
Natural Monopoly example: Public Water
Sometimes the government steps in to allow just one firm in each geographic area to provide a service such as water. The government ensures that resources are not wasted and in return for monopoly status, a firm with a natural monopoly agrees to let government control the prices it can charge and what services it must provide.
If the government did NOT do this, different water companies would invest huge amounts of money to dig reservoirs and set up overlapping networks of pipes and pumping stations to deliver

Technology and Change
Sometimes the development of a new technology can destroy a natural monopoly. A new innovation can cut fixed costs and make small companies as efficient as one large firm.
Example of technology destroying a natural monopoly: Cell
Phones
Local telephone services used to be a natural monopoly because all phone service was conducted using thick copper wires. In the
1990s, consumers began using cellular phones which are portable and carry phone calls via radio waves rather than through wires.
Cellular technology reduced the barriers to entry in the telephone market. Now cell phone companies simply need to build a few well-placed towers to be just as efficient as wire-based phone services.

Government Monopolies
A government monopoly is a monopoly created by the government.
Technological Monopolies
One way that the government can give a company monopoly power is by issuing a patent . A patent gives a company exclusive rights to sell a new good or service for a specific period of time.
Chuff Pharmaceuticals Patent example:
Chuff Pharmaceutical company develops a new effective asthma medication called BreatheDeep. If Chuff’s researchers can prove to the government that they invented the new drug, the government would grant them a patent. This patent would give
Chuff the exclusive right to sell BreatheDeep for 20 years.
Giving patents to companies rewards them for their hard work and research. This encourages companies to try to develop new things to improve our lives.

Franchises and Licenses
A franchise is a contract issued by a local authority that gives a single firm the right to sell its goods within an exclusive market.
Franchise example:
*Coke products at McDonald’s
*Pepsi products at Taco Bell
A license is government permission for a firms right to operate a business, especially where scarce resources are involved.
License example:
*Radio broadcast frequencies
*Television broadcast frequencies

Industrial Organizations
In rare cases the government allows the companies in an industry to restrict the number of firms in a market.
Example: Major League Baseball
The United States lets Major League Baseball restrict the number and location of their teams. The government allows team owners to choose new cities for their teams and does not charge them with violating the laws that prevent competitors from working together. The problem with this type of monopoly is that team owners may charge high prices for tickets.
Exemptions from these laws are called, antitrust laws. Antitrust laws were originally passed to break up an illegal form of monopoly know as a trust.

Output Decisions
If you had severe asthma what would BreatheDeep be worth to you?
Chuff Pharmaceutical could charge a very high price for its new medication. At the same time, could the company sell as much medication as it wanted to at whatever price it chose?
Even a monopolist faces a limited choice:
*Output
Or
*Price
In most cases a monopolist will chose to make fewer goods and charge higher prices.
The Monopolist’s Dilemma

Price Discrimination
Sometimes, monopolists are able to divide consumers into two or more groups and charge a different price to each group. Doing this is known as price discrimination.
Price discrimination is based on the idea that each customer has a maximum price that he or she will pay for a good.
Monopolist sets a high price: If a monopolist sets the good’s price at the highest maximum price of all the buyers in the market, the monopolist will sell only to the one customer willing to pay that much.
Monopolist sets a low price: If the monopolist sets a low price, the monopolist will gain a lot of customers, but the monopolist will lose profits it cold have made from the customers who bought at the low price but were willing to pay more.
Price discrimination can be used by any company with market power, not just Monopolists. Market power is the ability to control prices and total market output.

Targeted Discounts
Many companies divide consumers into large groups and design pricing for each group.
One common form of price discrimination is identifying a group that is not willing to pay the regular price and offering those customers a discounted price.
Another form of price discrimination is identifying a group that really needs a product and charging those customers more for that good.

Examples of Price Discrimination
1. Discounted Airline Fares- Airlines offer discounts to travelers who buy tickets in advance and to travelers willing to spend a weekend at their destination. Business travelers usually come back and fourth during weekdays but vacationers are not only willing to buy their tickets in advance but they also usually stay for longer periods of time before returning home.
2. Manufacturers’ Rebate Offers- Sometimes manufacturers offer mail-in rebates if you purchase their product. People who actually take the time to fill out and mail in the rebate are usually price conscious and may not have bought the item in the first place without the rebate offer.
3. Senior Citizen/Student Discounts- Many retirees and students have lower incomes than people who work full time. Some businesses offer discounts to attract people in these groups who normally wouldn’t spend money at their establishments.
4. Children Fly/Eat/Stay Free Promotions- Families with young children spend more of their income on food, clothing, and other expenses and have less left over for vacations and going

Limits of Price Discrimination
For price discrimination to work, a market must have the three conditions:
1. Businesses must have some market powerFirms must have some control over prices.
2. Customers must be divided into distinct customer groups-
Firms must be able to separate customers into different groups offering some groups discounts and raising the price for others.
3. Buyers must not be in a position where they can easily resell the good/service - Services like a meal at a restaurant are difficult to for a customer to resell and age discounts require proof.
Although most forms of price discrimination are perfectly legal, sometimes firms use price discrimination to drive other firms out of business. This illegal form of the practice is called predatory pricing.