Introduction to Monopoly Concepts

Introduction to Monopoly

• A monopoly is a market structure where there's only one seller of a product with no close substitutes.
• Monopolies have market power, enabling them to control the price of the product.
• Monopolies are price makers, setting the price, unlike perfectly competitive firms, which are price takers.

Characteristics of a Monopoly

• Single firm: Only one firm exists in the market.
• Unique product: The product has no close substitutes.
• Barriers to entry: Significant barriers prevent new firms from entering the market.
• Market power: The monopoly has substantial control over the price of its product.

Barriers to Entry

• Government-created barriers: Patents (protect inventions for a set period, typically 18 years), and copyrights (protect original works of authorship)
• Ownership of a key input: A single firm owns a critical resource needed for production, like bauxite for aluminum.
• Natural monopolies: The long-run average total cost curve shows a single firm can produce the entire market output more cheaply than multiple firms, like utilities with shared infrastructure.

Profit Maximization

• Monopolies maximize profit by producing the quantity where marginal revenue equals marginal cost (MR = MC).
• The marginal revenue curve for a monopoly has the same vertical intercept as the demand curve but twice the slope.
• Rule for linear demand curve: The marginal revenue curve has the same vertical intercept and twice the slope of the demand curve.
• Key difference between monopolies and perfectly competitive firms: A monopoly faces the entire market demand curve, while perfectly competitive firms face a perfectly elastic demand curve.
• The monopoly's price is greater than its marginal cost.
• Practical interpretation: Consumers pay a higher price for goods sold by a monopoly than production cost, leading to potential deadweight loss.
• Profit calculation: Profit = (Price - Average Total Cost) * Quantity
• Monopolies can earn positive profits or negative profits (losses) depending on demand and cost structure.

Monopoly Losses

• A monopoly can experience a negative profit (loss) if average total cost surpasses price.
• The area between the average total cost curve and the price represents the loss.

Monopoly and Supply Curves

• Monopolies lack a traditional supply curve.
• Monopolies determine supply based on marginal cost and demand curves.
• The price is determined by the demand curve, not the marginal cost curve.
• Competitive firms have a supply curve because marginal cost dictates both quantity and price.

Short-Run vs. Long-Run with Monopolies

• Monopolies don't experience entry or exit like competitive firms.
• Short-run profits persist in the long run for monopolies.
• No need for distinct short-run/long-run analysis.

The Impact of Monopolies on Total Surplus

• Monopolies decrease total surplus compared to competitive markets.
• Monopolies restrict quantity, increase price, decreasing consumer surplus and creating deadweight loss.
• Deadweight loss is the total surplus loss due to the monopoly restricting output compared to a competitive market.
• The triangle formed by the demand curve and the marginal cost curve represents deadweight loss from the monopoly.

Perfect Competition

• Price and Quantity Determination: Price and quantity are set at the intersection of the market demand and supply curves.
• Consumer Surplus: Consumer surplus in perfect competition lies above the price and below the demand curve.
• Producer Surplus: Producer surplus in perfect competition is below the price and above the supply curve.

Monopoly

• Consumer Surplus: Monopoly consumer surplus is limited to the area above the price and below the demand curve, the loss compared to perfect competition is "B" + "C".
• Producer Surplus: Monopoly producer surplus encompasses the area under the price and above the marginal cost curve ("B" + "D").
• Deadweight Loss: Deadweight loss ("C" + "E") results from the monopoly's output restriction, representing a societal loss despite efficient profit maximization.
• Government Intervention: Governments intervene to address deadweight loss:
  • Antitrust Legislation: Sherman Antitrust Act (1890) and subsequent legislation enables government to prevent mergers, break up monopolies, and regulate them.
  • Regulation: Governments regulate price or output, potentially setting monopolies price equal to marginal cost, which faces obstacles in natural monopolies, risking loss/market exit.
  • Government Takeover: The government may take over a monopoly (e.g., US Postal Service), potentially causing inefficiency due to lack of accountability.

Natural Monopoly

• Cost Curves: Natural monopolies have declining average total cost curves, often resulting from substantial fixed costs.
• Regulation Challenges: Regulating a natural monopoly is complex. Setting price equal to marginal cost may lead to losses and market exit since prices can fall below average total cost.

Price Discrimination

• Definition: Charging different customers different prices for the same good.
• Conditions: Price discrimination requires preventing arbitrage (consumers buying at a discount resell to those without).
• Types: Price discrimination can be based on factors like geography, age, or income.
• Examples: Senior discounts, student discounts, quantity discounts (Costco).

Perfect Price Discrimination

• Definition: Charging each customer their maximum willingness to pay.
• Rarity: This is highly uncommon.
• Benefits: Perfect price discrimination achieves perfect competition efficiency (same quantity as competitive, no deadweight loss). However, consumer surplus is zero, and all surplus accrues to the monopolist.
• Conditions: Requires knowing each customer's willingness to pay, which is usually impractical.

Monopolistic Competition and Oligopoly

• Next Steps: Explore monopolistic competition and oligopoly, market structures between perfect competition and monopoly.