Monopoly

© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair

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Prepared by: Fernando Prepared by: Fernando Quijano and Yvonn QuijanoQuijano and Yvonn Quijano

Monopoly and Antitrust PolicyMonopoly and Antitrust Policy


Imperfect CompetitionImperfect Competitionand Market Powerand Market Power

• An An imperfectly competitive industryimperfectly competitive industry is is an industry in which single firms have an industry in which single firms have some control over the price of their output.some control over the price of their output.

• Market powerMarket power is the imperfectly is the imperfectly competitive firm’s ability to raise price competitive firm’s ability to raise price without losing all demand for its product.without losing all demand for its product.


Defining Industry BoundariesDefining Industry Boundaries

• The ease with which consumers can The ease with which consumers can substitute for a product limits the extent to substitute for a product limits the extent to which a monopolist can exercise market which a monopolist can exercise market power.power.

• The more broadly a market is defined, the The more broadly a market is defined, the more difficult it becomes to find more difficult it becomes to find substitutes.substitutes.


Pure MonopolyPure Monopoly

• A A pure monopolypure monopoly is an industry with a is an industry with a single firm that produces a product for single firm that produces a product for which there are no close substitutes and in which there are no close substitutes and in which significant barriers to entry prevent which significant barriers to entry prevent other firms from entering the industry to other firms from entering the industry to compete for profits.compete for profits.


Barriers to EntryBarriers to Entry

• Things that prevent new firms from Things that prevent new firms from entering and competing in imperfectly entering and competing in imperfectly competitive industries include:competitive industries include:

• Government franchisesGovernment franchises, or firms that , or firms that become monopolies by virtue of a become monopolies by virtue of a government directive.government directive.




• PatentsPatents or barriers that grant the exclusive or barriers that grant the exclusive use of the patented product or process to use of the patented product or process to the inventor.the inventor.




• Economies of scale and other cost Economies of scale and other cost advantagesadvantages enjoyed by industries that enjoyed by industries that have large capital requirements. A large have large capital requirements. A large initial investment, or the need to embark in initial investment, or the need to embark in an expensive advertising campaign, deter an expensive advertising campaign, deter would-be entrants to the industry.would-be entrants to the industry.




• Ownership of a scarce factor of Ownership of a scarce factor of production:production: If production requires a If production requires a particular input, and one firm owns the particular input, and one firm owns the entire supply of that input, that firm will entire supply of that input, that firm will control the industry.control the industry.


Price: The Fourth Decision VariablePrice: The Fourth Decision Variable

• Firms with market power must decide:Firms with market power must decide:

1.1. how much to produce,how much to produce,

2.2. how to produce it,how to produce it,

3.3. how much to demand in each input market, how much to demand in each input market, andand

4.4. what price to charge for their output.what price to charge for their output.


Price and Output Decisions in Pure Price and Output Decisions in Pure Monopoly MarketsMonopoly Markets

• To analyze monopoly behavior we assume To analyze monopoly behavior we assume that:that:

• Entry to the market is blockedEntry to the market is blocked

• Firms act to maximize profitFirms act to maximize profit

• The pure monopolist buys in competitive input The pure monopolist buys in competitive input marketsmarkets

• The monopolistic firm cannot price discriminateThe monopolistic firm cannot price discriminate

• The monopoly faces a known demand curveThe monopoly faces a known demand curve


Price and Output Decisions in Pure Price and Output Decisions in Pure Monopoly MarketsMonopoly Markets

• With one firm in a monopoly market, there With one firm in a monopoly market, there is no distinction between the firm and the is no distinction between the firm and the industry. In a monopoly, the firm is the industry. In a monopoly, the firm is the industry.industry.

• The market demand curve is the demand The market demand curve is the demand curve facing the firm, and total quantity curve facing the firm, and total quantity supplied in the market is what the firm supplied in the market is what the firm decides to produce.decides to produce.


Collusion and Monopoly ComparedCollusion and Monopoly Compared

• CollusionCollusion is the act of working with other is the act of working with other producers in an effort to limit competition producers in an effort to limit competition and increase joint profits.and increase joint profits.

• When firms collude, the outcome would be When firms collude, the outcome would be exactly the same as the outcome of a exactly the same as the outcome of a monopoly in the industry.monopoly in the industry.


Public Choice TheoryPublic Choice Theory

• The idea of government failure is at the The idea of government failure is at the center of center of public choice theorypublic choice theory, which , which holds that public officials who set holds that public officials who set economic policies and regulate the players economic policies and regulate the players act in their own self-interest, just as firms act in their own self-interest, just as firms do.do.


Remedies for Monopoly:Remedies for Monopoly:Antitrust PolicyAntitrust Policy

• A A trusttrust is an arrangement in which is an arrangement in which shareholders of independent firms agree shareholders of independent firms agree to give up their stock in exchange for trust to give up their stock in exchange for trust certificates that entitle them to a share of certificates that entitle them to a share of the trust’s common profits. A group of the trust’s common profits. A group of trustees then operates the trust as a trustees then operates the trust as a monopoly, controlling output and setting monopoly, controlling output and setting price.price.


Landmark Antitrust LegislationLandmark Antitrust Legislation

• Congress began to formulate antitrust Congress began to formulate antitrust legislation in 1887, when it created the legislation in 1887, when it created the Interstate Commerce Commission (ICC)Interstate Commerce Commission (ICC) to oversee and correct abuses in the to oversee and correct abuses in the railroad industry.railroad industry.

• In 1890, Congress passed the In 1890, Congress passed the Sherman Sherman ActAct, which declared every contract or , which declared every contract or conspiracy to restrain trade among states conspiracy to restrain trade among states or nations illegal; and any attempt at or nations illegal; and any attempt at monopoly, successful or not, a monopoly, successful or not, a misdemeanor.misdemeanor.


Natural MonopolyNatural Monopoly

• A A natural monopolynatural monopoly is an is an industry that realizes such industry that realizes such large economies of scale in large economies of scale in producing its product that producing its product that single-firm production of that single-firm production of that good or service is most good or service is most efficient.efficient.

Education

Monopoly