Micro Chapter 12

(Assessment and Policy Options)

Antitrust laws: Break up the firm. Regulate it: Government determines price and quantity. Ignore it: Let time and markets get rid of monopoly. When monopoly power results in an adverse effect upon the economy, the government may choose to intervene on a case-by-case basis using antitrust laws. If the government feels that it is more beneficial to society to have a monopoly, then the government will regulate it. Although there are legitimate concerns of the effects of monopoly power on the economy, monopoly power is not widespread. While research and technology may initially strengthen monopoly power, over time it is likely to destroy monopoly position. Fortunately, monopoly is not widespread in the United States. Barriers to entry are seldom completely successful. Although research and technological advance may strengthen a monopoly's market position, technology may also undermine monopoly power. Over time, the creation of new technologies may destroy monopoly positions. For example, the development of courier delivery, fax machines, and e-mail has eroded the monopoly power of the U.S. Postal Service. Similarly, cable television monopolies are now challenged by satellite TV and by technologies that transmit audio and video over the Internet. Patents eventually expire; and even before they do, the development of new and distinct substitutable products often circumvents existing patent advantages. New sources of monopolized resources sometimes are found, and competition from foreign firms may emerge. If a monopoly is sufficiently fearful of future competition from new products, it may keep its prices relatively low so as to discourage rivals from developing such products. In that case, consumers may pay nearly competitive prices.

(Introduction to Pure Monopoly)

Characteristics of Pure Monopoly: Single seller-In a pure, or absolute, monopoly, a single firm is the sole producer of a specific good or the sole supplier of a service; the firm and the industry are synonymous. A sole producer. No close substitutes-A pure monopoly's product is unique in that there are no close substitutes. The consumer who chooses not to buy the monopolized product must do without it. Unique product. Price maker-The pure monopolist controls the total quantity supplied and thus has considerable control over price; it is a price maker (unlike a pure competitor, which has no such control and therefore is a price taker). The pure monopolist confronts the usual downward sloping product demand curve. It can change its product price by changing the quantity of the product it produces. The monopolist will use this power whenever it is advantageous to do so. Control over price. Blocked entry-A pure monopolist has no immediate competitors because certain barriers keep potential competitors from entering the industry. Those barriers may be economic, technological, legal, or of some other type. Strong barriers to entry. Nonprice competition-The product produced by a pure monopolist may be either standardized (as with natural gas and electricity) or differentiated (as with the Windows operating system or Frisbees). Monopolists that have standardized products engage mainly in public relations advertising, whereas those with differentiated products sometimes advertise their products' attributes. ​​Mostly PR but can engage in advertising to increase demand. In short-A pure monopoly means that there is only one producer of the good with no close substitutes being produced by any other firms. Since the firm is the industry, they have a great deal of control over the price that is charged for their good. Monopolies are created and sustained due to strong entry barriers which makes it very difficult for new firms to enter the industry. There is very little non-price competition since there are not any rival firms. However, there may be some non-price competition to increase the demand for the good.

(Monopoly Demand Schedule)

Table 12.1-Revenue and Cost Data of a Pure Monopolist-The demand curve for the monopolist (and for any imperfectly competitive seller) is quite different from that of the pure competitor. Because the pure monopolist is the industry, its demand curve is the market demand curve. And because market demand is not perfectly elastic, the monopolist's demand curve is downward sloping. Illustrated in columns 1 & 2. Note that quantity demanded increases as price decreases. Price will exceed marginal revenue because the monopolist must lower the price to sell the additional unit. The lower price is applied to all of the units being produced, not just the last unit, thereby causing marginal revenue to be less than price. The added revenue will be the price of the last unit less the sum of the price cuts which must be taken on all prior units of output.

(Examples of Price Discrimination)

Business travel-have relatively inelastic demand due to not having time to shop around and or wait. Also, the firm is paying for this business trip and whenever someone else pays for your consumption, you are not as concerned about the price. Therefore, airlines charge business travelers higher prices than the rest of the population. Hotels will charge the business traveler higher rates than the rest of the population. Common in the U.S. economy. For example, airlines charge high fares to business travelers, whose demand for travel is inelastic, and they offer lower, highly restricted, nonrefundable fares to attract vacationers and others whose demands are more elastic. Movie theaters and Golf courses-charge higher prices for the evening show than for an afternoon matinee. This is because those going to the matinee are more price sensitive than the rest of the population. Those going to the matinee may be retired, families with children, or unemployed people. Those going to the evening show often consider this a special event and are willing to pay full price or perhaps they are too busy working during the day to go to a matinee. This group will be less price sensitive. Also, movie theaters charge adults a higher price than children even though it costs the same amount to show a movie to an adult as to a child. This effort will bring in more people and more revenue because otherwise a family might not be able to afford to bring all members to the show.Movie theaters and golf courses vary their charges on the basis of time (for example, higher rates on evenings and weekends and age (for example, lower rates for children and senior discounts). Railroads vary the rate charged per ton-mile of freight according to the market value of the product being shipped. The shipper of 10 tons of television sets or refrigerators pays more than the shipper of 10 tons of gravel. Railroad companies. Coupons-Those who have the time and take the time to clip coupons and manage coupons are the price sensitive group. Those who do not take the time are those willing to pay regular price. Discount coupons, redeemable at purchase, are a form of price discrimination. They enable firms to give price discounts to their most price-sensitive customers who have elastic demand. Less price-sensitive consumers who have less elastic demand are not as likely to take the time to clip and redeem coupons. The firm thus makes a larger profit than if it had used a single-price, no-coupon strategy. International trade-we find that a foreign firm may sell to the United States at a relatively low price due to the availability of many substitute suppliers in the U.S. and but sell in the foreign firm's country at a higher price where there are fewer substitute suppliers available. A Russian aluminum producer, for example, might sell aluminum for less in the United States than in Russia. In the United States, this seller faces an elastic demand because several substitute suppliers are available. But in Russia, where the manufacturer dominates the market and trade barriers impede imports, consumers have fewer choices and thus demand is less elastic.

(Barriers to Entry)

In pure monopoly, strong barriers to entry effectively block all potential competition. Somewhat weaker barriers may permit oligopoly, a market structure dominated by a few firms. Still weaker barriers may permit the entry of a fairly large number of competing firms giving rise to monopolistic competition. And the absence of any effective entry barriers permits the entry of a very large number of firms, which provide the basis of pure competition. So barriers to entry are pertinent not only to the extreme case of pure monopoly but also to other market structures in which there are monopoly-like characteristics or monopoly-like behaviors. Barriers to entry are factors that prevent firms from entering the industry: Economies of scale-constitute one major barrier. This occurs where the lowest unit costs &, therefore, lowest unit prices for consumers depend on the existence of a small number of large firms or, in the case of a pure monopoly, only one firm. Because a very large firm with a large market share is most efficient, new firms can't afford to start up in industries with economies of scale. Google & Amazon both enjoy economies of scale in their respective markets. Public utilities are often natural monopolies because they have economies of scale in the extreme case where one firm is most efficient in satisfying the entire demand. Govt usually gives one firm the right to operate a public utility industry in exchange for govt regulation of its power. For new firms the massive expense of the plant facilities along with customer loyalty to the existing product would make the entry highly risky. Therefore, the new and untried enterprise would find it difficult to secure financing for its venture. In most cases the risks & financial obstacles to "starting big" are prohibitive. This explains why efforts to enter such industries as computer operating software. commercial aircraft. & household laundry equipment are so rare. Modern technology in some industries is such that economies of scale-declining ATC with added firm size-are extensive. In such cases, a firm's long-run average-cost schedule will decline over a wide range of output. Given market demand, only a few large firms or, in the extreme, only a single large firm can achieve low ATCs. Legal barriers to entry like patents & licenses-1. Patents grant the inventor the exclusive right to produce or license a product for 20 years (agreed on by the world's nations); this exclusive right can earn profits for future research, which results in more patents & monopoly profits. Patents have figured prominently in the growth of modern-day giants such as IBM, Pfizer, Intel, Xerox, Amazon, & DuPont. Research & development (R&D is what leads to most patentable inventions & products. Firms that gain monopoly power through their own research or by purchasing the patents of others can use patents to strengthen their market position. The profit from one patent can finance the research required to develop new patentable products. In the pharmaceutical industry, patents on prescription drugs have produced large monopoly profits that have helped finance the discovery of new patentable medicines. So monopoly power achieved through patents may well be self-sustaining, even though patents eventually expire & generic drugs then compete with the original brand. 2. Licenses are another form of entry barrier. At the national level, the Federal Communications Commission licenses radio & TV stations & taxi companies are examples of govt granting licenses where only one or a few firms are allowed to offer the service in each geographic area. In a few instances. the govt licenses itself to provide some product & thereby create a public monopoly. For example, in some states only state-owned retail outlets can sell liquor. Similarly, many states have "licensed" themselves to run lotteries. Ownership or control of essential resources-A monopolist can use private property as an obstacle to potential rivals. For example, a firm that owns or controls a resource essential to the production process can prohibit the entry of rival firms. International Nickel Co. of Canada (now called Vale Canada Limited) used to control about 90% of the world's nickel reserves. And it is very difficult for new sports leagues to be created because existing professional sports leagues have player contracts & long-term leases on major city stadiums. Pricing & other strategic barriers-Even if a firm is not protected from entry by, say, extensive economies of scale or ownership of essential resources, entry may effectively be blocked by the way the monopolist responds to attempts by rivals to enter the industry. Confronted with a new entrant, the monopolist may "create an entry barrier" by slashing its price, stepping up its advertising, or taking other strategic actions to make it difficult for the entrant to succeed. other strategic barriers such as selective price-cutting & advertising. Dentsply, an American manufacturer of false teeth, controlled about 80% of the market and in 2005 Dentsply was found to have illegally prevented independent distributors from carrying competing brands. That prevented several foreign competitors from entering the U.S. market and competing against Dentsply. In 2015 American Express was found guilty of unlawful restraint of trade when it disallowed merchants that accepted American Express from promoting other credit cards, like Visa & MasterCard to their customers.

(Economic Effects of Monopoly)

Income transfer-In general, a monopoly transfers income from consumers to the owners of the monopoly. The owners receive the income as revenue. Because a monopoly has market power, it can charge a higher price than would a purely competitive firm with the same costs. So the monopoly in effect levies a "private tax" on consumers. This private tax can often generate substantial economic profits that can persist because entry to the industry is blocked. Income distribution is more unequal than it would be under a more competitive situation; thus, monopoly power transfers income from the consumers to the business owners which results in a redistribution of income to the higher-income business owners. Cost complications: Given identical costs, a purely monopolistic industry will charge a higher price, produce a smaller output, and allocate economic resources less efficiently than a purely competitive industry. These inferior results are rooted in the entry barriers characterizing monopoly. But we must recognize that costs may not be the same for purely competitive and monopolistic producers. The unit cost incurred by a monopolist may be either larger or smaller than that incurred by a purely competitive firm. Costs may differ for four reasons: (1) economies of scale, (2) a factor called "X-inefficiency," (3) the need for monopoly-preserving expenditures, and (4) the "very long run" perspective, which allows for technological advance. Costs complications are that costs for monopolies may not be the same as for more competitive firms. Following are 4 reasons why costs may differ: Economies of scale-Where economies of scale are extensive, market demand may not be sufficient to support a large number of competing firms, each producing at minimum efficient scale. In such cases, an industry of one or two firms would have a lower average total cost than would the same industry made up of numerous competitive firms. At the extreme, only a single firm-a natural monopoly-might be able to achieve the lowest long-run average total cost. Some firms relating to new information technologies-for example, computer software, Internet service, and wireless communications-have displayed extensive economies of scale. As these firms have grown, their long-run average total costs have declined because of greater use of specialized inputs, the spreading of product development costs, and learning by doing. Simultaneous consumption and network effects have also reduced costs. Economies of scale may lead to just one or two firms operating in an industry; they are experiencing lower ATC than many competitive firms. These economies of scale may be the result of spreading large initial capital cost over a large number of units of output (natural monopoly) or, more recently, spreading product development costs over units of output, and a greater specialization of inputs. Simultaneous consumption-Some firms have been able to achieve extensive economies of scale due to the ability to produce a single product that many consumers can simultaneously enjoy, like products that once produced can be downloaded over the Internet. Also, network effects can be a factor that gives rise to monopoly power. Network effects-Such network effects may drive a market toward monopoly because consumers tend to choose standard products that everyone else is using. The focused demand for these products permits their producers to grow rapidly and thus achieve economies of scale. Smaller firms get acquired or go out of business. Even if natural monopoly develops, the monopolist is unlikely to pass cost reductions along to consumers as price reductions. So, with perhaps a handful of exceptions, economies of scale do not change the general conclusion that monopoly industries are inefficient relative to competitive industries. Network effects occur when the value of a product rises as the total number of users rise. An example would be computer software or Facebook. The more people that use it, the more benefits of the product to each person using it. People tend to use products that everyone else is using. X-inefficiency-In constructing all the average-total-cost curves used in this book, we have assumed that the firm uses the most efficient existing technology. This assumption is natural because firms cannot maximize profits unless they are minimizing costs. X-inefficiency occurs when a firm produces output at a higher cost than is necessary to produce it. Why does X-inefficiency occur? Managers may have goals, such as expanding their power, avoiding business risk, or giving jobs to incompetent relatives, that conflict with cost minimization. X-inefficiency may also arise when a firm's workers are poorly motivated or ineffectively supervised. And a firm may simply become lethargic, relying on rules of thumb in decision making rather than careful calculations of costs and revenues. For our purposes the relevant question is whether monopolistic firms tend more toward X-inefficiency than competitive producers do. Presumably they do. Firms in competitive industries are continually under pressure from rivals, forcing them to be internally efficient to survive. But monopolists are sheltered from such competitive forces by entry barriers. That lack of pressure may lead to X-inefficiency. May occur in monopoly since there is no competitive pressure to produce at the minimum possible costs. Rent-seeking behavior-is any activity designed to obtain a transfer of income or wealth to a particular firm or resource supplier at someone else's, or even society's, expense. We have seen that a monopolist can obtain an economic profit even in the long run. Therefore, it is no surprise that a firm may go to great expense to acquire or maintain a monopoly granted by the government through legislation or an exclusive license. Such rent-seeking expenditures add nothing to the firm's output, but they clearly increase its costs. Taken alone, rent seeking implies that monopoly involves even higher costs and even less efficiency than suggested in 12.6b. Often occurs as monopolies seek to acquire or maintain government-granted monopoly privileges at someone else's expense. Such rent-seeking may entail substantial costs (lobbying, legal fees, public relations advertising, etc.), which are inefficient. Technological advance-In the very long run, firms can reduce their costs through the discovery and implementation of new technology. If monopolists are more likely than competitive producers to develop more efficient production techniques over time, then the inefficiency of monopoly might be overstated. In general, economists believe that a pure monopolist will not be technologically progressive. Although its economic profit provides ample means to finance research and development, it has little incentive to implement new techniques (or products). The absence of competitors means there is no external pressure for technological advance. Because of its sheltered market position, the pure monopolist can afford to be complacent and lethargic. There simply is no major penalty for not being innovative. One caveat: Research and technological advance may be one of the monopolist's barriers to entry. Thus, the monopolist may continue to seek technological advance to avoid falling prey to new rivals. In this case, technological advance is essential to maintaining the monopoly. Technological progress and dynamic efficiency may occur in some monopolistic industries but not in others. The evidence is mixed. Some monopolies have shown little interest in technological progress. On the other hand, research can lead to lower unit costs, which help monopolies as much as any other type of firm. Also, research can help the monopoly maintain its barriers to entry against new firms.

(Regulated Monopoly)

Natural monopolies traditionally have been subject to rate regulation (price regulation), although the recent trend has been to deregulate wherever competition seems possible. For example, natural gas distribution, wireless communications, and long-distance electricity transmission have been, to one degree or another, deregulated. And regulators in some states are beginning to allow new entrants to compete with existing local telephone and electricity providers. Nevertheless, state and local regulatory commissions still regulate the prices that most local natural gas distributors, regional telephone companies, and local electricity suppliers can charge. These locally regulated monopolies are commonly called public utilities. Socially optimal price: Set price equal to marginal cost. One sensible goal for regulators is to get the monopoly to produce the allocatively efficient output level. The trick is to set the regulated price Pr, at a level such that the monopoly will be led by its profit-maximizing rule to voluntarily produce the allocatively efficient level of output. Because the monopoly will receive the regulated price Pr, for all units that it sells, Pr, becomes the monopoly's marginal revenue per unit. Thus, the monopoly's MR curve becomes the horizontal line moving rightward from price Pr, on the vertical axis. The monopoly will at this point follow its usual rule for maximizing profits or minimizing losses: It will produce where marginal revenue equals marginal cost. As a result, the monopoly will produce where the horizontal MR (= Pr.) line intersects the MC curve at point r. That is, the monopoly will end up producing the socially optimal output Qr, not because it is socially minded but because Qr, happens to be the output that either maximizes profits or minimizes losses when regulators force the firm to sell all units at the regulated price Pr. The regulated price Pr, that achieves allocative efficiency is called the socially optimal price. Because it is determined by the intersection of the MC curve and the demand curve, the socially optimal price is often summarized by the equation P= MC. Fair return price: One option is to provide a public subsidy to cover the loss that the socially optimal price would entail. Another possibility is to condone price discrimination, allow the monopoly to charge some customers prices above Pr, and hope that the additional revenue that the monopoly gains from price discrimination is enough so that it can break even, with a zero economic profit. Regulators set a regulated price that is high enough for monopolists to break even and continue in operation. This price is called a fair-return price because of a Supreme Court ruling requiring regulatory agencies to allow regulated utility owners to enjoy a "fair return" on their investments. In practice, a fair return is equal to a normal profit. Even better, the regulator also guarantees that the monopoly firm will earn exactly a normal profit. One final point about allocative efficiency: By choosing the fair-return price Pf the regulator leads the monopoly to produce Qf units. This amount of output is less than the socially optimal quantity Qr, but it is more than the Qm units that the monopolist would produce if left unregulated. So, although fair-return pricing does not lead to full allocative efficiency. it is still an improvement on what the monopoly would do if left to its own devices. Set price equal to average total cost. Dilemma of regulation-Comparing results of the socially optimal price (P = MC) and the fair-return price (P = ATC) suggests a policy dilemma, sometimes termed the dilemma of regulation. When its price is set to achieve the most efficient allocation of resources (P = MC), the regulated monopoly is likely to suffer losses. The firm's survival would presumably depend on permanent public subsidies taken from general tax revenues. On the other hand, although a fair-return price (P = ATC) allows the monopolist to cover costs, it only partially resolves the underallocation of resources that the unregulated monopoly price would foster. Despite this dilemma, regulation can improve on the results of monopoly from the social point of view. Price regulation (even at the fair-return price) can simultaneously reduce price, increase output, and reduce the economic profit of monopolies. That said, we need to provide an important caution: Fair-price regulation of monopoly looks simple in theory but is amazingly complex in practice. In the actual economy, rate regulation is accompanied by large, expensive rate-setting bureaucracies and maze-like sets of procedures. Also, rate decisions require extensive public input via letters and public hearings. Rate decisions are subject to lengthy legal challenges. Further, because regulatory commissions must set prices sufficiently above costs to create fair returns, regulated monopolists have little incentive to minimize average total costs. When these costs creep up, the regulatory commissions must set higher prices. Regulated firms therefore are noted for higher-than-competitive wages, more managers and staff than necessary, nicer-than-typical office buildings, and other forms of X-inefficiency. These inefficiencies help explain the trend of federal, state, and local governments abandoning price regulation where the possibility of competition looks promising. When monopoly power results in an adverse effect upon the economy, the government may choose to intervene on a case-by-case basis. Government usually intervenes when they feel that the monopoly is a natural monopoly. The dilemma for regulators is whether to choose a socially optimal price, where P = MC, or a fair-return price, where P = ATC. P = MC is most efficient but may result in losses for the monopoly firm, at which point the government would have to subsidize the firm for it to survive. P = ATC does not achieve allocative efficiency but does insure a fair return (normal profit) for the firm.

(Monopoly Demand and Price)

The downward slope of the monopolist's demand curve has 3 important implications: Marginal revenue will be less than price-With a fixed downward sloping demand curve, the pure monopolist can increase sales only by charging a lower price. Consequently, marginal revenue--the change in total revenue associated with a one-unit change in output -is less than price (average revenue) for every unit of output except the first. The lower price of the extra unit of output also applies to all prior units of output. The monopolist could have sold these prior units at a higher price if it had not produced and sold the extra output. Each additional unit of output sold increases total revenue by an amount equal to its own price less the sum of the price cuts that apply to all prior units of output. (12.2 confirm this) (Table 12.1 column 4) (12.3) Monopolist is a price maker-All imperfect competitors, whether pure monopolists, oligopolists, or monopolistic competitors, face downward sloping demand curves. As a result, any change in quantity produced causes a movement along their respective demand curves and a change in the price they can charge. Firms with downward sloping demand curves are thus price makers. By controlling output, they can "make the price." (columns 1 & 2 Table 12.1) Monopolist sets price in the elastic region of the demand curve-When demand is elastic, a decline in price will increase total revenue. When demand is inelastic, a decline in price will reduce total revenue. The implication is that a monopolist will never choose a price-quantity combination where price reductions cause total revenue to decrease (marginal revenue to be negative. The profit-maximizing monopolist always wants to avoid the inelastic segment of its demand curve in favor of some price-quantity combination in the elastic region. (12.3a) In summary-MR is less than price after the first unit sold. A price maker is a firm with pricing power, which is the ability of the firm to set its own price. The monopolist sets the price in the elastic region of the demand curve so that revenues will be higher and costs lower. The monopolist avoids setting the price in the inelastic range of demand because doing so would reduce total revenue and increase costs.

(Last word)

"Big Data" available to Internet retailers. Ability to set a price according to consumer's perceived ability to pay. Based on your online buying habits, backgrounds, and preferences. Low price for those with elastic demand. Higher price for those with inelastic demand. Personalized pricing strategy can fail when consumers comparison shop. Internet companies collect vast amounts of data about us while we are online. This huge collection allows retailers with monopoly power to engage in an individually tailored form of price discrimination known as personalized pricing. Price discrimination is selling the same product to different buyers at different prices when the price differences are not justified by cost differences. Now, online retailers can set individualized prices for most of its patrons and attempts to set a price for each individual that is just below his or her reservation price which means that the retailer can get as much revenue as possible from each customer while still leaving the customer with a bit of consumer surplus. There are limits to this pricing strategy though. Very few firms have substantial monopoly power due to competing sellers for almost any item online. Also, it is difficult to figure out what a buyer's reservation price is. However, if customers do not shop around, they may end up paying much more than they had to.

(Economies of Scale: The Natural Monopoly Case)

12.1-Economies of scale: the natural monopoly case. A declining long-run average-total-cost curve over a wide range of output quantities indicates extensive economies of scale. A single monopoly firm can produce, say, 200 units of output at lower cost ($10 each) than could two or more firms that had a combined output of 200 units. Indicates economies of scale over a wide range of outputs. If total consumer demand is within that output range, then only a single producer can satisfy demand at least cost. Note, for example, that a monopolist can produce 200 units at a per-unit cost of $10 & a total cost of $2,000. If the industry has two firms & each produces 100 units, the unit cost is $15 & total cost rises to $3,000 (= 200 units × $15). A still more competitive situation with four firms each producing 50 units would boost unit & total cost to $20 & $4,000, respectively. Conclusion: When long-run ATC is declining, only a single producer, a monopolist, can produce any particular amount of output at minimum total cost. A declining long-run average-total-cost curve over a wide range of output quantities indicates extensive economies of scale. A single monopoly firm can produce, say, 200 units of output at lower cost ($10 each) than could two or more firms that had a combined output of 200 units.

(Price and Marginal Revenue in Pure Monopoly)

12.2-Price and marginal revenue in pure monopoly. A pure monopolist, or any other imperfect competitor with a downward sloping demand curve such as D, must set a lower price in order to sell more output. Here, by charging $132 rather than $142, the monopolist sells an extra unit (the fourth unit and gains $132 from that sale. But from this gain must be subtracted $30, which reflects the $10 less the monopolist charged for each of the first 3 units. Thus, the marginal revenue of the fourth unit is $102 (= $132 - $30), considerably less than its $132 price. A pure monopolist, or any other imperfect competitor with a downsloping demand curve such as D, must set a lower price in order to sell more output. Here, by charging $132 rather than $142, the monopolist sells an extra unit (the fourth unit) and gains $132 from that sale. But from this gain must be subtracted $30, which reflects the $10 less the monopolist charged for each of the first 3 units. Thus, the marginal revenue of the fourth unit is $102 ( $132 - $30), considerably less than its $132 price. We have graphed part of the monopolist's demand data in Table 12.1 as demand curve D in 12.2. This is the monopolist's demand curve and the market demand curve.

(Demand, Marginal Revenue, and Total Revenue for a Pure Monopolist)

12.3-Demand, marginal revenue, and total revenue for a pure monopolist. (a) Because it must lower the price on all units sold in order to increase its sales, an imperfectly competitive firm's marginal-revenue curve (MR) lies below its downward sloping demand curve (D). The elastic and inelastic regions of demand are highlighted. (b) Total revenue (TR) increases at a decreasing rate, reaches a maximum, and then declines. Note that in the elastic region, TR is increasing and hence MR is positive. When TR reaches its maximum, MR is zero. In the inelastic region of demand, TR is declining, so MR is negative. In summary-This graph reflects the demand, marginal revenue, and total revenue for a pure monopolist. Because it must lower the price on all units sold in order to increase its sales, an imperfectly competitive firm's marginal-revenue curve (MR) lies below its downsloping demand curve (D). The elastic and inelastic regions of demand are highlighted in the graph. Note, that in the elastic region, TR is increasing and hence, MR is positive. When TR reaches its maximum, MR is zero. In the inelastic region of demand, TR is declining, so MR is negative. Notice there is no supply curve for the monopolist. This is because there is no unique relationship between price and quantity supplied for the monopolist. Recall that MR equals P in pure competition and that the supply curve of a purely competitive firm is determined by applying the MR (=P) = MC profit-maximizing rule. At any specific market-determined price, the purely competitive seller will maximize profit by supplying the quantity at which MC is equal to that price. When the market price increases or decreases, the competitive firm adjusts its output. Each market price is thus associated with a specific output, and all such price-output pairs define the supply curve. At first glance we might suspect that the pure monopolist's MC is also its supply curve. But, in fact, the pure monopolist has no supply curve. There is no unique relationship between price and quantity supplied for a monopolist. Like the competitive firm, the monopolist equates marginal revenue and marginal cost to determine output, but for the monopolist marginal revenue is less than price. Because the monopolist does not equate marginal cost to price, it is possible for different demand conditions to bring about different prices for the same output. (To understand, refer to 12.4) Conclusion: There is no single, unique price associated with each output level Qm and so there is no supply curve for the pure monopolist.

(Profit Maximization by a Pure Monopolist)

12.4-Profit maximization by a pure monopolist. The pure monopolist maximizes profit by producing at the MR = MC output, here Qm= 5 units. Then, as seen from the demand curve, it will charge price Pm= $122. Average total cost will be A= $94, meaning that per-unit profit is Pm-A and total profit is 5 ×(Pm-A). Total economic profit is thus represented by the green rectangle. Graphs the demand, MR, ATC, and MC data of Table 12.1. The profit-maximizing output occurs at 5 units of output (Qm), where the MR and MC curves intersect. There, MR = MC. In summary-This graph demonstrates profit maximization by a pure monopolist. The pure monopolist maximizes profit by producing at the MR = MC output, here Qm = 5 units. Then, as seen from the demand curve, it will charge price Pm = $122. Average total cost will be A = $94, meaning that per unit profit is Pm - A and total profit is 5 × (Pm - A). Total economic profit is thus represented by the green rectangle. (Another way to determine the profit-maximizing output is by comparing total revenue and total cost at each possible level of production and choosing the output with the greatest positive difference. Use columns 3 & 6 in Table 12.1. An accurate graphing of total revenue and total cost against output will also show the greatest difference (the maximum profit).)

(The Loss-Minimizing Position of a Pure Monopolist)

12.5-If demand, D, is weak and costs are high, the pure monopolist may be unable to make a profit. Because Pm exceeds V (the average variable cost at the MR = MC output Qm), the monopolist will minimize losses in the short run by producing at that output. The loss per unit is A - Pm and the total loss is indicated by the red rectangle. Like the pure competitor, the monopolist will not persist in operating at a loss. Faced with continuing losses, in the long run the firm's owners will move their resources to alternative industries that offer better profit opportunities. A monopolist such as the one depicted in here must obtain a minimum of a normal profit in the long run or it will go out of business.

(Inefficiency of Pure Monopoly Relative to a Purely Competitive Industry)

12.6-In this set of graphs we will compare the inefficiency of pure monopoly relative to a purely competitive industry. (A)In a purely competitive industry, entry and exit of firms ensures that price (Pc) equals marginal cost (MC) at the minimum average total-cost output where Qc is produced. Both productive efficiency (P = minimum ATC) and allocative efficiency (P = MC) are obtained (here at Qc).(B) In pure monopoly, the MR curve lies below the demand curve. The monopolist maximizes profit at output Qm, where MR = MC, and charges price Pm. Thus, output is lower (Qm rather than Qc) and price is higher (Pm rather than Pc) than they would be in a purely competitive industry. Monopoly is inefficient since output is less than that required for achieving minimum ATC (here at Qc) and because the monopolist's price exceeds MC. Monopoly creates an efficiency loss (here triangle abc). There is also a transfer of income from consumers to the monopoly (here rectangle PcPmbd). 12.6a-The S = MC curve reminds us that the market supply curve S for a purely competitive industry is the horizontal sum of the MC curves of all the firms in the industry. Suppose there are 1,000 such firms. Comparing their combined supply curve S with market demand D, we see that the purely competitive price and output are Pc, and Qc. Recall that this price-output combo results in both productive efficiency and allocative efficiency. Productive efficiency is achieved because free entry and exit force firms to operate where ATC is at a minimum. The sum of the minimum-ATC outputs of the 1,000 pure competitors is the industry output, Qc. Product price is at the lowest level consistent with minimum average total cost. The allocative efficiency of pure competition results because production occurs up to the output at which price (the measure of a product's value or marginal benefit to society) equals marginal cost (the worth of the alternative products forgone by society in producing any given commodity). In short: P=MC=minimum ATC. The competitive market supply curve S has become the monopolist's MC curve, the summation of the individual MC curves of its many branch plants. (Because the monopolist does not have a supply curve, we have removed the S label.) The important change, however, is on the demand side. From the viewpoint of each of the 1,000 individual competitive firms, demand was perfectly elastic, and marginal revenue was therefore equal to the market equilibrium price Pc. Thus each competitive firm equated its marginal revenue of Pc dollars per unit with its individual marginal cost curve to maximize profits. But market demand and individual demand are the same to the pure monopolist. The firm is the industry, and thus the monopolist sees the downward sloping demand curve D shown in 12.6b. For the monopolist, marginal revenue is less than price, and graphically the MR curve lies below demand curve D. In using the MR = MC rule, the monopolist selects output Qm & price Pm. The monopolist finds it profitable to sell a smaller output at a higher price than do the competitive producers. Monopoly yields neither productive nor allocative efficiency. Note that the monopolist's output Qm is less than Qc the output at which average total cost is lowest. In addition, the monopoly price Pm is higher than the competitive price Pc that we know in long-run equilibrium in pure competition equals minimum average total cost. Thus, the monopoly price exceeds minimum average total cost, which means that the monopoly will not be productively efficient. The monopolist's underproduction also implies allocative inefficiency. Also note that for every unit between Qm & Qc marginal benefit exceeds marginal cost because the demand curve lies above the supply curve. By choosing not to produce these units, the monopolist reduces allocative efficiency because the resources that should have been used to make these units will be redirected instead toward producing items that bring lower net benefits to society. The total dollar value of this efficiency loss (or deadweight loss) is equal to the area of the gray triangle labeled abc in 12.6b.

(Price Discrimination Applied to Different Groups of Buyers)

12.7-Price discrimination applied to different groups of buyers. The price-discriminating monopolist represented here maximizes its total profit by dividing the market into two segments based on differences in elasticity of demand. It then produces and sells at the MR = MC output in each market segment. (For visual clarity, average total cost (ATC) is assumed to be constant. Therefore MC equals ATC at all output levels.) (a) The price discriminating monopolist charges a high price (here Pb) to small business customers because they have a relatively inelastic demand curve for the product. (b) The firm charges a low price (here Ps) to students because their demand curve is relatively elastic. The firm's total profit, the sum of the two green rectangles, exceeds the profit (not shown) that would have occurred had the monopolist charged the same price to all customers. The demand curve Db. in the graph on the left indicates a relatively inelastic demand for the product by business customers. The demand curve Ds in the right-hand graph reflects students' more elastic demand. The marginal revenue curves (MRb & MRs) lie below their respective demand curves, reflecting the demand -marginal revenue relationship. For visual clarity we have assumed that average total cost (ATC) is constant. Therefore, marginal cost (MC) equals average total cost (ATC) at all quantities of output. These costs are the same for both versions of the software and therefore appear as the identical straight lines labeled "MC = ATC." What price will the pure monopolist charge to each set of customers? Using the MR = MC rule for profit maximization, the firm will offer Qb units of the software for sale to small businesses. It can sell that profit-maximizing output by charging price Pb. Again using the MR = MC rule, the monopolist will offer Qs units of software to students. To sell those Qs units, the firm will charge students the lower price Ps.

(Rate Regulation of a Natural Monopoly)

12.8-(Key Graph) shows the firm's demand and the long-run cost curves. Due to extensive economies of scale, the demand curve cuts the natural monopolist's long-run ATC curve at a point where that curve is still falling. It would be inefficient to have several firms in this industry because each would produce a much smaller output, operating well to the left on the long-run ATC curve. In short, each firm's lowest average total cost would be substantially higher than that of a single firm. Therefore, efficient, lowest-cost production requires a single seller. We know by application of the MR = MC rule that Qm and Pm are the profit-maximizing output and price that an unregulated monopolist would choose. Because price exceeds average total cost at output Qm the monopolist enjoys a substantial economic profit. Furthermore, price exceeds marginal cost, indicating an underallocation of resources to this product or service. The socially optimal price Pr, found where D and MC intersect, will result in an efficient allocation of resources but may entail losses to the monopoly. The fair-return price, Pf, will allow the monopolist to break even but will not fully correct the underallocation of resources.

(Global Perspective 12.1)

Competition from foreign multinational corporations diminishes the market power of firms in the United States. Here are just a few of the hundreds of foreign multinational corporations that compete strongly with U.S. firms in certain American markets. So what, if anything, should the government do about monopoly? Economists agree that the government needs to examine monopoly on a case-by-case basis. Three general policy options are available: If the monopoly is achieved and sustained through anticompetitive actions, creates substantial economic inefficiency, and appears to be long-lasting, the government can file charges against the monopoly under the antitrust laws. If the firm is found guilty of monopoly abuse, the government can expressly prohibit it from engaging in certain business activities or can break the monopoly into two or more competing firms. An example of the breakup approach was the dissolution of Standard Oil into several competing firms in 1911. If the monopoly is a natural monopoly, society can allow it to continue to expand. If no competition emerges from new products, government may then decide to regulate its prices and operations. If the monopoly appears to be unsustainable because of emerging new technology, society can simply choose to ignore it. In such cases, society simply lets the process of creative destruction do its work.

(Examples of Monopoly)

In most cities, govt-owned or govt-regulated Public utility companies: Natural gas, Electric & Cable television & water company (all monopolies or virtually so.) In which a single firm has the bulk of sales in a specific market. Near monopolies: Intel-produces 80% of the central microprocessors used in personal computers. Illumina-produces 90% of the world's gene-sequencing machines. Google-smartphone operating system. Android-is installed on 87% of the world's cell phones. Professional sports teams-in a sense, monopolies because they are the sole suppliers of specific services in large geographic areas. With a few exceptions, a single major-league team in each sport serves each large American city. (If you want to see a live Major League Baseball game in St. Louis or Seattle, you must patronize the Cardinals or the Mariners, respectively.) In summary-Pure monopolies are rare, but many examples of near monopolies exist. Examples of a monopoly or a near-monopoly today include the gas company, electric company, and the cable TV company. Private companies such as Intel, which enjoys nearly 80% of the market for microprocessors, and Android, which is installed on 87% of the world's cell phones, provide examples of near monopolies. Even professional sports teams may enjoy being a monopoly in their respective geographical area. Of course, there's almost always some competition even for these firms.

(Misconceptions of Monopoly Pricing)

Not the highest price-Because a monopolist can manipulate output and price, people often believe it will charge the highest price possible. That is incorrect. (12.4) Total, not unit, profit-The monopolist seeks maximum total profit, not maximum unit profit. (12.4 & Table 12.1) Possibility of losses-The likelihood of economic profit is greater for a pure monopolist than for a pure competitor. In the long run, the pure competitor is destined to have only a normal profit, whereas barriers to entry mean that any economic profit realized by the monopolist can persist. In pure monopoly, there are no new entrants to increase supply, drive down price, and eliminate economic profit. But pure monopoly does not guarantee profit. The monopolist is not immune from changes in tastes that reduce the demand for its product. Nor is it immune from upward-shifting cost curves caused by escalating resource prices. If the demand and cost situation faced by the monopolist is far less favorable, the monopolist will incur losses in the short run. (12.4 & 12.5) In summary-The monopolist does not charge the highest possible price because the monopolist can't sell much output at that price and profits are too low. The monopolist is interested in total profit, not per unit profit. There is always the possibility that the monopolist will earn losses. Monopolists are not protected from changes in demand nor from changes in costs.

(Price Discrimination)

Price discrimination: can take three forms: Charging each customer in a single market the maximum price she or he is willing to pay. Charging each customer one price for the first set of units purchased and a lower price for subsequent units purchased. Charging some customers one price and other customers another price. Charging different buyers different prices Different prices are not based on cost differences Conditions for success: Monopoly power-The seller must be a monopolist or, at least, must possess some degree of monopoly power-that is, some ability to control output and price. Market segregation-At relatively low cost to itself, the seller must be able to segregate buyers into distinct classes, each with a different willingness or ability to pay for the product. This separation of buyers is usually based on different price elasticities of demand. No resale-The original purchaser cannot resell the product or service. This condition suggests that service industries, such as the transportation industry or the industries for legal and medical services, where resale is impossible, are good candidates for price discrimination. Price discrimination is defined as charging different prices to different buyers when such price differences are not justified by cost differences. Monopoly power means that the firm must have some pricing power. Pricing power is the ability of a firm to set its own price. Therefore we find price discrimination in all types of markets except perfect competition. Market segregation means that you have identified your different buyers and can separate your market based on their willingness to pay. No resale means that a low-price buyer is prevented from buying at the low price and reselling the good to a high price buyer. Otherwise, the price discrimination scheme would break down.

(Output and Price Determination Steps)

Table 12.2-Steps for Graphically Determining the Profit-Maximizing Output, Profit-Maximizing Price, and Economic Profit (if Any) in Pure Monopoly. In summary-The MR = MC rule will tell the monopolist where to find its profit-maximizing output level. This can be seen in Table 12.1 (slide 8) & Figure 12.4 (slide 12). The same result can be found by comparing total revenue and total costs incurred at each level of production. The pure monopolist has no supply curve because there's no unique relationship between price and quantity supplied. The price and quantity supplied will always depend on the location of the demand curve. (Cost data-On the cost side, we will assume that the monopolist hires resources competitively. It also employs the same technology and therefore has the same cost structure as the purely competitive firms that we studied. Columns 5 through 7 in Table 12.1 the cost data. MR=MC Rule-A monopolist seeking to maximize total profit will use the same rationale as a profit-seeking firm in a competitive industry. If producing is preferable to shutting down, it will produce the output at which marginal revenue equals marginal cost (MR = MC). Columns 4 & 7 in Table 12.1 indicates MR=MC. The demand schedule shown as columns 1 & 2 in Table 12.1 shows there's only one price MR=MC occurs.)

(Monopoly Demand Overview)

The pure monopolist is the industry. Monopolist demand curve is the market demand curve. Demand curve is downward sloping. Marginal revenue is less than price. We want to build a model of pure monopoly so that we can analyze monopoly price and output decisions. The following analysis of monopoly demand makes 3 assumptions: The monopoly is secured by patents, economies of scale, or resource ownership. The firm isn't regulated by any unit of govt. The firm is a single-price monopolist; it charges the same price for all units of output. Note: there is not a monopolist supply curve. The crucial difference between a pure monopolist and a purely competitive seller lies on the demand side of the market. The purely competitive seller faces a perfectly elastic demand curve at the price determined by market supply and demand. The pure competitor is a price taker that can sell as much or as little as it wants at the going market price. Each additional unit sold adds the amount of the constant product price to the firm's total revenue. Therefore marginal revenue for the competitive seller is constant and equal to product price.