How Monopolies Form and Survive Barriers to Entry How a ProfitMaximizing Monopoly Chooses Output and Price What are the Welfare Effects of a Monopoly A pure monopoly is where one ID: 416969
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Slide1
9 | Monopoly
• How Monopolies Form and Survive: Barriers to Entry
• How a Profit-Maximizing Monopoly Chooses Output and Price
• What are the Welfare Effects of a MonopolySlide2
A pure monopoly is where
one
firm produces all of the output in a market. Slide3
There are two types of monopoly, based on the types of barriers to entry they exploit. One is natural monopoly, where
the barriers
to entry are something other than legal prohibition. The other is
legal monopoly, where laws prohibit (or severely limit) competition.
How Monopolies Form: Barriers to Entry
Barriers to entry
are the legal, technological, or market forces that discourage or prevent potential competitors
from entering a market. Barriers to entry can range from the simple and easily surmountable, such as the cost of renting
retail space
, to the extremely restrictive. For example, there are a finite number of radio frequencies available for
broadcasting. Once
the rights to all of them have been purchased, no new competitors can enter the market.Slide4
Newly entering firms find it difficult to match the low average costs of an existing (large firm). If LRAC has a long slope to the right, then any firm that initially gets started in the market and builds
sacle
is likely to become a natural monopoly Slide5
Note how that the small scale firm depicted in the graph on the left is at a clear disadvantage. With demand given as in the graph, the profit maximizing price for the large firm is very low and to meet this price, the small firm will likely suffer losses, perhaps more than fixed costs, in which case it would simply choose to shut down.
The small firm must find a way to
specialize
itself and sell to its own captured clientele. It must find a way to segment the market and avoid competition from the large firm. It can do this by making a higher quality product using a patented process. This involves creating a legal monopoly for itself through patent protection law. Slide6
A patent gives the inventor
the exclusive legal right to make, use, or sell the invention for a limited time; in the United States, exclusive
patent rights
last for 20 years. The idea is to provide limited monopoly power so that innovative firms can recoup their investment in R&D, but then to allow other firms to produce the product more cheaply once the patent expires.
A trademark is an identifying symbol or name for a particular good, like Chiquita bananas, Chevrolet cars, or the
Nike “swoosh
” that appears on shoes and athletic gear. Roughly 1.9 million trademarks are registered with the U.S.
government. A
firm can renew a trademark over and over again, as long as it remains in active use
.
A
copyright
, according to the U.S. Copyright Office, “is a form of protection provided by the laws of the United States
for ‘original
works of authorship’ including literary, dramatic, musical, architectural, cartographic, choreographic,
pantomimic, pictorial
, graphic, sculptural, and audiovisual creations.” No one can reproduce, display, or perform a copyrighted
work without
permission of the author. Copyright protection ordinarily lasts for the life of the author plus 70 yearsSlide7
Businesses have developed a number of schemes for creating barriers to entry by deterring potential competitors from entering
the market. One method is known as
predatory pricing
, in which a firm uses the threat of sharp price cuts to discourage competition. Predatory pricing is a violation of U.S. antitrust law, but it is difficult to prove.Slide8
How a Profit-Maximizing Monopoly Chooses
Output and
PriceSlide9
Can a Monopoly Go Bankrupt ?Slide10
Are there substitutes for monopoly products?
In almost all cases of consumer behavior, there is a set of alternative choices from which to select. Very seldom do we have situations where people are forced to buy things (unless mandated by the government) with no option to buy something else instead.
The most obvious substitute for any product being sold now is saving. One can always decide to buy things later. Monopolies may be the only seller, but this doesn’t help if people decide to buy later and not now. The demand we have been discussing in class is a demand for output NOW, not later. In a very real sense, saving represents a risk for firms. If consumers decide to save a large portion of their income, there is no reason to produce now. This includes previous purchased durable products.
In addition, there is always foreign competitors. It may be that a company is the only domestic seller of a product, but this may not be true internationally. Typically, foreign suppliers reduce the power of domestic monopolies.
Finally, there is always a risk to monopolies of new products being offered. Bill Gates testified before Congress and stated that an alternative to the Windows operating brand could be successfully installed to every computer in a matter of hours
over the entire world
, if such a strong competitor arose. This was when 95% of operating systems were Microsoft brands. Slide11
Most people criticize monopolies because they charge too high a price, but in addition economists object
that monopolies do not
supply enough output to be
allocatively efficient. To
understand why a monopoly is inefficient, it is useful to compare it with the benchmark model of perfect competition. Allocative
efficiency
is a social concept. It refers to producing the optimal quantity of some output, the quantity where
the marginal
benefit to society of one more unit just equals the marginal cost. The rule of profit maximization in a world
of perfect
competition was for each firm to produce the quantity of output where P = MC, where the price (P) is a measure
of how
much buyers value the good and the marginal cost (MC) is a measure of what marginal units cost society to produce
.
Following this rule assures allocative efficiency. If P > MC, then the marginal benefit to society (as measured by P)
is greater
than the marginal cost to society of producing additional units, and a greater quantity should be produced. But
in the
case of monopoly, price is always greater than marginal cost at the profit-maximizing level of output. Thus, consumers will suffer from a monopoly because a lower quantity will be sold in the market, at a higher price, than would have been the case in a perfectly competitive market.
Welfare Aspects of Monopoly