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Monopoly
This document discusses monopolies and provides examples and analysis. It begins by defining key characteristics of monopolies, including that there is a single firm producing the entire supply of a product without competitors. It then analyzes how a monopolist determines the profit-maximizing level of output and price, finding where marginal revenue equals marginal cost and charging the highest price the market will bear. The document emphasizes that barriers to entry, such as legal harassment, patent protection, exclusive licensing, and bundled products, allow monopolies to exist and earn economic profits.
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Monopoly
- 1. Monopoly “Give ‘em anycolor they want so long as it is black” -Henry Ford’s response to requests for more colors on the popular Model T Slide 1 of 23
- 2. We now continuein our study of firm behavior… Slide 2 of 30 We now turn our attention to an environment where there is not any competition. In this module, we’ll explore how monopolies behave, how they make decisions, and how they compete (or more specifically how they do not!). It covers a key learning outcome and if you continue to study economics, you will see it all again.
- 3. Monopoly…one firm…lots ofmarket power. If you want to buy it, you have to buy it from them. We now turn our attention to the second market structure - monopolies Perfect Competition Monopolistic Competition Oligopoly Duopoly Monopoly Slide 3 of 23
- 4. Recall the characteristicsof monopoly Perfect Competition Monopolistic Competition Oligopoly Duopoly Monopoly At this end of this spectrum, there is no competition. Mono means one. Only one firm exists. Characteristics of a monopoly: A single firm produces the entire supply of a product This means that the producer does not face competitors. Examples might include a cable or power provider in a rural area. The producer’s product does not have substitute Firms are price makers There are substantial, often insurmountable barriers to entry This means that buyers cannot switch to another product. If you want to buy it, you must buy it from the monopolist. Examples include Windows or diamonds. This means that producers can set the price as high as the market will bear. Examples include property owners. This means that it is very difficult to begin producing this product. Imagine trying to start a professional sports league. Examples include the NFL and NBA. Monopolies Slide 4 of 23
- 5. Monopolistic industries also haveunique qualities • The product has no substitutes • There is one supplier-the firm is the industry • There are substantial, sometimes insurmountable barriers to entry • Firms are “price makers” • Producers face a downward sloping demand curve The Characteristics of a Monopolistic Industry These characteristic will be described a little later. Monopolies The next slide will provide an example for these. Slide 5 of 23
- 6. Microsoft acts asa monopolist The product has no substitutes Some of you might say, “what about Red Hat”, but most of us have never even seen it. There is only one supplier If you want a PC operating system, you must buy it from Windows (for 90+% of us) There are insurmountable barriers to entry Go ahead and design an operating system and try to compete with Microsoft. How do you think you’ll do? Here are some other’s who have competed with Microsoft and lost: Monopolies Monopolistic Characteristic Comment Slide 6 of 23
- 7. Key characteristics ofa monopoly as compared to perfect competition Monopolies Slide 7 of 23
- 8. The monopolist’s demand curveis downward sloped Monopolies We saw that a perfectly competitive firm’s demand curve was perfectly elastic. For a monopolist the demand curve is downward sloped. It is the same as the industry’s demand curve. Why? Because the monopolist is the industry. If a good or service is demanded and it is produced by a monopolist, it is demanded from the monopolist. Monopolist’s Demand Slide 8 of 23
- 9. A monopolist’s productiondecision Monopolists determine their profit maximizing rate of output the same way a perfectly competitive firms do: The profit maximizing rate of output is where MR=MC Monopolies They determine price differently. My perfectly competitive counterparts take the price that the market gives them. I am the market. I don’t have to take the market price, I can choose the price that maximizes MY profit. I am a “Price Maker”. Slide 9 of 23
- 10. To see howa monopolist determines price, we first need to calculate their marginal revenue For a perfectly competitive firm, the market would buy as much as the firm could produce. They had no influence on price because they were an insignificant part of the market. Monopolies For a monopolist, they can lure more buyers with a lower price. They do have an impact on the market because they are the market. In this scenario, for each ten dollar reduction in price, an additional unit is demanded. Unlike perfectly competitive firms, monopolists must consider price. Slide 10 of 23
- 11. To see howa monopolist determines price, we need to first calculate their marginal revenue With a perfectly competitive firm, marginal revenue was constant. Each successive unit sold brought in the same revenue. Specifically, it brought in the market price. Monopolies For a monopolist, marginal revenue varies as you can see in the table. Be sure you understand how the last two columns are calculated. Recall: Slide 11 of 23
- 12. Monopolists do nothave unlimited pricing power Let’s review one important point. We call monopolists price makers because they influence price – they get to select the price that maximizes their profit. That does not mean they have unlimited power to charge anything they want. Remember that we as consumers still have one choice…we can go with out this good! At a price of $190, there is no demand. A monopolist must lower price to “lure in” customers. Slide 12 of 23
- 13. Marginal revenue, seengraphically Monopolies Again, note the downward sloping demand curve that the monopolist faces. Recall that for a perfectly competitive firm, Demand equaled MR. They were the same curve. For a monopolist they are not! The MR curve will be more steep. As price is lowered for one unit, it is lowered for all the units and that reduces marginal revenue. Slide 13 of 23
- 14. Let’s analyze theproduction decision of a monopolist Monopolies Henry Ford, 1919 Using the price, demand, and revenue data we looked at in the last few slides, we can illustrate how a monopolist such as Henry Ford may have made two key decisions: #1 – How many units do I want to produce? #2 – What price do I want to charge for each one? In order to analyze these decisions we need some costs data- specifically marginal cost (MC) and Average Total Cost (ATC). I’ll make those up for the next slide… Slide 14 of 23
- 15. Determining profit maximizingoutput and price for a monopolist Here we have added the MC curve Monopolies Like the perfectly competitive firm, the monopolist will maximize profit where MR=MC. But what price will the monopolist charge? The monopolist will charge as much as the market will bear. Follow the intersection of MR=MC all the way up to the demand curve. So how much profit will this monopolist earn? We need to add the ATC curve to determine that. Much like the perfectly competitive firm, the monopolist’s profit will be measured by this profit box. It is the difference between the price of the good and the average cost per unit (i.e. profit per unit)… …times the number of units sold. In this case it is about $38 (profit per unit) times 6 units… which is $230 in economic profit. Slide 15 of 23 Now we see how a monopolist makes a decision based on marginal benefit (revenue) – marginal cost analysis….a key learning outcome!
- 16. Let’s conduct thesame analysis from a table. Monopolies Determining profit maximizing output and price for a monopolist, in a table With no units produced, profit will be -$100, which are the fixed costs.With one unit produced, profit will be -$10, but MR>MC so expand production. With two units produced, profit will be $70, but MR>MC so expand production. With six units produced, profit will be $230, and MR=MC. The monopolist should stop there. With output above 6 units, MC>MR. The monopolist should not produce these units - they cost more to make than they bring in! One additional note- You might notice that profit is the same if the monopolist produced 5 units or 6 units. In these cases, always choose the higher output. This happens whenever MR=MC at a whole unit of output, such as 6. You could argue that the monopolist should not produce the 6th unit and have a good case. But think of it this way: the additional unit might expand your market and provide word of mouth advertising! Slide 16 of 23
- 17. Individual Exercise What isthe profit maximizing level of output for this monopolist? What is the profit at that output? Monopolies 5 units $225 Please fill in the blank cells and answer the two questions below. Click to see the answers. Slide 17 of 23
- 18. Individual Exercise Profit Monopolies Please graphthe following : The demand, MR, MC, and ATC curves, and the profit box. Slide 18 of 23
- 19. Barriers to entryallow the monopolist to exist Monopolies Recall, for perfectly competitive industries, the existence of economic profits would lure other firms into competition. For monopolistic industries, this doesn’t happen because there are barriers to entry. And with no barriers to entry, there is nothing stopping those firms from jumping in! Slide 19 of 23
- 20. Examples of barriersto entry • Legal Harassment – In the 1990s, a small Massachusetts firm was caught hacking into Microsoft code – Microsoft filed a lawsuit against it for hacking into their software. – The army of lawyers that Microsoft is capable of unleashing upon you certainly could act as a barrier to entry! Monopolies • Patent Protection – Polaroid developed the Instant camera. They quickly patented it – Kodak, copied it and sold their own – Polaroid sued Kodak and won a $910 million verdict – The lawsuit put Kodak out of the instant camera market for good (that is some barrier!) Slide 20 of 23
- 21. Examples of barriersto entry (Part 2) Monopolies • Exclusive licensing – As a consultant, I was required to sign a no-compete agreement upon hiring – Upon leaving the company, I could not compete with them for 7 years – That is a serious barrier for me to enter an industry • Bundled products – Producers can sell packages of products to ensure users avoid a competitors product – Bundling Explorer and Office products allowed Microsoft to obtain 96% of the browser market (Over Netscape) and 94% of the word processor market (over WordPerfect) Slide 21 of 23
- 22. Examples of barriersto entry (Part 3) Monopolies • Government Franchises – In some cases, government’s allow monopolies – Why, it would be silly to have multiple sets of power lines all over town – If the government gives you a franchise that means others can’t enter the market, another example of a barrier to entry • Predatory actions – These are my favorite – Predatory action are borderline unethical or illegal actions designed to keep competitors out – The next 2 slides give a good example Slide 22 of 23
- 23. A real worldapplication of predatory actions as a barrier to entry John D. Rockefeller was the Chairman of Standard Oil. Monopolies He dominated the oil and fuel industries in the early 1900s. He was known to arrive in a town and offer a gas station owner shares of his company in exchange for their station. Those that agreed became rich. Those that did not woke up to find him opening a gas station near theirs. He gave the gas away until the gas station owner went out of business. Then, as the only producer (monopolist) he restricted output and drove prices higher. Slide 23 of 23
- 24. In Summary Unlike perfectlycompetitive firms, monopolies are the only sellers. This gives them market power – allowing them to have some control over price (They are price takers) As a result, they can earn significant economic profits. In perfect competition, the entry of new firms causes that economic profit to eventually fade away. For a monopoly, barriers to entry ensure that they get to continue to enjoy those profits! Slide 24 of 23