IMPERFECT COMPETITION:

MONOPOLY NOTES

Definition
- A market structure characterized by a single seller of a product with no good
substitutes.
- Monopolist is the industry; because a monopolist is the sole provider of a desired
commodity
- Monopolists face no effective competition for specific products from either
established or potential rivals
- Monopolists are price makers that exercise significant control over market prices.
- This allows the monopolist to simultaneously determine price and output for
the firm

Aggressive Monopolists in the Philippines

- Roberto Benedicto (sugar industry)
- Eduardo ‘Danding’ Cojuangco (coconut industry)
- Herminio Disini (tobacco industry & logging concessions)
- Don Eugenio Lopez Sr. (electricity)
- Lucio Tan (tobacco industry)

Basic Features
- A single seller. A single firm produces all industry output. The monopoly is the
industry.
- Unique product. Monopoly output is perceived by customers to be distinctive and
preferable to its imperfect substitutes.
- Blockaded entry and/or exit. Firms are heavily restricted from entering or leaving the
industry.
- Imperfect dissemination of information. Cost, price, and product quality information is
withheld from uninformed buyers.
- Opportunity for economic profits in long-run equilibrium. Distinctive products allow
P>MC and P=AR>AC for efficient monopoly firms.

Examples
- Public utilities, including electricity, gas, and sanitary services
- Basic phone service was also provided by regulated monopolies, but technical
innovations have undermined many traditional telecommunications monopolies and
rendered much of the established regulation obsolete.
- On an international level, the Organization of the Petroleum Exporting Countries
(OPEC) has long been criticized for its aggressive use of monopoly power to restrict
output, create soaring oil prices, and wreak economic havoc. At the same time,
OPEC’s share of world oil production is trending down from a bit more than one-third
of world oil production, and overproduction by cheating members continues to
undermine OPEC’s position.
Profit Maximization
Price-Output Decision
- Under monopoly, the market demand
curve is identical to the firm demand
curve. Because market demand curves
slope downward, monopolists also face
downward-sloping demand curves.
- Profit maximization requires that firms
operate at the output level at which
marginal revenue and marginal cost are
equal. However, in monopoly markets,
firms are price makers. Their individual
production decisions have the effect of
setting market prices.
- Given a downward-sloping monopoly demand curve, price always exceeds marginal
revenue under monopoly. This stems from the fact that price is average revenue, and
a downward-sloping demand curve requires that marginal revenue is less than
average revenue.
- In a competitive market, P=MR=MC=AC in long-run equilibrium. In monopoly
markets, profit maximization also requires MR=MC, but barriers to entry make above-
normal profits possible and P>AC in long-run equilibrium.

Role of Marginal Analysis

- Monopoly profits are maximized when Mπ = MR − MC = 0 because this point of profit
maximization occurs where marginal revenue is set equal to marginal cost, an equivalent
expression that must be met for profit maximization in both competitive and
monopoly markets is that MR = MC.
- An added condition for profit maximization by monopoly firms, sometimes referred to
as a second-order condition, is that total profits must always be decreasing beyond
the point where MR = MC.
- Two factors make profit maximization by monopoly firms unique. Like all markets,
monopoly markets are characterized by downward-sloping demand curves. However,
because the monopoly firm serves the entire market, the monopoly firm demand
curve is downward sloping. This means that the monopoly demand curve is always
above the marginal revenue curve in monopoly markets P = AR > MR, because profit
maximization requires MR = MC, price will always exceed marginal cost at the profit-
maximizing point in monopoly markets. The role of marginal analysis in monopoly
firm profit maximization can be further illustrated by considering the analytic solution
to the CSI profit maximization problem.

Social Costs of Monopoly

- From a social perspective, the most closely focused upon source of inefficiency tied
to monopoly stems from the fact that monopoly firms have incentives to restrict
output so as to create scarcity and earn economic profits. Monopoly
underproduction results when a monopoly curtails output to a level at which the
marginal value of resources employed (measured by the marginal cost of production)
is less than the marginal social benefit derived. Marginal social benefit is measured
by the price that customers are willing to pay for additional output.
 - The tendency for monopoly firms to restrict output to increase prices and earn
economic profits gives rise to a deadweight loss from monopoly problems. Like any
restriction on supply, the reduced levels of economic activity typical of monopoly
markets create a loss in social welfare due to the decline in mutually beneficial trade
activity. The deadweight loss from the monopoly problem can be demonstrated by
considering the loss in social welfare that would occur if an important competitive
market was converted into a monopoly market.
- In addition to the deadweight loss from the monopoly problem, there is a wealth
transfer problem associated with monopoly. The creation of a monopoly results in the
transformation of a significant amount of consumer surplus into producer surplus. In
a free market, the value of consumer surplus is equal to the region under the market
demand curve that lies above the market equilibrium price. Under monopoly, the
value of consumer surplus is equal to the region under the market demand curve that
lies above the monopoly price.
- From the viewpoint of consumers, the problem with monopoly is twofold. Monopoly
results in both a significant deadweight loss in consumer surplus and a significant
transfer of consumer surplus to producer surplus. The wealth transfer problem
associated with monopoly is seen as an issue of equity or fairness because it
involves the distribution of income or wealth in the economy. Although economic
profits serve the useful functions of providing incentives and helping allocate
resources, it is difficult to justify monopoly profits that result from the raw exercise of
market power rather than from exceptional performance.

Social Benefits of Monopoly

Economies of Scale
- Monopoly is sometimes the result of vigorous competition. A natural monopoly is a
market in which the market-clearing price occurs at a point at which the monopolist’s
long run average costs are still declining. It is when a firm is capable of producing the
goods and services desired by customers at a lower total cost than could a number
of smaller competing firms. It evolves in markets subject to overwhelming economies
of scale in production created by extremely large capital requirements, scarce inputs,
insufficient natural resources, and so on. In such instances, the market-dominant
firm(the natural monopoly) is the most economically efficient firm. However, there is a
potential risk that an established natural monopolist could use its dominance of the
marketplace to unfairly restrict production(underproduce) and raise prices to further
enhance economic profits. Many real-world monopolists owe their existence to
government-created or government-maintained barriers to entry. Moreover, when
natural monopoly does in fact evolve in industry, it is often a temporary phenomenon.

Invention and Innovation

- To achieve the benefits flowing from dynamic, innovative, leading firms, public policy
sometimes confers explicit monopoly rights. For example, patents grant an
exclusive right to produce, use, or sell an invention or innovation for a limited period
of time. Without patents, competitors could quickly develop identical substitutes for
new products or processes, and inventing firms would fail to reap the full benefit of
their technological breakthroughs. In granting patents, the public confers a limited
opportunity for monopoly profits to stimulate research activity and economic growth.
 Additionally, firms cannot use patents to monopolize or otherwise unfairly limit
competition.
- It is important to recognize that monopoly is not always socially harmful. In the case
of Microsoft Corp, their developments in computer software technology has helped
transform work, play, and communication. Today, computer users can contact people
and access information from around the world in an instant. Groundbreaking
computer technologies have also opened the door to innovations in related fields of
human endeavor, like biotechnology, delivering new opportunity, convenience, and
value. It is also important to recognize that monopoly profits are often fleeting. Early
profits earned by firms like Microsoft attract a host of competitors. Still, the
tremendous social value of invention and innovation often remains long after early
monopoly profits have dissipated.

Monopoly Regulation
(https://thismatter.com/economics/monopoly-regulation.htm)

- Public utility regulation aims to enjoy the benefits of low-cost production by large
firms while avoiding the social costs of unregulated monopoly.

Dilemma of Natural Monopoly

- In the public utility sector, average costs sometimes decline as output expands, and
a single large firm has the potential to produce total industry output more efficiently
than any group of smaller producers. Demand equals supply at a point where the
industry long-run average cost curve is still declining. Natural monopoly describes
this situation because monopoly is a natural result of the superior efficiency of a
single large producer.
- Natural monopoly poses a dilemma because monopoly has the potential for greatest
efficiency, but unregulated monopoly can lead to economic profits and
underproduction. One possible solution is to allow natural monopoly to persist but to
impose price and profit regulations.

Utility Price and Profit Regulation

- The most common method of monopoly regulation is price and profit control. Such
regulations result in larger output quantities and lower profits than would be the case
with unrestricted monopoly.
- To determine a fair price, a regulatory commission must estimate a fair, or normal,
rate of return, given the risk inherent in the enterprise. The commission then
approves prices that produce the target rate of return on the required level of
investment.

Problems with Utility Price and Profit Regulation

- Although the concept of utility price and profit regulation is simple, several practical
problems arise in public utility regulation. In practice,(1) it is impossible to exactly
determine cost and demand schedules, or the minimum investment required to
support a given level of output. Moreover, because utilities serve several classes of
customers, many different rate schedules could produce the desired profit level.
- (2)Regulators also make mistakes with regard to the optimal level and growth of
service. For example, if a local telephone utility is permitted to charge excessive
rates, the system will grow at a faster-than-optimal rate. Similarly, when the allowed
rate of return exceeds the cost of capital, electric, gas, and water utilities have an
incentive to overinvest in fixed assets and shift to overly capital-intensive methods of
production. In contrast, if prices allowed to natural gas producers are too low,
consumers will be encouraged to deplete scarce gas supplies, producers will limit
exploration and development, and gas shortages can occur. If gas prices are too low
and offer only a below-market rate of return on capital, necessary expansion will be
thwarted.
- (3) A related problem is that of regulatory lag, or the delay between when a change in
regulation is appropriate and the date it becomes effective. More recently, rapid
changes in technology and competitive conditions have rendered obsolete many
traditional forms of regulation in the electricity and telecommunications industries.
When regulators are slow to react to such changes, both consumers and the industry
suffer.
- (4) Traditional forms of regulation can also lead to inefficiency. If a utility is
guaranteed a minimum return on investment, operating inefficiencies can be offset by
higher prices. The process of utility regulation itself is also costly. Detailed demand
and cost analyses are necessary to provide a reasonable basis for rate decisions. It
is expensive to pay regulatory officials, full-time utility commission staffs, record-
keeping costs, and the expense of processing rate cases. All of these expenses are
ultimately borne by consumers. Although many economists can see no reasonable
alternative to utility regulation for electric, gas, local telephone, and private water
companies, the costs and inefficiency of such regulation are troubling.