Chapter 10

Monopoly
 Learning Objective
• We'll look at these topics:
1. The graph of the monopolist.
2. How monopolist's profits are calculated.
3. The monopolist in the short run and long run.
4. Barriers to entry.
5. Limits to monopoly power .
6. Economies of scale and natural monopoly
7. What makes bigness bad?
 Monopoly Defined
 A monopoly is the ONLY firm in an industry.
• No one produces the output nor sells the monopolist's product.
• There are local monopolies.

Examples: local hardware store, dry cleaners, drugstore.

• There are national/regional monopolies.
some examples are diamonds dealers, gas and electric companies, and local phone
companies.
 A monopoly produces ALL the output in an industry.
 There are no close substitutes available for the product or service.
 The Graph of the Monopolist
 Monopoly is the first of three types of imperfect competition.
• the other two are monopolistics competition and oligopoly.

 The distinguishing characteristic imperfect competition is that the firm's

demand curve slopes downward to the right.
• this means the imperfect competitors has to lower price to sell more.
 The Graph of the Monopolist
• the imperfect competitor has to lower price to sell more.
Hypothetical Demand and Cost Schedule
for a Monopoly
Output Prices Total Marginal Total ATC MC
revenue Revenue Cost
1 16 20
2 15 30
3 14 36
4 13 42
5 12 50
6 11 63
7 10 84

Try completing the column for TR, MR, ATC and MC.
Hypothetical Demand and Cost Schedule
for a Monopoly
Output Price Total Marginal Total ATC MC Total
Revenue revenue Cost Profit
1 16 16 16 20 20 ______ -4
2 15 30 14 30 15 10 0
3 14 42 12 36 12 6 6
4 13 52 10 42 10.50 6 10
5 12 60 8 50 10 8 10
6 11 66 6 63 10.50 13 3
7 10 70 4 84 12 21 -14
 The Monopolist Making a Profit
• Here is a graph of the previous time.
 Questions for Further Discussion
Output Prices Total Marginal Total ATC MC
Revenues Revenue Cost
1 21 30
2 20 40
3 19 48
4 18 57
5 17 70
6 16 93
 Question for Further Discussion
Output Prices Total Marginal Total ATC MC Total
Revenues Revenue Cost Profit
1 21 21 21 30 30 _____ -9
2 20 40 19 40 20 10 0
3 19 57 17 48 16 8 9
4 18 72 15 57 14.25 9 15
5 17 85 13 70 14 13 15
6 16 96 11 93 15.50 23 3

 Q* is where MC = MR, or 5
 Profit = (P- ATC) x Q*
 Profit = (17- 14) x 5 = 3x5= 15
Questions for Further Discussion
 The Monopolist Losing Money
• If costs are too high relative to the price, the monopolist can lose money.
• What would that graph look like?
 The Monopolist Losing Money
• The calculation of the loss is still the same.
• MC=MR Q* = 200
• Loss = (P- ATC) x Q* or (18 - 21)x 5 = -15
 The Monopolist in the Short Run and the
Long Run
There is no distinction between the short run and the long
run for the monopolist.
• If there is a demand for their product or service, they
make a profit (economic profits).
• If there is not enough demand for their product for them to
make a profit, they go out of business.
 Are All Monopolies Big Companies?
 No... many monopolies are tiny firms operating in a very small market.
• What matters is size relative to the market the proverbial big fish in a small
pond.
• Chances are there is only one bookstore on your campus.
-it is not nearly as big as Barnes and Noble or Borders.
• The only grocery store in a very small community would be a monopoly.
-There are tens of thousands of gas stations, convenience stores, restaurant,
cleaners, and repair shops that have monopolies in their communities.
 Barriers to Entry
 Monopolies are created and/or maintained through barriers to entry. How?
1. control over an essential resources.
-Example: Debeers' land (mines): NFL's skilled labor/talent.
2. Economies of scale
3. Legal Barriers
- Examples: licensing, franchises (including government franchises). and patent.
- is there BOTH Cola-cola and Pepsi on your campus.
4. Required scale for innovation
-Large firms tend to buy ideas and sell them.
5. Economies of being established.
 Economies of Scale
• Typically, heavy industry with high start-up costs: iron, steel,copper, aluminum, and
automobiles.
-Once the plant and equipment are in place, you can take advantage of economies scale
with high volumes of output.
 Limits to Monopoly Power
The ultimate limit to monopoly power may come from the
government or from the market itself.
-If a firm gets too big or too bad, or both. the
government may decide to step in using antitrust laws.
-The market limits monopoly power basically through
the development of substitutes.
Economies of Scale and Natural Monopoly
• There are only two justifications for monopoly
-Economies of Scale justify bigness because sometimes only a firm with
the capability of very large output can produce anywhere close to the mininum
points of its ATC.

-A Natural Monopoly is a situation where one firm is able to provide a

service at lower cost than could several competing firms.
Examples : Local Utilities such as gas and electric companies: local phone
companies (though less and less); local cable company.
One Electric Company is Better than Four

Panel A shows a single electric transmission feeder cable

serving all the homes in 1 block. Panel B shows 4 cables serving that same block. It is a lot
more efficient ( and cheaper) to have one cable than four.

But what would be wrong with 1 cable shared by a 4 companies?

 Today Rationale for Natural Monopoly
 Today, the rationale for natural monopoly is disappearing.
- In more than half of the United States, the electric power industry has been
deregulated, so that local electric monopolies are getting a great deal of competition.
-Once the transmission cables were laid, it became possible under deregulated for
competition to develop, and the rationale for monopoly no longer was laid.
- The original local phone or electric company was a natural monopoly, but once we're
all connected, then let the competition begin -as long as enough firms stay in the market to
ensure competition.
 Two Policy Alternative
• Two ways to prevent public utilities from charging
outrageous prices.
1. Government Regulation
2. Government Ownership
 Is Bigness Good or Bad?
When Is Bigness Bad?

 Monopolies tend to be inefficient because they do not produce at the

minimum point on their ATC.
- This prevent resources from being allocated in the most efficient manner.

 Big business always has great political power.

- Economic power is easily converted into political power.

 The Monopolist may engage in price discrimination.

 The Corporate Hierarchy
Bigness can lead to inefficiency and exorbitant CEO pay.
 Is Bigness Good or Bad?
When is Bigness Good?

• Natural monopolies can take advantage of economies of scale and deliver

services much more cheaply than a multitude of competing firms.

• It is probably OK if a firm is big because that means it is very good.

• If a firm is big because it is bad, that is another story.

 The Economies Case Against Bigness
 Because there is no competition, there is no great incentive to control cost or
to use resources efficiently.

 There is no need to spend much money on research and development, to

improve processes, to develop new products, or to be responsive to
customer needs.

 A monopolist can charge higher prices and provide poorer quality and service
 Conclusion
• Natural Monopolies are probably Ok, but only if they do not abuse
their power.
• Monopolies based on other factors must be looked on with
suspicion.
- They may be up to no good.
- They may even be illegal
• Any monopoly must pass the test of whether or not there are
close substitutes.
- who decides this? The buyers do.
Chapter Issue: Would You Allow Wal-Mart to Open a
Supercenter in Your Community?
• Pros
- Wal-Mart charges is low prices. who can resist the bargains?
- Wal-Mart imports 20 billion a year in goods from China.
- Wal-Mart runs an efficient, lean and mean organization.
- Low income customers save about 1,000 a year with higher income customers
saving even more.
- Wal-Mart saves consumers over a 100 billion a year.
- Every new store is flooded with applicants, even with the low wages they offer.
- Wal-Mart kept stores open during hurricane Katrina and didn't gouge but continued
their policy of lowest prices.
Chapter Issue: Would You Allow Wal-Mart to Open a
Supercenter in Your Community?
• Cons:
- Wal-Mart's full time employees' wages average only 10 an hour, 30% less
than its competitors.
- Wal-Mart import 20 billion a year in goods from China, adding to our trade
deficit and putting Americans out of work.
- Wal-Mart runs a ruthless, lean and mean organization.
- Less than half have any kind of health insurance.
- Wall-Mart has been accused of discriminition against women
employees and mistreatment of employees in some instances.
- Wall-Mart has driven smaller retailers out of business.
 Chapter Issue: Would You Allow Wal-Mart to
Open a Supercenter in Your Community?
• Many communities oppose Wal-Mart opening new stores because
of the cons.

• Other communities welcome Wal-Mart opening a store because of

their pros.

• Like always , it's you (through local planning boards) who decides
one way or the other.