MONOPOLY

RODMAN T. CAJES
SEPTEMBER 10, 2021
Adapted from Boundless Economics
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COURSE AGENDA
• Introduction to Monopoly
• Barriers to Entry
• Impacts of Monopoly on Efficiency
• Price Discrimination
• Monopoly in Public Policy
• Ice breaker
• Let’s Practice
• References
COURSE OBJECTIVES
• Differentiate monopolies and competitive markets
• To know the barriers to entry or the reasons for monopolies to
exist
• Know the impact of monopoly on effeciency
• Examine and analyze price discrimination
• Discuss the Public Policy on monopoly
Introduction to Monopoly

A monopoly is a specific type of economic market structure. A monopoly exists when a

specific person or enterprise is the only supplier of a particular good. As a result, monopolies
are characterized by a lack of competition within the market producing a good or service.

Monopoly characteristics include profit maximizer, price maker, high barriers to entry,
single seller, and price discrimination.

Sources of monopoly power include economies of scale, capital requirements,

technological superiority, no substitute goods, control of natural resources, legal
barriers, and deliberate actions.
 There are a few similarities between a monopoly and competitive market: the cost functions
are the same, both minimize cost and maximize profit, the shutdown decisions are the same,
and both are assumed to have perfectly competitive market factors.

Differences between the two market structures including: marginal revenue and price,
product differentiation, number of competitors, barriers to entry, elasticity of demand, excess
profits, profit maximization, and the supply curve.

The most significant distinction is that a

monopoly has a downward sloping demand instead
of the “perceived” perfectly elastic curve of the
perfectly competitive market.
Barriers to Entry: Reason for Monopolies to Exist

1. Resource Control
Control over natural resources that are critical
to the production of a good is one source of
monopoly power. Single ownership over a resource
gives the owner of the resource the power to raise
the market price of a good over marginal cost
without losing customers to competitors. In other
words, resource control allows the controller to
charge economic rent. This is a classic outcome of
imperfectly competitive markets.

De Beers is a classic example of a monopoly based on

a natural resource. De Beers had a lot of market power
in the world market for diamonds over the course of the
20th century, keeping the price of diamonds high.
2. Economies of Scale and Network Externalities

Economies of scale and network externalities

are two types of barrier to entry. They discourage
potential competitors from entering a market, and
thus contribute to the monopolistic power of some
firms. Economies of scale are cost advantages that
large firms obtain due to their size.They occur
because the cost per unit of output decreases with
increasing scale, as fixed costs are spread over
more units of output. A natural monopoly arises as
a result of economies of scale. For natural
monopolies, the average total cost declines
continually as output increases, giving the
monopolist an overwhelming cost advantage over
potential competitors. It becomes most efficient for Economies of Scale: Large firms obtain economies
production to be concentrated in a single firm. of scale in part because fixed costs are spread over
more units of output.
 Network externalities (also called network effects) Facebook: Network effects are one
occur when the value of a good or service increases reason why it’s so difficult for new
as a result of many people using it. companies to compete against
Facebook: they simply will
have difficulty establishing a
network of users to compete.

3. Government Action

There are two types of government-initiated monopoly: a government

monopoly and a government-granted monopoly. Government monopolyis a
form of monopoly in which a government agency is the sole provider of a
particular good or service and competition is prohibited by law while
Government-granted monopoly is a form of monopoly in which a government
grants exclusive rights to a private individual or firm to be the sole provider of a
good or service. This two types differ in the decision-making structure of the
monopolist. In a government-granted monopoly, business decisions are made Postal Service: The postal
by a private firm. In a government monopoly, decisions are made by a service operates as a government
government agency. In both types of government-initiated monopoly monopoly in many countries,
competition is kept out of the market through laws, regulations, and other including the United States.
mechanisms of government enforcement.
4. Legal Barriers
The government creates legal barriers through
patents, copyrights, and granting exclusive rights to
companies.

 Copyright
Copyright gives the creator of an original creative
work (such as a book, song, or film) exclusive rights to it,
usually for a limited time, with the intention of enabling the
creator to be compensated for his or her work.

Copyright: Copyright is an example

Intellectual property rights are an example of legal of a temporary legal monopoly
barriers that give rise to monopolies. The government can granted to creators of original
provide exclusive or special rights to companies that creative works.
legally allow them to be monopolies.
5. Natural Monopolies
Natural monopolies occur when a single firm can serve the entire market at a lower cost than a
combination of two or more firms.A natural monopoly ‘s cost structure is very different from that of most
industries. For a natural monopoly, the average total cost continues to shrink as output increases. Natural
monopolies tend to form in industries where there are high fixed costs. Other firms are discouraged from
entering the market because of the high initial costs and the difficulty of obtaining a large enough market
share to achieve the same low costs as the monopolist.

Natural Monopoly: The total cost of the natural monopoly’s

production is lower than the sum of the total costs of two firms producing the same quantity.
Impacts of Monopoly on Efficiency
In a monopoly, the firm will set a specific price for a good that is available to all consumers. The
quantity of the good will be less and the price will be higher. The monopoly pricing creates a deadweight
loss because the firm forgoes transactions with the consumers. The deadweight loss is the potential gains
that did not go to the producer or the consumer. As a result of the deadweight loss, the combined surplus
(wealth) of the monopoly and the consumers is less than that obtained by consumers in a competitive
market.
Monopolies can become inefficient and less innovative over time because they do not have to
compete with other producers in a marketplace. For private monopolies, complacency can create room for
potential competitors to overcome entry barriers and enter the market. Also, long term substitutes in other
markets can take control when a monopoly becomes inefficient.

In the case of monopolies, abuse of power can lead to market failure. Market failure occurs when the
price mechanism fails to take into account all of the costs and/or benefits of providing and consuming a
good.As a result, the market fails to supply the socially optimal amount of the good. A monopoly is an
imperfect market that restricts output in an attempt to maximize profit.Without the presence of market
competitors it can be challenging for a monopoly to self-regulate and remain competitive over time.
 Understanding and Finding the Deadweight Loss
Deadweight Loss is a loss of economic efficiency that can occur when equilibrium for a good or service is
not Pareto optimal (is an economic state where resources cannot be reallocated to make one individual better
off without making at least one individual worse off)
When deadweight loss occurs, there is a loss in economic surplus within the market. Deadweight loss
implies that the market is unable to naturally clear.The supply and demand of a good or service are not at
equilibrium. Causes of deadweight loss include:

 imperfect markets
 externalities
 taxes or subsides
 price ceilings
 price floors

 Determining Deadweight Loss

In order to determine the deadweight loss in a market, the equation P=MC is used. The deadweight
loss equals the change in price multiplied by the change in quantity demanded. This equation is used to
determine the cause of inefficiency within a market.
 An example of deadweight loss due to taxation involves the price set on wine and beer. If a glass of
wine is $3 and a glass of beer is $3, some consumers might prefer to drink wine. If the government
decides to place a tax on wine at $3 per glass, consumers might choose to drink the beer instead of the
wine. At times, policy makers will place a binding constraint on items when they believe that the benefit
from the transfer of surplus outweighs the adverse impact of deadweight loss.

Deadweight loss: This graph shows the deadweight loss

that is the result of a binding price ceiling. Policy makers
will place a binding price ceiling when they believe that the
benefit from the transfer of surplus outweighs the adverse
impact of the deadweight loss.
Price Discrimination
In a competitive market, price discrimination occurs when identical goods and services are sold at
different prices by the same provider. In pure price discrimination, the seller will charge the buyer the
absolute maximum price that he is willing to pay. Companies use price discrimination in order to make the
most revenue possible from every customer.

Price discrimination: A producer that can charge price Pa to its customers with
inelastic demand and Pb to those with elastic demand can extract more total profit than
if it had charged just one price.
 Three factors that must be met for price discrimination to occur:

 the firm must have market power,

 the firm must be able to recognize differences in demand, and
 the firm must have the ability to prevent arbitration, or resale of the product.

 Types of Price Discrimination

 First degree price discrimination – the monopoly seller of a good or service must know the absolute
maximum price that every consumer is willing to pay.
 Second degree price discrimination – the price of a good or service varies according to the quantity
demanded.
 Third degree price discrimination – the price varies according to consumer attributes such as age, sex,
location, and economic status.
 Forms of Price Discrimination

There are a variety of ways in which industries legally use price discrimination. It is not important that
pricing information be restricted, or that the price discriminated groups be unaware that others are being
charged different prices:

 Coupons: coupons are used in retail as a way to distinguish customers by their reserve price.
 Premium pricing: premium products are priced at a level that is well beyond their marginal cost.
 Discounts based on occupation: many businesses offer reduced prices to active military members.
Less publicized discounts are also offered to off duty service workers such as police.
 Retail incentives: retail incentives are used to increase market share or revenues. They include
rebates, bulk and quantity pricing, seasonal discounts
 Gender based discounts: gender based discounts are offered in some countries including the United
States.
 Financial aid: financial aid is offered to college students based on either the student and/or the parents
economic situation.
 Haggling: haggling is a form of price negotiation that requires knowledge and confidence from the
customer.
 Industries that Use Price Discrimination

Travel industry: airlines and other travel companies use differentiated pricing often. Travel products and
services are marketed to specific social segments. Airlines usually assign specific capacity to various booking
classes. Also, prices fluctuate based on time of travel (time of day, day of the week, time of year). Prices
fluctuate between companies as well as within each company.

Pharmaceutical industry: price discrimination is common in the pharmaceutical industry. Drug-makers

charge more for drugs in wealthier countries. For example, drug prices in the United States are some of the
highest in the world. Europeans, on average, pay only 56% of what Americans pay for the same prescription
drugs.

Textbooks: price discrimination is also prevalent within the publishing industry. Textbooks are much
higher in the United States despite the fact that they are produced in the country. Copyright protection laws
increase the price of textbooks. Also, textbooks are mandatory in the United States while schools in other
countries see them as study aids.
Monopoly in Public Policy

 The Value of Competition

In a perfectly competitive market, the
antithesis of a monopoly, demand is completely
elastic and the production quantity and price point
align perfectly with marginal costs and actual costs.
Also, perfect competition is a theoretical
competitive framework. However, markets will
naturally deviate to varying degrees (in order to
capture profitable returns). As such, the perfect
competition model is most useful in identifying and
measuring deviations or departures from the
competitive ideal.
Perfect Competition Economics: This is
a graphical illustration of economics within
the context of a perfectly competitive
market (theoretically).
Societal Risks of Monopolies

The accumulation of power and leverage on behalf of the suppliers largely revolves around the fact that
monopolies can ultimately control supply in its entirety for a specified product or service. Through utilizing this
control strategically, a profit-maximizing monopoly could create the following societal risks:

Price Discrimination: This concept is often strongly emphasized as a potential economic risk of
monopolies and the economic justification is easily illustrated.
Reduced Efficiency: A less direct societal risk of monopolies is the fact that competition is closely linked
to incentives. As a result, no competition will provide the monopoly very little reason to improve internal
inefficiencies or cut costs.
Reduced Innovation: A monopoly will also have limited motivation to innovate, as there is little value in
differentiation in a thoroughly controlled market (for the only incumbent). As a result there is reduced
improvements that could substantially improve the ability of the firm to fulfill the needs of the consumer.
Deadweight Loss: A monopoly will choose to produce less and charge more than would occur in a
perfectly competitive market. As a result, a monopoly causes deadweight loss, an inefficient economic
outcome.
Antitrust Law
It is a law opposed to or against the
establishment or existence of trusts (monopolies),
usually referring to legislation. The concept of
antitrust largely revolves around governmental
restrictions that limit incumbents in any given
industry from consolidating too much power.

The worst case scenario of consolidation

results in a monopoly, which is when one company
or organization becomes the sole supplier of a
given product or service. The adverse effects of
these manipulations can be seen in, which
underlines the economic threat monopolies pose Monopolistic Effects on Price: This graph
the end consumer. Antitrust law is in place to illustrates the way in which monopolistic
ensure such circumstances do not arise, or when incumbents can control economic factors,
they do that they are regulated appropriate to ultimately creating surpluses or shortages to
minimize adverse societal effects. garner advantage.
 Due to the increasingly international focus for many large corporations, antitrust laws and other
competitive regulations must function not only at the country level but on a global level. Organizations such
as the World Trade Organization (WTO) attempt to garner international support for the establishment of
global standards in competitive markets in conjunction with the internal competitive laws which govern
each nation individually. While these antitrust laws differ from nation to nation, they can loosely be
summarized in three components:

 Actively ensuring that no agreements in place are counter to a competitive market.

 Regulating against strategic actions that may result in diminishing the competitive elements of a
market.
 Overseeing mergers, acquisitions, joint ventures and other strategic alliances to avoid consolidation
that may be damaging to free markets.

In the U.S., antitrust policy finds its roots in 1890 with the Sherman Antitrust Act, and saw substantial
expansion in 1914 via the Clayton Antitrust Act and the Federal Trade Commission Act.
 Regulations of Natural Monopoly
A natural monopoly is defined by an incumbent in an
industry where the largest supplier can theoretically create
the lowest production prices, generally through economies
of scale or economies of scope. In this type of
circumstance, the industry naturally lends itself to
providing advantages for the single largest provider at the
cost of allowing for competitive forces. Natural
monopolistic conditions are therefore at high risk of
creating actual monopolies, and society benefits from
regulating these situations to even the playing field.

Regulating industries to minimize monopolization and

maintain competitive equality can be pursued through
average cost pricing, price ceilings, rate of return
Price Advantage for Natural Monopolies: While
regulations, taxes and subsidies. While the concept of a monopolies are generally poor economic constructs for
monopoly is generally perceived as a threat to free creating value, natural monopolies are predicated on
markets, there are specific circumstances where natural the fact that a single supplier can achieve the greatest
monopolies are either pragmatically useful (cost effective) economies of scale (cost advantages). This graph
or virtually unavoidable. demonstrates this concept.
Icebreaker
1. Is an example of a monopoly based on natural resources?
a. Electric Company b. De Beers c. Postal Service d. Copyright

2. Is a loss of economic efficiency that can occur when equilibrium for a good or service is not Pareto
optimal.
a. Weight Loss b. Price Discriminationc. Deadweight Loss d. Monopoly Efficiemcy

3. Monopoly characteristics except:

a. profit maximizer b. price maker c. low barriers to entry d. price discrimination.

4. Is defined by an incumbent in an industry where the largest supplier can theoretically create the lowest
production prices, generally through economies of scale or economies of scope.
a. Natural Monopoly b. Price Discriminationc. Profit Maximation d. Economic Scale
Let’s Practice!

1-5. Give the similarities and structure

differences between monopoly and competitive
market.
6 - 10. Give the 5 barriers to entry or the reason
why monopoly exist.
References:
• https://courses.lumenlearning.com/boundless-economics/chapter/introduction-to-monopoly/
• https://courses.lumenlearning.com/boundless-economics/chapter/barriers-to-entry-reasons-for-
monopolies-to-exist/
• https://courses.lumenlearning.com/boundless-economics/chapter/monopoly-production-and-pricing-
decisions-and-profit-outcome/
• https://courses.lumenlearning.com/boundless-economics/chapter/impacts-of-monopoly-on-efficiency/
• https://courses.lumenlearning.com/boundless-economics/chapter/price-discrimination/
• https://courses.lumenlearning.com/boundless-economics/chapter/monopoly-in-public-policy/
• https://opentextbc.ca/principlesofeconomics/chapter/introduction-to-a-monopoly/
• https://www.youtube.com/watch?v=nyt7uZ63vMU
• https://www.youtube.com/watch?v=ZiuBWSFlfoU
• https://www.youtube.com/watch?v=Sb_-wfmJnHA
Let’s Practice Answers:
1-5. There are a few similarities between a monopoly and competitive market: the cost functions are the
same, both minimize cost and maximize profit, the shutdown decisions are the same, and both are
assumed to have perfectly competitive market factors. While the differences between the two market
structures including: marginal revenue and price, product differentiation, number of competitors, barriers to
entry, elasticity of demand, excess profits, profit maximization, and the supply curve.

6-10.
 Resource Control
 Economies of Scale and Network Externalities
 Government Action
 Legal Barriers
 Natural Monopoly