Monopoly: EC 221 Jacksonville State University

Monopoly
EC 221
Jacksonville State University
Fall 2018
Monopoly
Monopoly
A monopoly exists when:

One firm serves an entire market.
It sells a good with no close substitutes.
High entry barriers exist.
Monopolization can occur in specific product markets:
Alcoa
Or geographic markets:
Public utilities
Would a single gas station in an isolated town be a good example of
monopoly?
Monopoly
Sources of Monopoly Power
Large sunk investments

Some industries require an initial investment that is quite high.
Technical Superiority
Microsoft in the 1990s.
Monopoly
Economies of Scale
single producer lowers average total cost
Control over an essential resource
Aluminum Company of America’s (ALCOA)
Monopoly
Patents and Copyrights

A patent guarantees an inventor the sole right to the profits for a
fixed period of time.
A copyright guarantees the creator of a work of art, literature,
movie, etc. the exclusive right to profits stemming from the work.
Upside: encourages innovation
Downside: might last too long
Monopoly
Other legal barriers

“Certificates of need”
Exclusive rights granted to utilities and cable companies
Taxi cab medallions
Licensing requirements
Monopoly
The Monopolist’s Output Decision
Like a perfectly competitive firm, a monopolist maximizes profits

where marginal revenue equals marginal cost.
However, since the monopolist faces the entire downward-sloping
demand curve, the monopolist will also face a downward-sloping
marginal revenue curve.
Monopoly
The Monopolist’s Output Decision
Since p > MR at the profit-maximizing level of output we have the

case where p > MR = MC .
Diagram:
P
Q/t
Monopoly
Monopoly Profit
Since entry barriers (either artificial or technological) are high a

monopolist can earn positive economic profits that aren’t competed
away.
Compared with perfect competition, the monopoly outcome results
in a higher price and lower market output in both the short- and
long-run. This is inefficient.
The consequences of restricted competition are one reason that
economists are in favor of breaking up some monopolies.
Note, while it may be desirable to break up monopolies that exist
solely to restrict competition, we may not want to break up firms
that have achieved their status due to technological advantages.
Monopoly
Monopoly Profit
Diagramming positive and zero economic profit:

P P
Q Q
Monopoly
Monopoly Profit
p > ATC can persist for a long time

Even if p = ATC , p > min ATC
Monopolist doesn’t achieve allocative or productive efficiency
A monopolist might still earn zero economic profit over the long-run,
especially if entry is artificially restricted.
Competition for inputs can drive up costs.
The firm can always sell!
Monopoly
Other Consequences of Monopoly
A monopolist will try to increase demand through advertising, even

though there may be few competitors.
Especially if it monopolizes a competitive industry.
A monopolist will likely face bureaucratic and managerial
inefficiencies that result from its large scale.
Conversely, the monopolist might be able to economize on fixed
costs and engage in more specialization.
Incentive to invest in research & development
short-run cost
long-run innovation and cost savings
Monopoly
Natural Monopoly
Exists when ATC is downward-sloping for all market demand

High fixed costs and large economies of scale
Examples include
Alabama Power
Monopoly
Natural Monopoly
Large economies of scale are represented by a downward-sloping

ATC curve
When a pure natural monopoly exists, the competitive outcome
(p=mc) cannot exist. Ideally, a regulator will attempt to set p=ATC.
Diagram:
P
Q/t
Monopoly
Price Discrimination
Price discrimination: charging di↵erent prices to di↵erent

customers for the same good
We are familiar with price discrimination:
Student discounts
Senior citizen discounts
airline pricing
apartments
tuition
Monopoly
Price Discrimination
In order for price discrimination to work, a monopolist must:

Identify groups with di↵erence elasticities of demand
Prevent resale
Usually, the group with the higher elasticity of demand is charged
the lower price.
Why do senior citizens get discounts? Students? Which group is
charged a higher price by an airline, business or leisure travelers?
Monopoly

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Monopoly

A monopoly exists when:

Large sunk investments

Patents and Copyrights

Other legal barriers

Like a perfectly competitive firm, a monopolist maximizes profits

Since p > MR at the profit-maximizing level of output we have the

Since entry barriers (either artificial or technological) are high a

Diagramming positive and zero economic profit:

p > ATC can persist for a long time

A monopolist will try to increase demand through advertising, even

Exists when ATC is downward-sloping for all market demand

Large economies of scale are represented by a downward-sloping

Price discrimination: charging di↵erent prices to di↵erent

In order for price discrimination to work, a monopolist must:

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