Chapter+15+Emily+K.

= =

= = = =

= How does a monopoly differ from a competitive firm? =

= = In this chapter, you will learn about monopolies. You have probably heard of monopolies, and are probably thinking they are bad. But why are they bad? After reading this chapter, you will be able to answer this question of why monopolies are unfavorable to the economy as a whole. And you will also know how to work with these monopolies and reduce their market powers. While reading this chapter, keep in mind how the monopolistic firm differs from a competitive firm. The two have contrasting characteristics, and it is important that you realize the difference between the two types of firms.

= = = What is a Monopoly? =


 A **monopoly** is a firm that is the only seller in the market and does not have any competitors . This happens because while the monopolistic firm is in the market, other firms cannot enter the market. In other words, other firms are blocker by barriers of market. How do the barriers of market arise?
 * The monopoly owns a key resource
 * The monopoly gains from the government an exclusive right to produce a good or service
 * The monopoly's cost of production is lower than other firms' costs of production

= Three Barriers to Entry =

The reason why a monopoly is the only firm in the market is because it imposes barriers to entry to the market it belongs. In other words, monopolies possess special powers that discourage other firms from entering the market. There are three main ways these barriers can arise. Let's take a look.

media type="youtube" key="hGq4jKJ3xUo" height="344" width="425" Before you read to find out about the different barriers of entry, you may want to watch this video first to give yourself an idea about how monopolies arise. For your entertainment and ease of understanding, the actual game Monopoly has been used. Believe it or not, the actual board game Monopoly shows some great examples of how monopolies can arise.

Monopoly's Resources
 The easiest way for a monopoly to arise is for a firm to own a key resource in the production of an item. For example, if a firm that produces tires owned all the rubber resources by itself, it could surely make a lot of money. No other firm could produce tires (or they would have to buy the rubber from the monopolistic firm). Thus, exclusive ownership of resources is a very important factor in monopolies. Nevertheless, such a case rarely occurs in real life. Honestly, this world contains a lot of different resources as well as a lot of people. Because the markets are so big, the resources are owned by many different groups, rather than one. However, there are a few firms who own resources without close substitutes. An example would be the diamond. Most people (especially women!) think that there cannot be a substitute for diamonds. Thus, the firms who own the diamond resources are considered to be pretty monopolistic.



**Government-created Monopolies** Yes, it sounds weird, but sometimes the government creates monopolies. And you have probably, at some point in your life, encountered them. For example, the books you buy at a book store are what give each author monopolistic power. What happens is that authors put a copyright  on their books since the book consists of the author's original ideas, and that prevents anyone else from using or copying those ideas in the book. Thus, the author has an exclusive right on his or her creation. A similar situation occurs when the government creates patents for an original creation . For example, when a new drug is found, the firm that created it will request for a patent from the government, and if granted, the company gets exclusive right to sell the item for as long as 20 years. This means that even if another firm eventually develops the same medicine, it cannot sell it until the patent-protection term is over. The government creates these various monopolies in order to benefit the public. By providing opportunities to become monopolies, the government provides incentives for researchers and firms to create better and helpful and original goods, the products which would be greatly appreciated by the public.

Natural monopolies arise because of a "natural" phenomenon, where <span style="color: #008000; font-family: Verdana,Geneva,sans-serif;">a single firm can produce at a lower cost than can two or more firms <span style="font-family: Verdana,Geneva,sans-serif;">. So for example, if a city wanted to create railroads, it would be much easier for one company to take care of the entire job, than having two or more companies trying to build them, right? If two or more companies were trying to build the railroad, they may get in each other's way of working, and furthermore, each would have to pay the fixed cost of producing. Thus, if only one firm were to create the railroads, it could do so more efficiently, for a lower cost. Because other firms know this, when a firm is in a natural monopolistic market, <span style="color: #008000; font-family: Verdana,Geneva,sans-serif;">other firms are discouraged from entering <span style="font-family: Verdana,Geneva,sans-serif;">. Natural monopolies arise when there are economies of scale.
 * Natural Monopolies**

<span style="font-family: Verdana,Geneva,sans-serif;">
=<span style="color: #008000; font-family: Verdana,Geneva,sans-serif;">Monopoly vs. Competitive Firm = <span style="font-family: Verdana,Geneva,sans-serif;"> Since the structures of a monopoly and a competitive firm are so different, their graphs also look completely different. We learned in the previous chapter that a competitive firm really has no market power, that it is just a price taker. Thus, the market price becomes the competitive firm's marginal revenue. The demand curve is perfectly elastic. However, a monopoly is different. Since a monopoly is the only firm in the market, the market demand curve is the firm's demand curve. You (of course) know that the market demand curve always slopes downward: as quantity increases, price decreases. Thus, if a monopoly wants to increase production, it must reduce the price of each item sold. This downward curve of the monopoly (thankfully) puts a constraint on the monopoly's otherwise uncontrollable market power.

<span style="font-family: Verdana,Geneva,sans-serif;">Downward Curve and Revenue
<span style="font-family: Verdana,Geneva,sans-serif;"><span style="font-family: Verdana,Geneva,sans-serif;"> In a perfectly competitive market, there are many, many sellers. So in that case, demand is perfectly elastic: if one firm were to change the price of its output, the consumers would simply walk away to the seller next-door. As a result, all firms in the competitive market are price takers that work with a horizontal demand curve. Situations change for the monopoly, though. The monopoly is the only firm in the market, so it gets to have some market power, meaning it is not a complete price taker. The monopoly adopts the market's downward sloping demand curve, because the market //is// the monopolistic firm! This downward sloping demand curve forces the monopoly to decrease price as quantity increases.

<span style="font-family: Verdana,Geneva,sans-serif;">Monopoly's Revenue
Because the monopoly's demand curve is downward sloping, the monopoly must reduce the price of its good every time it increases the quantity of output. This makes the monopoly's marginal revenue to be always less than the price of the good. Because the price of the good decreases with every additional unit produced, the additional revenue collected decreases with increasing quantity. This is a noticeable difference from a competitive firm's behavior. Because a competitive firm has a perfectly elastic demand curve, the price does not change with increasing quantity.

<span style="font-family: Verdana,Geneva,sans-serif;">Monopoly's Profit Maximization
In a competitive firm, the demand curve is the marginal revenue curve, so the firm does not need to worry about following a separate demand curve from the marginal revenue curve. A monopoly does have to. The monopoly finds the profit maximizing quantity where marginal cost equals marginal revenue (just like a competitive firm does). And then, the monopoly needs to find the corresponding price at that quantity, by following the demand curve.

To summarize, in a competitive firm, the price = marginal revenue = marginal cost however, in a monopoly, the price > marginal revenue = marginal cost

= Why monopolies are inefficient = <span style="font-family: Verdana,Geneva,sans-serif;"> A monopoly is inefficient when compared to a perfectly competitive firm, because the monopoly <span style="color: #008000; font-family: Verdana,Geneva,sans-serif;">produces at a quantity that is less than the socially efficient point <span style="font-family: Verdana,Geneva,sans-serif;">. The socially efficient quantity is where the demand curve and marginal curve intersect. However, monopolies produce at the point where the marginal cost curve and marginal revenue curve intersect. This creates a deadweight loss similar to the one that occurs from a tax. Another way to see why the monopoly is inefficient is that the value of goods to customers is higher than the cost for the monopoly to produce the good.

=<span style="color: #008000; font-family: Verdana,Geneva,sans-serif;">What do you do with a monopoly? = <span style="font-family: Verdana,Geneva,sans-serif;">You know and I know and the government knows, too, that monopolies can be dangerous when they are too powerful. Thus, often times governments will make effort to thwart monopolies from gaining too much power. There are four general ways of dealing with a monopoly. These methods can help decrease the inefficiency created by monopolies.

<span style="font-family: Verdana,Geneva,sans-serif;"> 1. Increase competition
<span style="font-family: Verdana,Geneva,sans-serif;"> Governments try to make monopolies become more competitive by creating laws. The <span style="color: #008000; font-family: Verdana,Geneva,sans-serif;">Sherman Antitrust Act of 1890 <span style="font-family: Verdana,Geneva,sans-serif;"> was a law passed by the Congress in order to reduce the market power of dominant monopolies. Under this law, government promotes competition among firms. The government will prevent two powerful companies from merging if it sees that the combination can produce a greatly monopolistic company. For example, if Coca-Cola and Pepsi were to merge and form one gigantic coke company, it would most likely become an ultimately powerful monopoly. Thankfully, the government prevents such cases from happening. The government can also break up already existing companies into smaller ones, if it thinks the company is too powerful. This way, the monopolistic power will be divided and distributed among the smaller companies. Lastly, a government can prevent companies from doing things that make the markets less competitive.

<span style="font-family: Verdana,Geneva,sans-serif;">2. Regulation
<span style="font-family: Verdana,Geneva,sans-serif;">Another way that the government deals with monopolies is by directly regulating the behavior of monopolies. Such a case is common for natural monopolies, like water or electricity companies. The <span style="color: #008000; font-family: Verdana,Geneva,sans-serif;">government controls the pries of these companies <span style="font-family: Verdana,Geneva,sans-serif;">, so they cannot make their own prices. However, choosing the price for the monopoly is a difficult matter. If the government set the price to be the marginal cost, then the company would experience loss, since the marginal cost would be lower than the firm's average total cost. In order to solve this unfairness, the government then has to subsidize the company, or pay the compensation for the loss. Subsidizing means the government needs to raise more money through collecting taxes, and that will result in the deadweight loss, which is inefficient. There is another problem that arises from the government setting the price for the monopoly, and that is that the company will then lose the incentive to keep its costs low. So as you can see, this method of regulation can surely reduce the market powers of monopolies, but it will cause other problems economically.

<span style="font-family: Verdana,Geneva,sans-serif;">3. Public Ownership
<span style="font-family: Verdana,Geneva,sans-serif;"> Governments can sometimes turn private monopolies into public enterprises. This means that the <span style="color: #008000; font-family: Verdana,Geneva,sans-serif;">government itself owns and operates the monopolistic firms <span style="font-family: Verdana,Geneva,sans-serif;">. The government usually uses this method for natural monopolistic utilities such as telephone companies, water companies, and electric companies. Also, in the United States, the government runs the postal service, in order to prevent a massive natural monopoly from rising. If one company took care of the entire postal service in America, it would end up possessing too much power. Although this method of turning private monopolies into public ones can reduce the powers of monopolies, economists still prefer for monopolies to stay as private enterprises. This is because if the company were publicly owned, the government will have no incentive to put the costs down as much as possible, since it is not directly gaining profit from it. This means the consumers will suffer.

<span style="font-family: Verdana,Geneva,sans-serif;">4. Do nothing!
<span style="font-family: Verdana,Geneva,sans-serif;">The last and most simple method of dealing with monopolies is to do nothing. All of the previously mentioned policies have some drawbacks. Thus, as it applies to any other economic problems, the government can choose to leave the monopolies as they are, because after all, they are part of the economy. Economists believe that sometimes it is best for the government to not do anything and let the economy guide itself. Laissez faire. Hands off!

= Price Discrimination = Because the monopoly has some market power, it is able to do something the competitive firm cannot do: price discrimination. **Price discrimination** refers to the practice of selling the same product at different prices for different buyers. The monopoly can do this because even if it changes the price, consumers will still buy from the firm, considering that it is the only one in the market.

==

With price discrimination, the monopoly is able to accomplish efficiency. When the monopoly sells its good all at the same price, some consumers who do not value the product as much do not buy the product. However, when these consumers can buy the product for cheaper and those who are willing to pay high prices still buy the product, the monopoly is able to sell all its products. Thus, deadweight loss is gone, and monopoly increases profit, as you can see in the graph above.

A good example of the price discrimination is airline tickets. An airline company usually has different prices for their tickets. The tickets where the traveler has to stay over a Saturday night are usually cheaper than other tickets. Although the actual staying over a Saturday night has nothing to do with the airline company's costs, such price discrimination separates those who are willing to pay high prices from those who want to take the cheaper price. Most businessmen going on business trips would choose to buy the more expensive tickets because they do not want to spend their Saturdays over. However, other travelers will sacrifice a Saturday night for the cheaper cost.

=<span style="color: #008000; font-family: Verdana,Geneva,sans-serif;">Conclusion = <span style="font-family: Verdana,Geneva,sans-serif;">Monopolies arise when there are barriers to entry in the market. As a result of these barriers, the monopolistic firm becomes the only firm left in the market. Thus, the monopoly gets to enjoy some market power that a competitive firm does not have. The monopolistic firm can choose its own price, although the price must decrease with every extra unit of output produced. The monopolistic firm sells its products for higher prices that do competitive firms. With higher prices, the quantity produced is decreased. This causes the deadweight loss which is a negative effect to the economy as a whole. The monopoly, however, can combat the deadweight loss with price discrimination, which is an exclusive power that only a monopoly holds. By selling its products to everyone at different prices, the monopoly can increase its profit greatly and reduce deadweight loss.



Question:What are the pros and cons of the government's action of interfering in the merging of two large companies?
Answer: A positive factor of the government interfering the merging of two large companies is that the act can prevent the companies from having too much market power. If firms have too much market power, they have become more and more of "price makers" rather than "price takers." This means that a dishonest company can raise the prices of its products greatly, putting much burden of the consumers. The government can interfere and prevent such a potential danger from happening. However, the government may also prevent a positive effect that can arise from the merging of two companies. When two companies merge, they can work together more efficiently and create products for lower prices. If they create synergy in such a way, the consumers will actually be happier. Thus, there are both pros and cons to the government's decision to interfere in the merging of two companies.

== <span style="font-family: Verdana,Geneva,sans-serif;"><span style="display: block; font-family: Verdana,Geneva,sans-serif; text-align: center;"> <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;">**monopoly:** firm that is the only seller in the market and does not have any competitors <span style="font-family: Verdana,Geneva,sans-serif;"> **natural monopoly:** monopoly that arises when <span style="color: #000000; font-family: Verdana,Geneva,sans-serif;">a single firm can produce at a lower cost than can two or more firms <span style="font-family: Verdana,Geneva,sans-serif;"> **price discrimination:** practice of selling the same product at different prices for different buyers