Chapter15+JDEM



The word 'monopoly' typically brings to mind negative images of companies that charge exorbitant prices for simple good (either that, or the board game- which has similar concepts). This chapter will focus on explaining exactly why it is possibly for monopolies to do what they do- and even why they exist in the first place. To begin, check out the big questions below:



1. only one firm 2. prohibitive barriers that prevent other firms from entering the market 3. the firm has substantial market power (is a price MAKER, not a price taker) 4. the product is unique 5. there CAN be long run economic profit. *explained later
 * What are the characteristics of a monopoly?**

1. Lack of resources If one company owns all the resources that are required to make a good, they are the only company that will be able to produce that good. A monopoly will arise naturally, because all other companies lack the resources to join the market- even if they want to join that market. An example of monopolies that arise from a general lack of resources is the oil market; only some countries are actually able to join the oil market because not ALL countries produce oil. Because only a few countries are able to produce oil, these countries are able to form a monopoly.
 * Why is there only one firm?**
 * Because there are barriers that prevent other firms from entering the market. The main factors that prohibit other firms from entering the market are:

2. Patent or Copyright Although many companies may possess the resources to enter a market, some may still be unable to do so because of a patent or copyright. If a company owns the patent or copyright to a product, they are the only ones that are permitted (by law) to produce that good. The lack of competition in these markets results in a monopoly. An example of this sort of monopoly is 'Coca Cola'. Although many companies might own the resources to produce Coke, they would still be unable to do so because the law prohibits them from "copying" Coca Cola- however, patents and copyright do not stop other companies from making // similar // products.

Why is there a difference between the demand curve and the marginal revenue curve?** The difference between the demand curve and the marginal revenue curve is a result of the fact that the monopoly is the only producer of that good. When a monopoly firm only produces 10 units for a good the demand for that good rises, because the monopoly firm is the ONLY producer of that good. Since demand is high, the firm can charge a higher price for each unit of the good. However, if the monopoly firm were to produce 10 MORE units of the good, the demand of that good would drop. Therefore the monopoly firm would have to charge lower prices, for ALL of its goods (it would need to lower the prices of all its goods, even the ones produced before the additional 10). For each additional unit of a good that the monopoly firm produces, the demand steadily drops, meaning price must be lowered to match demand, meaning that the firm earns less and less revenue for additional unit of good they produce --> marginal revenue decreases. Conclusions: As quantity produced increases, demand falls, price falls, total revenue falls, and marginal revenue begins to fall. This explains why there is a gap between the demand curve and the marginal revenue curve.
 * Quantity of goods produced || price of goods || total revenue || marginal revenue ||
 * 0 || - || 0 || - ||
 * 1 || $1000 || $1000 || 1000 ||
 * 10 || $90 || $900 || -100 ||
 * 30 || $20 || $600 || -300 ||
 * 50 || $5 || $250 || -350 ||


 * What are the types of monopolies?**

A) Government Created Monopolies/Regulated Monopolies

These are monopolies created as a result of patents or copyrights. When the government gives one firm the legal rights to produce a good, and prevents all other firms from producing the good, they are opening opportunities for the creation of a monopoly. The government's reason for creating monopolies is to maximize social benefit. When firms have an opportunity to earn long term profit (*explained later) by becoming a monopoly, they have a greater incentive to create goods of higher quality and originality.

B) Natural Monopolies  These are monopolies created because a single firm has better access to necessary resources, hence it is cheaper for them to produce a good. In examples such as the sale of utilities, the fixed cost of production is so high that it takes a long time for the revenue to reach a 'break even' point, in comparison to the total cost. If 2 firms were to attempt to sell utilities, the new firm would receive no benefit from entering the market- the total cost of production and the cost of entering the market (building new power lines, new plumbing systems, etc..) would outweigh any potential gain in profit, because the revenue of the original firm would have to be divided between the 2 firms. Thus, when it is more convenient/efficient for 1 firm to produce a good, as a result of having better/the only access to crucial resources, a monopoly will occur //naturally.//



Because a monopoly firm has no competition, it is able to charge at its own price- it has no need to match its price with other companies. As shown in the graph below :
 * What are the results of the firm being a price maker?**



A monopoly firm produces at QUANTITY A because that is where MARGINAL COST is equal to MARGINAL REVENUE. by producing at this point the firm ensures that it can earn back whatever it costs them to produce a good. However, instead of charging at PRICE A they charge at PRICE D. This can be explained by the fact that there are still people willing to pay MORE THAN PRICE A, at QUANTITY A. Because DEMAND is still at PRICE D, the company changes PRICE D for QUANTITY A of its good.

//When the monopoly firm charges PRICE D for QUANTITY A it is both allocatively and productively inefficient.// To be allocatively efficient a firm needs to sell at Price=Marginal Cost. This would mean producing where the demand curve meets the marginal cost curve; producing QUANTITY C for PRICE C. To be productively efficient a firm needs to produce&sell above the minimum of the ATC curve. This would mean producing QUANTITY B and charging PRICE B. In comparing the situations we can see that the monopoly firm //produces less// and //charges more// than what is productively and allocatively efficient.

In a perfectly competitive/monopolistically competitive market, new firms will enter a market when there is profit to be earned. This lowers the demand for each individual's firm's goods, decreasing the amount of profit, until each firm makes no profit or loses money. When firms begin to lose money they will gradually leave the market, causing demand for each individual firm's goods to rise, earning revenue for the firms. Because of these constant changes in the flow of demand it is impossible for competitive firms to earn profit in the long run.
 * Why can there be long run economic profit?**

Yet it is possible for a monopoly firm to ear profit, because barriers to entry prevent other firms from entering the market. No matter how much profit a monopoly firm makes, and no matter how much other firms WANT to enter the market, they are unable to do so because of the factors previously mentioned (lack of resources/patents and copyrights). This means that the monopoly firm can continue to earn profit without interference from other firms and changing demands. In conclusion, monopoly firms can earn profit, even in the long run.

Conclusion: monopolies arise for a variety of reasons, whether this happens to be because of access to resources of government sanctions. However the one thing all monopolies share is the fact that they are inefficient- they charge more and produce less than is ideal. Because of this they can earn profit, even in the long run. Yet, monopolies are not as 'negative' as they may seem because they do not incur DWL. Although there is not consumer surplus, total surplus does not decrease.

Market Power: the amount of influence that a single firm/consumer has on the market. Economic Profit: Total revenue - (total cost + opp. cost) Demand Curve: curve that represents the sum of all individual demands in the market. Marginal Revenue Curve: the curve that shows the change in revenue that results Total Revenue: the total amount of $ that a firm earns. Calculated by Price x Quantity. Total Costs: Fixed cost + Variable cost. How much it costs the firm to produce their good. Average total cost: Total Cost/quantity. The average cost of producing 1 unit of a good. Cost of entry: How much it would cost a firm to enter a market. Marginal Cost curve: Curve that represents the additional cost of producing a good. Allocative efficiency: distributing resource within the market so that  the greatest amount of consumer wants are met. (Maximizing social benefit and utility) Productive efficiency: getting the most possible products from a limited supply of resources. Producing ON the PPF curve. **
 * Glossary