Principles of Economics - 3e Chapter 9 Monopoly

Monopoly FIGURE Political Power from a Cotton the century , the United States , the Southern states , had a near monopoly in the cotton that they supplied to Great Britain . These states attempted to leverage this economic power into political to sway Great Britain to formally recognize the Confederate States of America , Credit of cotton ! by , BY ) CHAPTER OBJECTIVES In this chapter , you will learn about How Monopolies form Barriers to Entry How a Monopoly Chooses Output and Price Introduction to a Monopoly HOME The Rest is History Many of the opening case studies have focused on current events . This one steps into the past to observe how monopoly , or near monopolies , have helped shape history . In spring 1773 , the East India Company , a that , in its time , was designated too big to fail , was experiencing . To help shore up the failing , the British Parliament authorized the Tea Act . The act continued the tax on teas and made the East India Company the sole legal supplier of tea to the American colonies , By November , the citizens of Boston had had enough . They refused to permit the unloading of tea , main complaint No taxation without Several newspapers , including The Massachusetts Gazette , warned arriving ships , We are prepared , and shall not fail to pay them an unwelcome visit by The .

216 Monopoly Step forward in time to eve of the American Civil another near monopoly supplier of historical the cotton industry . At that time , the Southern states provided the majority of the cotton Britain imported . The South , wanting to secede from the Union , hoped to leverage Britain high dependency on its cotton into formal diplomatic recognition of the Confederate States of America . This leads us to this chapter topic a firm that controls all ( or nearly all ) of the supply of a good or monopoly . How do monopoly behave in the marketplace ?

Do they have power ?

Does this power potentially have unintended consequences ?

We return to this case at the end of the chapter to see how the tea and cotton monopolies influenced history . Many believe that top executives at are the strongest supporters of market competition , but this belief is far from the truth . Think about it this way If you very much wanted to win an Olympic gold medal , would you rather be far better than everyone else , or locked in competition with many athletes just as good as you ?

Similarly , ifyou would like to attain a very high level , would you rather manage a business with little or no competition , or struggle against many tough competitors who are trying to sell to your customers ?

By now , you might have read the chapter on Perfect Competition . In this chapter , we explore the opposite extreme monopoly . If perfect competition is a market where have no market power and they simply respond to the market price , monopoly is a market with no competition at all , and have a great deal of market power In the case of monopoly , one produces all of the output in a market . Since a monopoly faces no competition , it can charge any price it wishes , subject to the demand curve . While a monopoly , by , refers to a single , in practice people often use the term to describe a market in which one merely has a very high market share . This tends to be the that the Department of Justice uses . Even though there are very few true monopolies in existence , we do deal with some of those few every day , often without realizing it The . Postal Service , your electric , and garbage collection companies are a few examples . Some new drugs are produced by only one pharmaceutical no close substitutes for that drug may exist . From the until 2004 , the Department ofJustice prosecuted the Corporation for including Internet Explorer as the default web browser with its operating system . The Justice argument was that , since possessed an extremely high market share in the industry for operating systems , the inclusion of a free web browser constituted unfair competition to other , such as Navigator . Since nearly everyone was using Windows , including Internet Explorer eliminated the incentive for consumers to explore other and made it impossible for competitors to gain a foothold in the market . In 2013 , the Windows system ran on more than 90 of the most commonly sold personal computers . In 2015 , a federal court tossed out antitrust charges that Google had an agreement with mobile device makers to set Google as the default search engine . This chapter begins by describing how monopolies are protected from competition , including laws that prohibit competition , technological advantages , and certain of demand and supply . It then discusses how a monopoly will choose its quantity to produce and what price to charge . While a monopoly must be concerned about whether consumers will purchase its products or spend their money on something altogether different , the monopolist need not worry about the actions of other competing producing its products . As a result , a monopoly is not a price taker like a perfectly competitive , but instead exercises some power to choose its market price . Access for free at

How Monopolies Form Barriers to Entry 217 How Monopolies Form Barriers to Entry LEARNING OBJECTIVES By the end of this section , you will be able to Distinguish between a natural monopoly and a legal monopoly . Explain how economies of scale and the control of natural resources led to the necessary formation of legal monopolies Analyze the importance of trademarks and patents in promoting innovation Identify examples of predatory pricing Because of the lack of competition , monopolies tend to earn economic . These should attract vigorous competition as we described in Perfect Competition , and yet , because of one particular characteristic of monopoly , they do not . Barriers to entry are the legal , technological , or market forces that discourage or prevent potential competitors from entering a market . Barriers to entry can range from the simple and easily surmountable , such as the cost of renting retail space , to the extremely restrictive . For example , there are a number of radio frequencies available for broadcasting . Once an entrepreneur or has purchased the rights to all of them , no new competitors can enter the market . In some cases , barriers to entry may lead to monopoly . In other cases , they may limit competition to a few . Barriers may block entry even if the or currently in the market are earning . Thus , in markets with barriers to entry , it is true that abnormally high will attract new , and that this entry of new will eventually cause the price to decline so that surviving earn only a normal level of in the long run . There are types of monopoly , based on the types of barriers to entry they exploit . Natural Monopoly Economies of scale can combine with the size of the market to limit competition . We introduced this theme in Production Cost and Industry Structure ) 92 presents a average cost curve for the airplane manufacturing industry . It shows economies of scale up to an output of planes per year and a price of , then constant returns to scale from to planes per year , and of scale at a quantity of production greater than planes per year . Now consider the market demand curve in the diagram , which intersects the average cost ( curve at an output level of planes per year and at a price , which is higher than . In this situation , the market has room for only one producer Ifa second attempts to enter the market at a smaller size , say by producing a quantity of planes , then its average costs will be higher than those of the existing , and it will be unable to compete . If the second attempts to enter the market at a larger size , like planes per year , then it could produce at a lower average it could not sell all planes that it produced because of demand in the market .

218 Monopoly , Cost or Price ( Demand A 16 000 Output FIGURE Economies of Scale and Natural Monopoly In this market , the demand curve intersects the average cost ( curve at its part . A natural monopoly occurs when the quantity demanded is less than the minimum quantity it takes to be at the bottom of the average cost curve . Economists call this situation , when economies of scale are large relative to the quantity demanded in the market , a natural monopoly . Natural monopolies often arise in industries where the marginal cost of adding an additional customer is very low , once the costs of the overall system are in place . This results in situations where there are substantial economies of scale . For example , once a water company lays the main water pipes through a neighborhood , the marginal cost of providing water service to another home is fairly low . Once the electric company installs lines in a new subdivision , the marginal cost additional electrical service to one more home is minimal . It would be costly and duplicative for a second water company to enter the market and invest in a whole second set of main water pipes , or for a second electricity company to enter the market and invest in a whole new set of electrical wires . These industries offer an example where , because of economies of scale , one producer can serve the entire market more than a number of smaller producers that would need to make duplicate physical capital investments . A natural monopoly can also arise in smaller local markets for products that are to transport . For example , cement production exhibits economies of scale , and the quantity of cement demanded in a local area may not be much larger than what a single plant can produce . Moreover , the costs of transporting cement over land are high , and so a cement plant in an area without access to water transportation may be a natural monopoly . Control of a Physical Resource Another type of monopoly occurs when a company has control of a scarce physical resource . In the economy , one historical example of this pattern occurred when Aluminum Company of most of the supply of bauxite , a key mineral used in making aluminum . Back in the 19303 , when controlled most of the bauxite , other were simply unable to produce enough aluminum to compete . As another example , the majority of global diamond production is controlled by , a multinational company that has mining and production operations in South Africa , and Canada . It also has exploration activities on four continents , while directing a worldwide distribution network of rough cut diamonds . Although in recent years they have experienced growing competition , their impact on the rough Access for free at

How Monopolies Form Barriers to Entry 219 diamond market is still considerable . Legal Monopoly For some products , the government erects barriers to entry by prohibiting or limiting competition . Under law , no organization but the . Postal Service is legally allowed to deliver mail . Many states or cities have laws or regulations that allow households a choice of only one electric company , one water company , and one company to pick up the garbage . Most legal monopolies are necessary for everyday are socially . As a consequence , the government allows producers to become regulated monopolies , to ensure that customers have access to an appropriate amount of these products or services . Additionally , legal monopolies are often subject to economies of scale , so it makes sense to allow only one provider Promoting Innovation Innovation takes time and resources to achieve . Suppose a company invests in research and development and the cure for the common cold . In this world of near ubiquitous information , other companies could take the formula , produce the drug , and because they did not incur the costs of research and development ( undercut the price of the company that discovered the drug . Given this possibility , many would choose not to invest in research and development , and as a result , the world would have less innovation . To prevent this from happening , the Constitution of the United States in Article I , Section The Congress shall have Power . to Promote the Progress and Useful Arts , by securing for limited Times to Authors and Inventors the Exclusive Right to their Writings and Discoveries . Congress used this power to create the Patent and Trademark , as well as the . Copyright . A patent gives the inventor the exclusive legal right to make , use , or sell the invention for a limited time . In the United States , exclusive patent rights last for 20 years . The idea is to provide limited monopoly power so that innovative can recoup their investment in , but then to allow other to produce the product more cheaply once the patent expires . A trademark is an identifying symbol or name for a particular good , like Chiquita bananas , Chevrolet cars , or the Nike swoosh that appears on shoes and athletic gear Between 2003 and 2019 , roughly million trademarks were registered with the government . A can renew a trademark repeatedly , as long as it remains in active use . A copyright , according to the . Copyright , is a form of protection provided by the laws of the United States for original works of authorship including literary , dramatic , musical , architectural , cartographic , choreographic , pantomimic , pictorial , graphic , sculptural , and audiovisual creations . No one can reproduce , display , or perform a copyrighted work without the author permission . Copyright protection ordinarily lasts for the life of the author plus 70 years . Roughly speaking , patent law covers inventions and copyright protects books , songs , and art . However , in certain areas , like the invention of new software , it has been unclear whether patent or copyright protection should apply . There is also a body of law known as trade secrets . Even if a company does not have a patent on an invention , competing are not allowed to steal their secrets . One famous trade secret is the formula for , which is not protected under copyright or patent law , but is simply kept secret by the company . Taken together , we call this combination of patents , trademarks , copyrights , and trade secret law intellectual property , because it implies ownership over an idea , concept , or image , not a physical piece like a house or a car . Countries around the world have enacted laws to protect intellectual property , although the time periods and exact provisions of such laws vary across countries . There are ongoing negotiations , both through the World Intellectual Property Organization ( and through international treaties , to bring greater harmony to the intellectual property laws of different countries to determine the extent to which those in other countries will respect patents and copyrights of those in other countries . Government limitations on competition used to be more common in the United States . For most of the

220 Monopoly twentieth century , only one phone legally allowed to provide local and long distance service . From the to the , one set of federal regulations limited which destinations airlines could choose to to and what fares they could charge . Another set of regulations limited the interest rates that banks could pay to depositors yet another how much trucking could charge customers . What products we consider utilities depends , in part , on the available technology . Fifty years ago , telephone companies provided local and long distance service over wires . It did not make much sense to have many companies building multiple wiring systems across towns and the entire country . AT lost its monopoly on long distance service when the technology for providing phone service changed from wires to microwave and satellite transmission , so that multiple could use the same transmission mechanism . The same thing happened to local service , especially in recent years , with the growth in cellular phone systems . The combination of improvements in production technologies and a general sense that the markets could provide services adequately led to a wave of deregulation , starting in the late and continuing into the . This wave eliminated or reduced government restrictions on the that could enter , the prices that they could charge , and the quantities that many industries could produce , including telecommunications , airlines , trucking , banking , and electricity . Around the world , from Europe to Latin America to Africa and Asia , many governments continue to control and limit competition in what those governments perceive to be key industries , including airlines , banks , steel companies , oil companies , and telephone companies . LINK IT this website patents for examples of some pretty bizarre patents . Potential Competition Businesses have developed a number of schemes for creating barriers to entry by deterring potential competitors from entering the market . One method is known as predatory pricing , in which a uses the threat of sharp price cuts to discourage competition . Predatory pricing is a violation of antitrust law , but it is difficult to prove . Consider a large airline that provides most of the between two particular cities . A new , small airline decides to offer service between these two cities . The large airline immediately slashes prices on this route to the bone , so that the new entrant can not make any money . After the new entrant has gone out of business , the incumbent can raise prices again . After the company repeats this pattern once or twice , potential new entrants may decide that it is not wise to try to compete . Small airlines often accuse larger airlines of predatory pricing in the early , for example , accused Delta pricing , Frontier accused United , and Reno Air accused Northwest . In 2015 , the Justice Department ruled against American Express and Mastercard for imposing restrictions on retailers that encouraged customers to use lower swipe fees on credit transactions . In some cases , large advertising budgets can also act as a way of discouraging the competition . Ifthe only way to launch a successful new national cola drink is to spend more than the promotional budgets of and Pepsi Cola , not too many companies will try . A firmly established brand name can be to dislodge . Summing Up Barriers to Entry Table 91 lists the barriers to entry that we have discussed . This list is not exhaustive , since have proved to be highly creative in inventing business practices that discourage competition . When barriers to entry exist , perfect competition is no longer a reasonable description of how an industry works . When barriers to entry are high enough , monopoly can result . Access for free at

How a Monopoly Chooses Output and Price 221 Barrier to Entry Government Role ?

Example Government often responds with regulation Natural monopoly ( ip Water and electric companies Control of a physical No for diamonds resource , Legal monopoly Yes ce pas a ion air ines and trucking Patent , trademark , and Yes , through protection of intellectual New drugs or software copyright property Intimidating potential Somewhat Predatory pricing brand competitors names TABLE Barriers to Entry How a Monopoly Chooses Output and Price LEARNING OBJECTIVES By the end of this section , you will be able to Explain the perceived demand curve for a perfect competitor and a monopoly Analyze a demand curve for a monopoly and determine the output that maximizes and revenue Calculate marginal revenue and marginal cost Explain as it pertains to the of a monopoly Consider a monopoly , comfortably surrounded by barriers to entry so that it need not fear competition from other producers . How will this monopoly choose its quantity of output , and what price will it charge ?

for the monopolist , like any , will be equal to total revenues minus total costs . We can analyze the pattern of costs for the monopoly within the same framework as the costs of a perfectly competitive is , by using total cost , cost , variable cost , marginal cost , average cost , and average variable cost . However , because a monopoly faces no competition , its situation and its decision process will differ from that ofa perfectly competitive . The Clear It Up feature discusses how hard it is sometimes to market in a monopoly situation . Demand Curves Perceived by a Perfectly Competitive Firm and by a Monopoly A perfectly competitive acts as a price taker , so we calculate total revenue taking the given market price and multiplying it by the quantity of output that the chooses . The demand curve as it is perceived bya perfectly competitive appears in Figure ( a ) The perceived demand curve means that , from the viewpoint of the perfectly competitive , it could sell either a relatively low quantity like or a relatively high quantity like at the market price .

222 Monopoly cu in I Perceived A I I demand I I I Perceived . I I demand I I I TIT Quantity Quantity ( a ) Perceived demand for a perfect competitor ( Perceived demand for a monopolist FIGURE The Perceived Demand Curve for a Perfect Competitor and a Monopolist ( a ) A perfectly competitive perceives the demand curve that it faces to be flat . The flat shape means that the firm can sell either a low quantity ( or a high quantity ( Oh ) at exactly the same price ( A monopolist perceives the demand curve that it faces to be the same as the market demand curve , which for most goods is . Thus , if the monopolist chooses a high level of output ( Oh ) it can charge only a relatively low price ( PI ) Conversely , if the monopolist chooses a low level of output ( it can then charge a higher price ( The challenge for the monopolist is to choose the combination of price and quantity that maximizes . CLEAR IT UP What defines the market ?

A monopoly is a firm that sells all or nearly all of the goods and services in a given market . However , what the market ?

In a famous 1947 case , the federal government accused the DuPont company of having a monopoly in the cellophane market , pointing out that DuPont produced 75 of the cellophane in the United States . DuPont countered that even though it had a 75 market share in cellophane , it had less than a 20 share of the flexible packaging materials , which includes all other papers , and foils . In 1956 , after years of legal appeals , the Supreme Court held that the broader market was more appropriate , and it dismissed the case against DuPont . Questions over how to the market continue today . True , in the had a dominant share of the software for computer operating systems , but in the total market for all computer software and services , including everything from games to programs , the share was only about 14 in 2014 . The Greyhound bus company may have a on the market for intercity bus transportation , but it is only a small share of the market for intercity transportation if that market includes private cars , airplanes , and railroad service . has a monopoly in diamonds , but it is a much smaller share of the total market for precious gemstones and an even smaller share of the total market . A small town in the country may have only one gas station is this gas station a monopoly , or does it compete with gas stations that might be , 10 , or 50 miles away ?

In general , if a produces a product without close substitutes , then we can consider the a monopoly producer in a single market . However , if buyers have a range of if not available from other , then the is not a monopoly . Still , arguments over whether substitutes are close or not close can be controversial . While a monopolist can charge for its product , nonetheless the demand for the product constrains the price . No monopolist , even one that is thoroughly protected by high barriers to entry , can Access for free at

How a Monopoly Chooses Output and Price 223 require consumers to purchase its product . Because the monopolist is the only in the market , its demand curve is the same as the market demand curve , which is , unlike that for a perfectly competitive , Figure illustrates this situation . The monopolist can either choose a point like with a low price ( and high quantity ( Oh ) or a point like with a high price ( and a low quantity ( or some intermediate point . Setting the price too high will result in a low quantity sold , and will not bring in much revenue . Conversely , setting the price too low may result in a high quantity sold , but because of the low price , it will not bring in much revenue either . The challenge for the monopolist is to strike a balance between the price it charges and the quantity that it sells . However , why is the perfectly competitive demand curve also the market demand curve ?

See the following Clear It Up feature for the answer to this question . CLEAR IT UP What is the difference between perceived demand and market demand ?

The demand curve as perceived by a perfectly competitive firm is not the overall market demand curve forthat product . However , the firms demand curve as perceived by a monopoly is the same as the market demand curve . The reason for the difference is that each perfectly competitive firm perceives the demand for its products in a market that includes many other firms . In effect , the demand curve perceived by a perfectly competitive firm is a tiny slice of the entire market demand curve . In contrast , a monopoly perceives demand for its product in a market where the monopoly is the only producer . Total Cost and Total Revenue for a Monopolist We can illustrate for a monopolist with a graph of total revenues and total costs , with the example of the hypothetical in Figure . The total cost curve has its typical shape that we learned about in Production Costs and Industry Structure , and that we used in Perfect Competition that is , total costs rise and the curve grows steeper as output increases , as the final column of Table shows . Total cost Total revenue Total Revenue ( I Quantity FIGURE Total Revenue and Total Cost for the Monopoly Total revenue for the monopoly firm called first rises , then falls . Low levels of output bring in relatively little total revenue , because the quantity is low . High levels of output bring in relatively less revenue , because the high quantity pushes down the market price . The total cost curve is . will be highest at the quantity of output where total revenue is most above total cost . The level of output is not the same as the level of output , which should make sense , because take costs into account and revenues do not .

224 Monopoly Quantity Price Total Revenue Total Cost 500 750 900 300 700 600 500 TABLE Total Costs and Total Revenues of Total revenue , though , is different . Since a monopolist faces a downward sloping demand curve , the only way it can sell more output is by reducing its price . Selling more output raises revenue , but lowering price reduces it . Thus , the shape of total revenue is clear . Let explore this using the data in Table , which shows quantities along the demand curve and the price at each quantity demanded , and then calculates total revenue by multiplying price times quantity at each level of output . In this example , we give the output as , and so on , for the sake of simplicity . Ifyou prefer a dash of greater realism , you can imagine that the pharmaceutical company measures these output levels and the corresponding prices per or pills . As the illustrates , total revenue for a monopolist has the shape of a hill , rising , next out , and then falling . In this example , total revenue is highest at a quantity of or . However , the monopolist is not seeking to maximize revenue , but instead to earn the highest possible . In the example in Figure , the highest will occur at the quantity where total revenue is the farthest above total cost . This looks to be somewhere in the middle of the graph , but where exactly ?

It is easier to see the maximizing level of output by using the marginal approach , to which we turn next . Marginal Revenue and Marginal Cost for a Monopolist In the real world , a monopolist often does not have enough information to analyze its entire total revenues or total costs curves . After all , the does not know exactly what would happen if it were to alter production dramatically . However , a monopolist often has fairly reliable information about how changing output by small or moderate amounts will affect its marginal revenues and marginal costs , because it has had experience with such changes over time and because modest changes are easier to extrapolate from current experience . A monopolist can use information on marginal revenue and marginal cost to seek out the combination of quantity and price . Table expands Table using the on total costs and total revenues from the example to calculate marginal revenue and marginal cost . This monopoly faces typical marginal cost and marginal revenue curves , as Figure shows . Notice that marginal revenue is zero at a quantity of , and turns negative at quantities higher than . It may seem counterintuitive that marginal revenue could ever be zero or negative after all , does an increase in quantity sold not always mean more revenue ?

For a perfect competitor , each additional unit sold brought a Access for free at How a Monopoly Chooses Output and Price 225 positive marginal revenue , because marginal revenue was equal to the given market price . However , a monopolist can sell a larger quantity and see a decline in total revenue . When a monopolist increases sales by one unit , it gains some marginal revenue from selling that extra unit , but also loses some marginal revenue because it must now sell every other unit at a lower price . As the quantity sold becomes higher , at some point the drop in price is proportionally more than the increase in greater quantity of sales , causing a situation where more sales bring in less revenue . In other words , marginal revenue is negative . Marginal cost ) 000 Marginal revenue ' 500 FIGURE Marginal Revenue and Marginal Cost for the Monopoly For a monopoly like , marginal revenue decreases as it sells additional units of output . The marginal cost curve is . The choice for the monopoly will be to produce at the quantity where marginal revenue is equal to marginal cost that is , If the monopoly produces a lower quantity , then at those levels of output , and the firm can make higher by expanding output . If the firm produces at a greater quantity , then , and the firm can make higher by reducing its quantity of output . Quantity Total Revenue Marginal Revenue Total Cost Marginal Cost 500 500 775 275 800 225 600 250 400 400 200 850 TABLE Costs and Revenues of A monopolist can determine its price and quantity by analyzing the marginal revenue and marginal costs of producing an extra unit . If the marginal revenue exceeds the marginal cost , then the firm should produce the extra unit . For example , at an output of in Figure , marginal revenue is 600 and marginal cost is 250 , so producing this unit will clearly add to overall . At an output of , marginal revenue is 400 and marginal cost is 400 ,

226 Monopoly so producing this unit still means overall are unchanged . However , expanding output from to would involve a marginal revenue of 200 and a marginal cost of 850 , so that sixth unit would actually reduce . Thus , the monopoly can tell from the marginal revenue and marginal cost that of the choices in the table , the level of output is . The monopoly could seek out the level of output by increasing quantity by a small amount , calculating marginal revenue and marginal cost , and then either increasing output as long as marginal revenue exceeds marginal cost or reducing output if marginal cost exceeds marginal revenue . This process works without any need to calculate total revenue and total cost . Thus , a monopoly should follow the rule up to the quantity where marginal revenue is equal to marginal is , This quantity is easy to identify graphically , where and intersect . Maximizing Profits If you it counterintuitive that producing where marginal revenue equals marginal cost will maximize , working through the numbers will help . Step . Remember , we marginal cost as the change in total cost from producing a small amount of additional output . change in total cost change in quantity produced Step . Note that in Table , as output increases from to units , total cost increases from 500 to 775 . As a result , the marginal cost of the second unit will be 775 275 Step . Remember that , similarly , marginal revenue is the change in total revenue from selling a small amount of additional output . change in total revenue change in quantity sold Step . Note that in Table , as output increases from to units , total revenue increases from 1200 to 2200 . As a result , the marginal revenue of the second unit will be 220 ( 1200 1000 Quantity Marginal Revenue Marginal Cost Marginal Total 500 700 700 275 725 800 225 575 600 250 350 TABLE Marginal Revenue , Marginal Cost , Marginal and Total Access for free at

How a Monopoly Chooses Output and Price Quantity Marginal Revenue Marginal Cost Marginal Total 400 400 200 850 200 TABLE Marginal Revenue , Marginal Cost , Marginal and Total Table repeats the marginal cost and marginal revenue data from Table , and adds two more columns Marginal is the of each additional unit sold . We it as marginal revenue minus marginal cost . Finally , total is the sum of marginal . As long as marginal is positive , producing more output will increase total . When marginal turns negative , producing more output will decrease total . Total is maximized where marginal revenue equals marginal cost . In this example , maximum occurs at units of output . A perfectly competitive will also its level of output where . The key difference with a perfectly competitive is that in the case of perfect competition , marginal revenue is equal to price ( while for a monopolist , marginal revenue is not equal to the price , because changes in quantity of output affect the price . Illustrating Monopoly Profits It is straightforward to calculate of given numbers for total revenue and total cost . However , the size of monopoly can also be illustrated graphically with Figure , which takes the marginal cost and marginal revenue curves from the previous exhibit and adds an average cost curve and the monopolist perceived demand curve . Table shows the data for these curves . Quantity Demand AC 500 500 275 388 800 225 333 900 600 250 313 800 400 400 330 700 200 850 417 600 571 500 800 TABLE 227

228 Monopoly 2500 , Marginal cost I ) ix 1500 Total profit Average cost ! 500 Demand Marginal revenue i i Quantity FIGURE Illustrating Profits at the Monopoly This begins with the same marginal revenue and marginal cost curves from the monopoly from Figure . It then adds an average cost curve and the demand curve that the monopolist faces . The first chooses the quantity where . In this example , the quantity is . The monopolist then decides what price to charge by looking at the demand curve it faces . The large box , with quantity on the horizontal axis and demand ( which shows the price ) on the vertical axis , shows total revenue for the . The box , which is quantity on the horizontal axis and average cost of production on the vertical axis shows the total costs . The large total revenue box minus the smaller total cost box leaves the darkly shaded box that shows total . Since the price charged is above average cost , the is earning positive . Figure illustrates the process where a monopolist selects the quantity to produce decides what price to charge determines total revenue , total cost , and . Step The Monopolist Determines Its Level of Output The can use the points on the demand curve to calculate total revenue , and then , based on total revenue , calculate its marginal revenue curve . The quantity will occur where at the last possible point before marginal costs start exceeding marginal revenue . On Figure , occurs at an output of . Step The Monopolist Decides What Price to Charge The monopolist will charge what the market is willing to pay . A dotted line drawn straight up from the maximizing quantity to the demand curve shows the price which , in Figure , is 800 . This price is above the average cost curve , which shows that the is earning . Step Calculate Total Revenue , Total Cost , and Total revenue is the overall shaded box , where the width of the box is the quantity sold and the height is the price . In Figure , this is 800 4000 . In Figure , the bottom part of the shaded box , which is shaded more lightly , shows total costs that is , quantity on the horizontal axis multiplied by average cost on the vertical axis or 330 1650 . The larger box of total revenues minus the smaller box of total costs will equal , which the darkly shaded box shows . Using the numbers gives 4000 1650 2350 . In a perfectly competitive market , the forces of entry would erode this in the long run . However , a monopolist is protected by barriers to entry . In fact , one obvious sign ofa possible monopoly is when a earns year after year , while doing more or less the same thing , without ever seeing increased competition eroding those . Access for free at

How a Monopoly Chooses Output and Price 229 Step Look at demand curve to see what price to charge for , I Average cost Price ( Identify the quantity ( where Marginal revenue Step Identify profit Quantity FIGURE How a Monopoly Decides Price In Step , the monopoly chooses the maximizing level of output 01 , by choosing the quantity where . In Step , the monopoly decides how much to charge for output level 01 by drawing a line straight up from to point on its perceived demand curve . Thus , the monopoly will charge a price ( In Step , the monopoly its . Total revenue will be multiplied by . Total cost will be 01 multiplied by the average cost of producing 01 , which point shows on the average cost curve to be . Profits will be the total revenue rectangle minus the total cost rectangle , which the shaded zone in the shows . CLEAR IT UP Why is a marginal revenue always less than the price ?

The marginal revenue curve for a monopolist always lies beneath the market demand curve . To understand why , think about increasing the quantity along the demand curve by one unit , so that you take one step down the demand curve to a slightly higher quantity but a slightly lower price . A demand curve is not sequential It is not that first we sell 01 at a higher price , and then we sell at a lower price . Rather , a demand curve is conditional If we charge the higher price , we would sell 01 . If , instead , we charge a lower price ( on all the units that we sell ) we would sell 02 . When we think about increasing the quantity sold by one unit , marginal revenue is affected in two ways . First , we sell one additional unit at the new market price . Second , all the previous units , which we sold at the higher price , now sell for less . Because of the lower price on all units sold , the marginal revenue of selling a unit is less than the price of that the marginal revenue curve is below the demand curve . Tip For a demand curve , and demand have the same vertical intercept . As output increases , marginal revenue decreases twice as fast as demand , so that the horizontal intercept of is halfway to the horizontal intercept of demand . You can see this in the Figure .

230 Monopoly Demand Marginal Revenue FIGURE The Marginal Revenue Curve versus Demand Curve Because the market demand curve is conditional , the marginal revenue curve for a monopolist lies beneath the demand curve . The inefficiency of Monopoly Most people criticize monopolies because they charge too high a price , but what economists object to is that monopolies do not supply enough output to be . To understand why a monopoly is , it is useful to compare it with the benchmark model of perfect competition . is an economic concept regarding at the social or societal level . It refers to producing the optimal quantity of some output , the quantity where the marginal to society of one more unit just equals the marginal cost . The rule of maximization in a world of perfect competition was for each to produce the quantity of output where , where the price ( is a measure of how much buyers value the good and the marginal cost ( is a measure ofwhat marginal units cost society to produce . Following this rule assures . If , then the marginal to society ( as measured by ) is greater than the marginal cost to society of producing additional units , and a greater quantity should be produced . However , in the case of monopoly , price is always greater than marginal cost at the maximizing level of output , as you can see by looking back at Figure . Thus , consumers do not from a monopoly because it will sell a lower quantity in the market , at a higher price , than would have been the case in a perfectly competitive market . The problem of for monopolies often runs even deeper than these issues , and also involves incentives for over longer periods of time . There are incentives here . On one side , may strive for new inventions and new intellectual property because they want to become monopolies and earn high least for a few years until the competition catches up . In this way , monopolies may come to exist because of competitive pressures on . However , once a barrier to entry is in place , a monopoly that does not need to fear competition can just produce the same old products in the same old still ringing up a healthy rate of . John Hicks , who won the Nobel Prize for economics in 1972 , wrote in 1935 The best of all monopoly is a quiet life . He did not mean the comment in a complimentary way . He meant that monopolies may bank their and slack off on trying to please their customers . When AT provided all of the local and phone service in the United States , along with manufacturing most of the phone equipment , the payment plans and types of phones did not change much . The was that you could have any color phone you wanted , as long as it was black . However , in 1982 , government litigation split up AT into a number of local phone companies , a phone company , and a phone equipment manufacturer . An explosion of innovation followed . Services like call waiting , caller ID , calling , voice mail through the phone company , mobile phones , and wireless connections to the Access for free at

How a Monopoly Chooses Output and Price 231 internet all became available . Companies offered a wide range of payment plans , as well . It was no longer true that all phones were black . Instead , phones came in a wide variety of shapes and colors . The end of the telephone monopoly brought lower prices , a greater quantity of services , and also a wave of innovation aimed at attracting and pleasing customers . BRING IT HOME The Rest is History In the opening case , we presented the East India Company and the Confederate States as a monopoly or near monopoly provider of a good . Nearly every American schoolchild knows the result of the unwelcome visit the bestowed upon Boston Harbor Boston Tea Party . Regarding the cotton industry , we also know Great Britain remained neutral during the Civil War , taking neither side during the conflict . Did the monopoly nature of these business have unintended and historical consequences ?

Might the American Revolution have been deterred , if the East India Company had sailed the ships back to England ?

Might the southern states have made different decisions had they not been so King Cotton would force diplomatic recognition of the Confederate States of America ?

Of course , it is not possible to answer these questions . We can not roll back the clock and try a different scenario . We can , however , consider the monopoly nature of these businesses and the roles they played and hypothesize about what might have occurred under different circumstances . Perhaps if there had been legal free tea trade , the colonists would have seen things differently . There was smuggled Dutch tea in the colonial market . If the colonists had been able to freely purchase Dutch tea , they would have paid lower prices and avoided the tax . What about the cotton monopoly ?

With one in jobs in Great Britain depending on Southern cotton and the Confederate States as nearly the sole provider of that cotton , why did Great Britain remain neutral during the Civil War ?

At the beginning of the war , Britain simply drew down massive stores of cotton . These stockpiles lasted until near the end of 1862 . Why did Britain not recognize the Confederacy at that point ?

Two reasons The Emancipation Proclamation and new sources of cotton . Having outlawed slavery throughout the United Kingdom in 1833 , it was politically impossible for Great Britain , empty cotton warehouses or not , to recognize , diplomatically , the Confederate States . In addition , during the two years it took to draw down the stockpiles , Britain expanded cotton imports from India , Egypt , and Brazil . Monopoly sellers often see no threats to their superior marketplace position . In these examples did the power of the monopoly hide other possibilities from the decision makers ?

Perhaps . As a result of their actions , this is how history unfolded .

232 Key Terms Key Terms producing the optimal quantity of some output the quantity where the marginal to society of one more equals the marginal cost barriers to entry the legal , technological , or market forces that may discourage or prevent potential competitors from entering a market copyright a form of legal protection to prevent copying , for commercial purposes , original works of authorship , including books and music deregulation removing government controls over setting prices and quantities in certain industries intellectual property the body of law including patents , trademarks , copyrights , and trade secret law that protect the right of inventors to produce and sell their inventions legal monopoly legal prohibitions against competition , such as regulated monopolies and intellectual property protection marginal of one more unit of output , computed as marginal revenue minus marginal cost monopoly a situation in which one produces all of the output in a market natural monopoly economic conditions in the industry , for example , economies of scale or control ofa critical resource , that limit effective competition patent a government rule that gives the inventor the exclusive legal right to make , use , or sell the invention for a limited time predatory pricing when an existing uses sharp but temporary price cuts to discourage new competition trade secrets methods of production kept secret by the producing trademark an identifying symbol or name for a particular good and can only be used by the that registered that trademark Key Concepts and Summary How Monopolies Form Barriers to Entry Barriers to entry prevent or discourage competitors from entering the market . These barriers include economies of scale that lead to natural monopoly control of a physical resource legal restrictions on competition patent , trademark and copyright protection and practices to intimidate the competition like predatory pricing . Intellectual property refers to legally guaranteed ownership of an idea , rather than a physical item . The laws that protect intellectual property include patents , copyrights , trademarks , and trade secrets . A natural monopoly arises when economies of scale persist over a large enough range of output that if one supplies the entire market , no other can enter without facing a cost disadvantage . How a Monopoly Chooses Output and Price A monopolist is not a price taker , because when it decides what quantity to produce , it also determines the market price . For a monopolist , total revenue is relatively low at low quantities of output , because it is not selling much . Total revenue is also relatively low at very high quantities of output , because a very high quantity will sell only at a low price . Thus , total revenue for a monopolist will start low , rise , and then decline . The marginal revenue for a monopolist from selling additional units will decline . Each additional unit a monopolist sells will push down the overall market price , and as it sells more units , this lower price applies to increasingly more units . The monopolist will select the level of output where , and then charge the price for that quantity as determined by the market demand curve . If that price is above average cost , the monopolist earns positive . are not productively , because they do not produce at the minimum of the average cost curve . are not , because they do not produce at the quantity where . As a result , produce less , at a higher average cost , and charge a higher price than would a combination of in a perfectly competitive industry . also may lack incentives for innovation , Access for free at

Questions 233 because they need not fear entry . Questions . Classify the following as a barrier to entry , a barrier to entry that is not enforced , or a situation that does not involve a barrier to entry . 57 A patented invention A popular but easily copied restaurant recipe An industry where economies of scale are very small compared to the size of demand in the market A reputation for slashing prices in response to new entry A brand name that has been carefully built up over many years Classify the following as a barrier to entry , a barrier to entry that is not enforced , or a situation that does not involve a barrier to entry . 57 A city passes a law on how many licenses it will issue for taxicabs A city passes a law that all taxicab drivers must pass a driving safety test and have insurance A trademark Owning a spring that offers very pure water An industry where economies of scale are very large compared to the size of demand in the market Suppose the local electrical utility , a legal monopoly based on economies of scale , was split into four size , with the idea that eliminating the monopoly would promote competitive pricing of electricity . What do you anticipate would happen to prices ?

If Congress reduced the period of patent protection from 20 years to 10 years , what would likely happen to the amount research and development ?

Suppose demand for a monopoly product falls so that its price is below average variable cost . How much output should the supply ?

Hint Draw the graph . Imagine a monopolist could charge a different price to every customer based on how much the customer is willing to pay . How would this affect monopoly ?

Review Questions . How is monopoly different from perfect competition ?

What is a barrier to entry ?

Give some examples . What is a natural monopoly ?

10 . 11 . 12 . 13 . 14 . 15 . 16 . 17 . 18 . What is a legal monopoly ?

What is predatory pricing ?

How is intellectual property different from other property ?

What legal mechanisms protect intellectual property ?

In what sense is a natural monopoly natural ?

How is the demand curve perceived by a perfectly competitive different from the demand curve perceived by a monopolist ?

How does the demand curve perceived by a monopolist compare with the market demand curve ?

Is a monopolist a price taker ?

Explain . What is the usual shape ofa total revenue curve for a monopolist ?

Why ?

234 Critical Thinking Questions 19 . 20 . 21 . 22 . 23 . 24 . What is the usual shape ofa marginal revenue curve for a monopolist ?

Why ?

How can a monopolist identify the level of output if it knows its total revenue and total cost curves ?

How can a monopolist identify the level of output if it knows its marginal revenue and marginal costs ?

When a monopolist its quantity of output , how does it decide what price to charge ?

Is a monopolist ?

Why or why not ?

How does the quantity produced and price charged by a monopolist compare to that of a perfectly competitive ?

Critical Thinking Questions 25 . 26 . 27 . 28 . 29 . 30 . does not have the monopoly power it once had . How do you suppose their barriers to entry were weakened ?

Why are generic pharmaceuticals cheaper than name brand ones ?

For many years , the Justice Department has tried to break up large like IBM , and most recently Google , on the grounds that their large market share made them essentially monopolies . In a global market , where compete with from other countries , would this policy make the same sense as it might in a purely domestic context ?

Intellectual property laws are intended to promote innovation , but some economists , such as Milton , have argued that such laws are not desirable . In the United States , there is no intellectual property protection for food recipes or for fashion designs . Considering the state of these two industries , and bearing in mind the discussion of the of monopolies , can you think of any reasons why intellectual property laws might hinder innovation in some cases ?

Imagine that you are managing a small and thinking about entering the market ofa monopolist . The monopolist is currently charging a high price , and you have calculated that you can make a nice charging 10 less than the monopolist . Before you go ahead and challenge the monopolist , what possibility should you consider for how the monopolist might react ?

Ifa monopoly is earning , how much would you expect these to be diminished by entry in the long run ?

Problems 31 . 32 . Return to Figure . Suppose is 10 and is 11 . Suppose a new with the same curve as the incumbent tries to break into the market by selling units of output . Estimate from the graph what the new average cost output would be . If the incumbent continues to produce units , how much output would the two supply to the market ?

Estimate what would happen to the market price as a result of the supply the incumbent and the new entrant . Approximately how much would each earn ?

Draw the demand curve , marginal revenue , and marginal cost curves from Figure , and identify the quantity of output the monopoly wishes to supply and the price it will charge . Suppose demand for the monopoly product increases dramatically . Draw the new demand curve . What happens to the marginal revenue as a result of the increase in demand ?

What happens to the marginal cost curve ?

Identify the new quantity and price . Does the answer make sense to you ?

Access for free at Problems 235 33 . Draw a demand curve , marginal revenue , and marginal cost curves . Identify the monopolist output level . Now , think about a slightly higher level of output ( say ) According to the graph , is there any consumer willing to pay more than the marginal cost of that new level of output ?

If so , what does this mean ?