How will you know a monopoly if you see one?
Think back to the characteristics: there'll be a single seller, someone who sells a product
for which there are no close substitutes, and there are significant barriers to entry,
barriers that are so high, in fact, that no other producers can enter the industry.
What kinds of barriers could there be that would keep competitors out?
Patents would keep others out, at least until the patent expired, or unless you sell the
right to use the idea to other people; sole ownership of a key resource would prevent
competition.
For example, if you're a large bookstore that owns the only book distributor, then there's
not really any way for other bookstores to get inventory.
What about costs?
Extremely high costs would keep many other producers out; in fact, in the case of extraordinarily
high fixed costs, you can get a situation where economies of scale kick in, and you're
actually better off to have only one producer.
Look, think about power generation plants.
It not only costs about gazillion dollars to build the plant itself, but then you need
the power grid -- all those towers and lines to deliver the electricity.
So, if there’s just one company incurring all those upfront costs, that firm can spread
the costs out over a large quantity of production, and the cost per unit ends up being very low.
But if you break this company up, creating 10 smaller firms that would compete with each
other, each firm must repeat these initial costs, yet has only 1/10 of the customers,
in this example.
Cost per unit ends up being very high.
In a case like this, with huge economies of scale, it's actually more efficient to have
only one producer, as a natural outcome of the cost structure.
This would be a natural monopoly.
With a natural monopoly, the enormous fixed costs dominate, so that effectively, the average
total cost curves look like what we’re accustomed to seeing in an average fixed cost curve;
the more you produce, the lower the cost per unit.
This type of monopoly is the exception, though, and not the rule.
OK, enough about that atypical monopoly; what does the typical monopoly look like?
First of all, because the monopoly is the only seller of the product, anyone who wants
to buy the product must buy from the monopoly.
This means that the demand faced by the monopolist is the entire industry, or market, demand.
What does marginal revenue look like?
To figure that out, let's look at a basic demand schedule: as my prices drop, the quantity
that I can sell rises.
I need to calculate total revenue before I can calculate marginal revenue, which I do
by multiplying the price per unit times the number of units.
Then I can address marginal revenue, or the amount of additional revenue I generate by
selling another unit.
Since I had NO revenue when my output was zero, the marginal revenue of my first unit
is +$10.
The second unit adds $8 to revenue, the third adds $6, and so on.
Notice that, unlike perfect competition, the marginal revenue figures are less than the
prices.
If I plot out the numbers for demand and marginal revenue, you can see the contrast.
I use the price and quantity figures to plot demand, and the marginal revenue and quantity
figures to plot the marginal revenue curve, so I know that generally demand and marginal
revenue look like this.
To determine the monopolist’s chosen output, though, I need to be able to find the output
at which marginal revenue equals marginal cost; so I also need to add a marginal cost
curve.
Because marginal cost looks the same, no matter what the market structure is, all I need to
do is add our usual J-shaped marginal cost curve to the existing diagram.
Now I can see the monopolist’s profit-maximizing output, Q*.
OK, this part is important: we don't know the monopolist’s price yet.
To find it, you have to remember that this producer can raise the price as high as the
consumers are willing to pay.
Since the demand reflects the buyers’ willingness to pay, I go up to the demand curve to see
what price I can get for these Q* units of output.
If Q* is the monopolist’s profit-maximizing output, and P* is the price that can be charged
for that output, what's the monopolist’s profit?
Well, we don’t really know, do we?
We’re still missing the average cost curves, which need to be added in order to determine
the amount of profit.
Look -- let's say you want to show monopolist who is earning a positive profit.
This means that the price must be higher than the cost per unit.
In this case, remember that price times quantity yields your total revenue (in green), and
average total cost times quantity gives your total cost (in red).
The remaining area that I have here in blue is the firm's profit.
What happens the monopoly's profit in the long run?
I mean, if a competitive firm makes a profit in the short run, then over time, other firms
enter, and profits go to zero.
So what happens to the monopolist’s profit?
Nothing happens.
Remember the barriers to entry?
Those barriers keep competitors out, protecting the monopolist’s profit.
Does the monopolist necessarily earn profit?
No; just because you're the only producer of something doesn't guarantee you’ll earn
a profit.
If the cost per unit exceeds the price, you’ll be losing money just like any other business
owner.
What’ll happen in the long run?
Any producer who's losing money in the short run will get out in the long run, taking his/her
resources elsewhere.
Where does this leave industry?
If this producer leaves, there is no industry.
One last thing about monopoly -- why do so many people consider the monopolist to be
the bad guy?
This is just a producer, trying to maximize profits like any other producer.
Well here’s the thing: most people are opposed to a monopoly because they prefer the alternative,
competition.
Look back at the monopolist.
Now, if this were a competitive market, instead?
Remember that in a competitive market, the market supply and the market demand determine
the price and quantity.
We know already that the monopoly faces the industry, or market, demand; where’s the
industry supply?
The marginal cost curve, as long as we're above that minimum average variable cost,
is the monopoly supply; and since the monopolist is the only supplier, it's also the industry
supply.
The intersection of industry supply and industry demand yield the price and quantity that we’d
see if this were perfectly competitive market.
Why do people consider the monopolist to be the bad guy?
Because the monopolist charges more, and provide less product.
The “people” who don't like the monopolist are the consumers, who would rather see the
lower prices and greater quantities associated with a competitive market.
NEXT TIME: Regulation TRANSCRIPT00(MICRO) EPISODE 27: MONOPOLY