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12. Monopoly
1. Structure
There is only one seller and the firm is the whole industry.
There are no close substitutes for the product or imports.
Considerable barriers to entry must exist. These may include:
a patent
a license that limits the number of firms to one
control or ownership of raw materials
extremely high infrastructure or capital costs
government restrictions for essential services
Natural monopolies will form where infrastructure costs are high.

Natural Monopoly Argument: Where the capital cost associated with
running a business is extremely high then it can be argued that a monopoly
should operate in this industry so as the gain maximum economies of scale
and avoid the cost of duplicating expensive infrastructure. Monopolies often
operate in industries where capital costs are extremely high. ie
Telecommunications.

2. Conduct
Monopolies tend to restrict output or raise price. This is called
monopolisation and results in supernormal profits.
A monopolist can set the price in the industry and is a price maker. It is
not possible to control both price and output. A monopolist will choose to
control one or the other. Either way a monopolist will make a
supernormal profit.
There is no need for advertising or product differentiation. Product
differentiation means to make your product different to that of your
competitors. In monopoly there are no competitors.
A monopolist will only undertake research & development if it can
reduce their costs or increase profits. Product improvements that are
unprofitable will not be implemented.
Price discrimination may occur where a monopolist is able to segregate
the market into groups with a different willingness to pay. A monopolist
has no competition and if consumers are unable to resell the product or
service then the monopolist can make some consumers pay more than
others. For example a monopolist phone company could charge daytime
business users more than night-time casual users. An electricity company
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could charge users more in the early hours of the evening when
customers are using hot water and cooking their dinner.

3. Performance
Monopolies make supernormal profits in the long run. New firms that
may be attracted by these large profits are unable to enter the industry
because of the barriers to entry. This means that monopolies can make
supernormal profits in the long run. Consumers are paying for these
profits in the form of higher prices. The average revenue in a monopoly
is usually much higher than in other markets.
As a result of the fact that a monopolist restricts output by producing at
the profit maximising level of output, productive efficiency is not
achieved and the full benefits of economies of scale are not passed on to
the consumer. The firm does not produce at the point where MC = ATC.
For the same reason a monopolist will not achieve allocative efficiency.
A monopolist that restricts output forces the consumer to pay a higher
price (higher up the demand curve) than what would be paid if resources
were allocated efficiently. A monopolist does not produce at the point
where P = MC.
A monopolist has the money to spend on research & development but
will only do so if there is an improvement in profitability. This means
that a monopolist will only partially achieve dynamic efficiency.


Monopoly Supernormal Profit

Output ATC MC D = AR MR
1 260 90 300 230
2 200 80 275 175
3 150 70 250 115
4 115 65 225 65
5 96 66 200 15
6 84 70 175
7 80 80 150
8 84 105 125
9 96 140 100
10 115 185 75
11 150 240 50
12 200 310
13 260 350

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Monopoly - Supernormal Profit
0
50
100
150
200
250
300
350
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
Output
R
e
v
e
n
u
e

&

C
o
s
t


All firms produce at the profit maximising level of output where MC = MR.
For the monopolist in the above diagram this occurs at 4 units of output. In
the above table both MC and MR are equal to 65 at 4 units of output. At this
point the monopolist makes a supernormal profit because AR > AC. At 4
units of output AR = 225 and AC = 115 which means that the monopolists
profit margin is 225 115 = 110. If the firm produces 4 units of output then
the supernormal profit is 110 x 4 = 440.

Examples of Monopoly in Australia
It is difficult to find examples of monopolies because government policy has
introduced competition in many industries. Monopolies have only been
allowed to exist in industries where the natural monopoly argument has
justified their existence.

In the pay television industry it was argued that the cost of digitalization and
providing content could only be justified if there were only one operator.
Foxtel recently upgraded its service to digital and introduced a number of
new channels. Foxtel is now the only pay TV operator in Australia.

There is only one international airport in Sydney because of the difficulty of
finding suitable land and the noise problem than an airport can generate.
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Sydney is expected to have one international airport for the next twenty
years according to recent government policy statements. This airport is
operated by the Sydney Airports Corporation which naturally has a
monopoly. When airlines negotiate landing slots (times) and landing fees
they are negotiating with a monopoly operator. Airlines may not be able to
fly to Sydney because they are unable to obtain landing slots. Cathay Pacific
was recently granted more landing slots in Sydney and Dragon Air will be
allowed to fly to Sydney next year.

Telstra is a large phone company that is 50% owned by the government. It
still has monopoly power in the local phone industry because it owns the
copper wire phone network. This monopoly is weakening because of the use
of mobile phones and the Internet. VOIP (voice over Internet protocol)
allows local phone calls to be placed over the Internet thus avoiding the
copper wire network. Telstra still has a dominant position in
telecommunications but the market has changed in some service areas to
duopoly or oligopoly.

Australia Post has a monopoly in the delivery of mail and letters. This
business is still owned by the government and it has evolved over a number
of decades. With the need for post boxes, postcodes and post offices in all
areas of Australia it is logical that one operator would be more efficient in
this industry. Australia Post has competition in the delivery of parcels and
airfreight. This monopoly has been created by a government license.

The State Rail Authority as the name suggests is a government rail
operator. The high cost of providing train tracks in Sydney and the impact
on local residents in terms of noise and disruption to roads, makes it logical
that only one train operator would exist in Sydney.

4. Government Policies for Monopoly

Regulation of Monopoly
Monopolies will not operate in the public interest unless they are regulated
by government. Regulation refers to any action by the government that is
intended to influence the conduct of industries or firms. Regulation can be
used to achieve efficient performance and fair conduct. Regulation aims to
achieve workable competition, which occurs when all firms operate near
their optimal scale. The concept of workable competition is based on what
would occur in a perfectly competitive market.
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Regulation of monopolies may include any of the following:
A regulation requiring a minimum standard of service. For example
Telstra has a Universal Service Obligation that requires that all
Australian households can have a phone service if they require it.
Regulations requiring a minimum standard of service may have the effect
of increasing output of the product beyond the profit maximising level
thus improving both productive and allocative efficiency.
Attaching conditions to licenses requiring a certain conduct.
The imposition of government legislation such as prescribed maximum
fee scales for some professions eg Real-estate agents.

Competition Policy & Monopoly
Under the Trade practices Act it is illegal to practice monopolisation.
Section 46 of the Trade Practices Act makes it illegal for a firm to take
advantage of market power for predatory purposes. A firm shall not take
advantage of market power to eliminate a competitor, prevent entry of a
competitor into the industry, or prevent another firm from engaging in
competitive activities. It applies to any situation in which a firm attempts to
limit competition or engages in conduct to prevent competitors from
entering an industry. Using pricing or output policies to drive competitors
out of an industry so as to maintain market dominance would be an example
of conduct which is targeted by this law.

Section 49 of the Trade Practices Act deals with price discrimination. This
section makes it illegal for a corporation to discriminate between suppliers in
regard to: the price charged for goods, discounts, allowances or credits and
in the provision of services in respect of those goods, if the discrimination is
not cost-justified and is of a magnitude that it would lessen competition.

Governments are able to operate business enterprises. It is possible to
run Government Business Enterprises GBE in some industries to compete
against monopolies. Such government businesses could be operated at a loss
or normal profit and could force prices down and reduce supernormal
profits. This could improve allocative and productive efficiency. Some
arguments against this might be that the GBE is inefficient and this approach
may require the duplication of expensive capital equipment.

The Australian government could pass Antitrust laws like the Sherman
Act in the United States and then break up monopolies into smaller
competing firms as was done in that country. A major telephone company
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called Bell Corporation was broken up into the baby bells: Bell North,
Bell South, Bell Atlantic etc. These baby bells compete against each other
and so the original monopoly has been broken up. There is much talk about
the use of operational separation in the case of Telstra. This would involve
splitting the company into retail and wholesale components. This proposal
has arisen because of concerns of unfair trading practices and anti
competitive behavior used by Telstra.


In Australia we declared the telephone network a public asset forced Telstra
(a 50% government owned phone monopoly) to allow Optus to have access
to the telephone lines. It was proving to be too expensive for Optus to build
its own network and the only way to gain competition was to open the
access to the telephone network. Mobile phone companies are providing
some competition to Telstra however Telstra is also dominant in this market.

Tariff reductions may also be used to increase foreign competition in some
industries. Tariffs protect local producers. Some of these producers may be
monopolies. A good example of the impact of tariff reductions in Australia
is the steel industry and BHP, which had a monopoly in steel for many
years. As steel tariffs fell BHP was forced to become more competitive and
lost its market dominance. We now have three steel producers, a major
upgrade in steel making technology and much lower steel prices. Lower
steel prices have made Australian businesses that use steel much more
internationally competitive.

Deregulation & Monopoly
The term deregulation refers to the process of removing government
regulation from industry in the belief that it will perform more efficiently
without them. This may be particularly relevant in the case of a monopoly
that has been protected by a government license or restriction. Deregulation
will create much needed competition which could improve efficiency.

Currently the NSW State Government is considering competition against
Sydney Water (a State Government monopoly). Private operators claim that
they could run aspects of the sewerage and water system more efficiently.




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Cross Subsidisation & Natural Monopolies
Natural monopolies occur where there are large economies of scale in the
industry and having only one producer is more efficient. Such natural
monopolies are created by government legislation or licenses which act as
barriers to entry for potential competitors. These natural monopolies serve
the whole community at the lowest possible cost and often charge subsidised
prices. However the cost of providing the service may be higher in one
region compared to another. In a normal commercial situation these
consumers would pay higher prices. Natural monopolies often spread this
cost over the whole community which means that some consumers pay more
than they should and others pay less. This is called cross subsidisation.

The recent decision by the NSW State Government to build a desalination
plant is an example of cross subsidisation. Sydney has experienced drought
conditions and water restrictions for several years. To ensure that Sydney
has an adequate water supply the NSW State Government has decided to use
sea water. Only the residents in the eastern suburbs of Sydney will use
desalinated water but all water users in Greater Sydney will be paying an
additional amount on their water bills to cover the cost of the plant.

Microeconomic Reform & Monopoly
Microeconomic reform (MER) involves a selection of strategies to improve
the efficiency of Australias public and private sectors. MER aims to make
our products more competitive on world markets by making factor and
product markets work more efficiently.

Many of these reforms have been targeted at utilities and natural monopolies
especially where they provide essential business services and have a major
impact on the cost of production of Australian firms. An example of these
reforms has been the introduction of competition by allowing the gas utilities
like AGL to sell electricity and the electricity utilities like Energy Australia
to sell gas. This has increased competition in these natural monopolies in the
hope of forcing companies to charge lower prices.
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Exam Questions
Multiple Choice Questions
1. A typical barrier to entry in a monopoly would be:
a) Advertising.
b) Economies of scale.
c) A license.
d) Product differentiation.

2. Workable competition attempts to develop a realistic model based on
which market structure?
a) Perfect Competition.
b) Monopoly.
c) Oligopoly.
d) Monopolistic Competition.

3. Public utilities usually operate as:
a) Duopolies.
b) Oligopolies.
c) Monopolies.
d) Perfect competitors.

4. The demand curve faced by a monopolist is:
a) Relatively elastic.
b) Perfectly elastic.
c) Relatively inelastic.
d) Perfectly inelastic.

5. The growth of natural monopolies requires:
a) Economies of scale.
b) Cross subsidisation.
c) Profitable production.
d) Microeconomic reform.

6. Monopolisation means to:
a) Restrict output.
b) Raise the price.
c) Restrict output and raise the price.
d) Restrict output or raise the price.
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Short Answer
1. Why must there be no close substitutes in a monopoly?
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2. Why do monopolies always have high barriers to entry?
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3. Why is there no need for product differentiation in monopoly?
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4. What is meant by the term monopolisation?
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5. What is price discrimination? Why is it likely to occur in monopoly?
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6. Why is a monopolist unlikely to achieve allocative or productive
efficiency?
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7. Why do monopolists make supernormal profits in the long run?
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8. Why do monopolies require regulation?
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9. What has the Australian government done in terms of competition policy
to improve the operation of industries dominated by monopolies?
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10. How could deregulation be used to increase competition in a monopoly?
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Extended Response
What are the structure, conduct and performance of a monopoly?

Rule 1: Define the terms in the question: Monopoly, structure, conduct and
performance.
Rule 2: Identify & define related concepts: Barriers to entry, substitutes,
patents, monopolisation, price discrimination and price maker.
Rule 3: Link introduced terms to the question: There is only one seller in a
monopoly because barriers to entry prevent new firms entering the market.
Rule 5: Draw relevant diagrams: Monopoly SNP
Rule 6: Text reference to diagram in your answer: A monopolist will make a
supernormal profit in the long run.
Rule 7: Use examples to communicate additional meaning: A mathematical
example of supernormal profit.
Rule 4: Draw logical conclusions: A monopolist will always make a
supernormal profit. By producing at the profit maximising level of output a
monopolist will never achieve allocative and productive efficiency.