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Monopoly
By the end of this chapter, you should be able to:
ur explain the assumptions of monopoly
E
o xr- define, explain, and give examples of sources of monopoly power/
o barriers to entry
I xl define, explain, and illustrate a natural monopoly
xr- explain and illustrate the demand curve facing the monopolist
xl explain and illustrate possible profit situations in monopoly
rl explain, illustrate, and calculate the revenue maximizing level of
output and price
xl explain and illustrate levels of efficiency in monopoly
Hr compare monopoly and perfect competition.
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8. A,4onopoly E
I Economies of scale
As we have seen in Chapter 6, firms gain average cost advantages as
their size increases: these are known as economies of scale. Things
such as specialization, the division of labour, bull<-buying, and
financial economies may lead to cost savings and lower unit costs. If a
monopoly is large, then they will be experiencing economies of scale.
Any firm wishing to enter the industry wiLl probably have to start up
in a relatively small way and so will not have the economies of scale
that are enjoyed by the monopolist. Even if the new firm were able
to start up with the same size as the monopolist, it would still not
have the economies that come from expertise in the industry, such as
managerial economies, promotional economies, and research and
development.
Without equal economies of scale, a would-be entrant to the industry
knows that it would not be able to compete with the existing
monopolist, who would simply have to reduce price to the level of
normal profits. At this level the new entrant would be making losses,
because the average costs would be higher, so the lack of economies
of scale acts as a deterrent to firms that might want to enter a
monopoly industry.
2 Natural monoPoly
Some industries are classified as natural monopolies. An industry is a
natural monopoly if there are only enough economies of scale
available in the market to support one firm. This is best shown by
a diagram, such as Figure 8.I.
In this case, the monopolist is the industry and has the demand curve
Dr. The long-run average cost cuwe faced by the monopolist is LRAC
and its position and shape are set by the economies of scale that the
firm is experiencing. The monopolist is able to make abnormal profits Quantity demanded
by producing an output between qr and qr, because the average
revenue is greater than the average cost for that range of output. Figure 8.1 A natural monopolY
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|!!!!l 8. Monopoly
If another firm were to enter the industry, then the firm would take
demand from the monopolist and the monopolist,s demand curve
would shift to the left, in this case to D2. Since we can assume that
the situation will be the same for both Iirms, the two firms would
now be in a position where it is impossible for them to make even
normal profits. Their LRACs would be above AR at every level of
output.
F In this industry, the LRAC, which is shaped by the economies of scale
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experienced by the monopolist, will only give an abnormal profit if
I
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the monopolist is able to satisfy all of the demand in the market. The
industry is a natural monopoly, because the market will only support
one firm. Examples of natural monopolies include the industdes that
supply utilities such as water, electdcity, and gas.
3 Legal barriers
In certain situations, a firm may have been given a legal right to be
the only producer in an industry, i.e. rhe legal right to be a monopoly. Congratllations! Yoer geerr of
exfentiye retear<h anl Jev<totrr,cnt
This is the case with patents, which give a firm the right to be the
hav Paid sff. For 2c' geart, 9oq
only producer of a product for a certain number oI years after it has
sr;(t be the ontg ffoducer
been invented. Patents are usually valid for approximately 20 ycars.
Pernlttcl to
When a patent expires other producers will then be allowed to NATtoNAL
thi r
?rodoc
produce and sell the product. Patents exist as a means to encourage ?ATENT
invention. If individuals or firms put time and money into AurHoRl
inventions, only to find that they were copied as soon as they were
successful, then there would be little incentive to do so. However, if a
firm knows that, if its invention is successful, it will have a protected
monopoly for a number of years, then it is more likely to invest in
research and development.
5 Anti-competitive behaviour
A monopolist may also attempt to stop competition by adopting
restrictive practices, which may be legal or illegal. For example, an
established monopoly should be in a strong position to start a "price
war" if another firm enters the industry. The monopoly can lower its
price to a loss-making level and should be able to sustain the losses for
a longer time than the new entrant, thus forcing the new firm out of
the industry. Indeed, knowledge of this possibility should be enough
to dissuade new firms from even attempting to enter the industry.
In 2004, the European Union Competition Commission filed
Microsoft 497 million for 'bundling' its windows Media Player
and messaging technologies into its Windows operating system. The
comrnission daimed that this prevented potential competitors from
reaching consumers. It also ordered Microsoft to make public technical
information to allow other companies the ability to produce goods that
are compatible with Microsoft to give Microsoft more competition
again in 2008 for failure to comply with the ruling, and was ordered
to pay 899 million Euros, the largest fine ever given by the
European Compe tition Con-lmission.
That is not the end of it, however. In 2009, the EU Competition
Commission again found Microsoft guilty of anti-competitive
practices, this time for bundling its Internet Explorer browser into
its Windows operating system. According to the commission:
E
o "The evidence gathered during the investigation leads the Commission to believe
o
that the tying of Internet Explorer with Wnd.owL which makes Internet
Explorer available on 90% of the wo d's PCs, distofts competition on the Student workpolnt 8.4
meits between competing web br1wsers insofar as it proides Intemet Exploret Be an inquirer-conduct
with an artificial distribution advantage which other web browserc are researrh and assess the
unable to match. The Commission is concerned that through the tying, Miffosoft outcomes
shields Internet Explorer from head to head competition with other browsers I N/lake an annotated time
which is detrime tal to the paee of proiluct innovation and to the line to briefly explain the
quality of produds which eonsumers ultimately obtain. In addition, the series of events and
decisions in the Microsoft
Commission is concet'ned that the ubiquity of Internet Explofer creates artifrcial
leSal baftle with the
incentives for content proiders and sofiware developers to design websites or
European Union
software primarily for Internet Explorer whi.ch ultimately risks undermining
Competition Commission.
competition and inn1vation in the provision of sentices to consumers."
2 What are the argumen6 for
Source: Europa press release, January l7th, 2009 and against the large fine?
g PRM
Efficiency in monopoly
Unlike perfect comptition, the monopolist produces at the level ol
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output where there is neither productive efficiency nor allocative
o efficiency. This is shown in Figure 8.6.
o
The monopolist is producing at the profit-maximizing level of output, q.
Output is being restricted in order to force up the price and to maximize
profit. However, the most efficient level of output, q1 and the allocatively
eflicient level of output, q2, are not being achieved.
Output
Advantages and disadvantages of monopoly in
comparison with perfect competition Figure 8.6 Produdive and allocative
efficiency in monopoly
Although they are both theoretical market forms, there has always
been much debate about the relatlve merits and demerits of perfect
competition and monopolies.
Output
PJ
Output
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!!!!! 8. N,4onopoly
EXAMINATION QUESTIONS
Paper I, pail (a) questions
I Explain the level of output at which a monopoly firm will produce. [10 norks]
2 Using a diagram, explain the concept of a natural monopoly. [10 morks]
5 Using appropriate diagrams, explain whether a monopoly is likely to be more efficient or less
efficient than a firm in perfect competition. [t0 norks]
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o
o Paper I, essay question
I a Explain three barriers to entry that allow a firm to be a monopoly. [lo morks]
b Evaluate the view that governments should a/roys prevent firms from being monopolies. [15 moks]
a patent [2 morks]
b monopoly. [2 narks]
UsinS an appropriate diagram, explain why Merck was able to earn huge
profits from its sales of Zocor. [4 morks]
Using an appropnate diagram, explain how cheaper labour allows lndia to
manufacture generic drugs at low p.i6g5. [4 nork]
Using information from the text and your knowledge of economics, evaluate the effects
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of the Zocor patent expjry on the market for cholesterolreducing medicines. [8 mo*s]