Question

a. Choose a monopoly that you are familiar with (not the NFL) and briefly explain how the firm has established barriers to entry. Draw the market graph for this firm and make sure to show DWL and profit. What are the two main differences between this graph and the perfectly competitive graph you drew earlier?

Explain why MR is always less than P for the monopolist.

b. Explain intuitively why monopoly leads to deadweight loss relative to perfect competition. Why might the government decide to step in and regulate this monopoly. Why might the government instead decide to allow this monopoly to exist?

c. Now give an example of an event that would decrease the costs of this monopolist. Use a graph to show how price, quantity, and profit will change.

d. Name the two most important factors that must be in place in order for firms to be able to price discriminate. Give two examples of how the monopolist you chose might use price discrimination.

Answer 1

Barriers to Entry

Because of the lack of competition , monopolies tend to earn significant economic profits. These profits should attract vigorous competition as described on Perfect Competition, and yet, because of one particular characteristic of monopoly, they do not.

Barriers to entry are the legal, technological, opr 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 finite number of radio frequencies vailable for broadcasting. Once the rights to all of them have been purchased, no new competitors can enter the market.

I n some cases, barriers to entry may lead to monopoly. In other cases, they may limit competition to a few firms. Barriers may block entry even if the firm or firms currently in the market are earning profits. Thus, in markets with significant barriers to entry, it is not true that abnormally high profits will attract new firms, and that this entry of new firms will eventually cause the price to decline so that surviving firms earn only a normal level of profit in the long run.

There are two types of monopoly , based on the types of barriers to entry they exploit. One is Natural Monopoly, where the barriersa to entry are something other than legal prohibition. The other is Legal Monopoly, where laws prohibit (or severely limit) competition.

When barriers to entry are high enough, monopoly can result:

Barrier to Entry Government Role    Example

Natural Monopoly Government often responds with regulation Water and electric companies

Control of a physical resource No DeBeers for Diamonds

Legal Monopoly Yes Post Office, past regulation of airlines and trucking

Patent trademark, and copyright Yes, through protection of intellectual property New drugs or software

Intimidating potential competitors Somewhat Predatory pricing; well- known brand names

Key concepts and summary

Barriers to entry prevent or discourage competitors from entering the market. These barriers include: economies of scale that lead to natural monopoly: control of physical resource, legal resytrictions 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.

# Barriers# entry

Government regulates monopolies:

The government may wish to regulate monopolies to protect the interests of consumers. For example, monopolies have the market power to set prices higher than in competitive markets. The government can regulate monopolies through price capping, yardstick competition and preventing the growth of monopoly power.

• Prevent excess prices, without government regulation, monopolies could put prices above the competitive equilibrium. This would lead to allocative inefficiency and a decline in consumer welfare.
• Quality of Service, If a firm has a monopoly over the provision of a particular service, it may have little incentive to offer a good quality service. Government regulation can ensure the firm meets minimum standards of service.
• Monospony power, A firm with monopoly selling power may also be in a position to exploit monopsony buying power. For example, supermarkets may use their dominant market position to squeeze profit margins of farmers.
• Promote Competition, In some industries, It is possible to encourage competition, and therefore there will be less need for government regulation.
• Natural Monopolies, Some Industries are natural monopolies- due to high economics of scale, the most efficient number of firms is one. Therefore , we cannot encourage competition, and it is essential to regulate the firm to prevent the abuse of monopoly power.

Monopoly to exist:

This is the most extreme , but not the most common, example of market power. A monopoly is a market with only one seller. A monopolist is free to set prices or production quantitiea, but not both because he faces a downward-sloping demand curve. He cannot haver a high price and a high quantity of sales- if he has a high price, people will buy less.

There are three ways that a monopoly can exist:

• All of some resource is owned by some firm (e.g, Diamonds etc)
• The Government allows a monopoly to exist (not common in the US, but in many countries things like airlines or railways are government-designated monopolies).
• A Natural Monopoly exists (e.g. local power company). We will talk more about natural monopolies a bit later in the course.

At this point, you might think about some markets that have a dominant market share held by a single firm, such as Microsoft in marmket for spreadsheet software. These are not monopolies , in that firms in these markets do have competitors, and consumers do have choices.

If a firm obtains an inordinate market share due to offering a product that many people want to buy, we do not have a lot of market power, and may face a lot of scrutiny from the government, but they are not technically monopolies.

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