Chapter 15- Monopoly
Why Monopolies Arise
A firm is a monopoly if it is the sole seller of its product and if its product does not have
close substitutes. The fundamental cause of monopoly is barriers to entry: a monopoly
remains the only seller in its market because other firms cannot enter the market and
compete with it. Barriers to entry, in turn, have three main sources:
1. A key resource is owned by a single firm
2. The government gives a single firm the exclusive right to produce some good or
service.
3. The cost of production makes a single producer more efficient than a large number of
producers.
Monopoly Resources
The simplest way for a monopoly to arise is for a single firm to own a key resource. For
example, consider the market for a small town in the Old West. If dozens of town residents
have working wells, the price of a gallon on water is driven to equal the marginal cost of
pumping an extra gallon. But if there is only 1 well in town and it is impossible to get water
from anywhere else, then the owner of the well has a monopoly on water.
Government-Created Monopolies
In some cases, monopolies arise because the government has given one person or firm the
exclusive right to sell some good or service. Sometimes the monopoly arises from sheer
political clout of the would-be monopolist. The government grants a monopoly because
doing so is viewed to be in the public interest. For instance, the US government has given a
monopoly to a company called Network Solutions, Inc. which maintains the database of
all .com, .net, and .org internet addresses, on grounds that such data need to be centralized
and comprehensive. The patent and copyright laws are two important examples of how the
government creates a monopoly to serve the public interest. When a pharmaceutical
company discovers a new drug, it can apply to the government for a patent. If the
government deems the drug to be truly original, it approves the patent, which gives the
company the exclusive right to manufacture and sell the drug for 20 years. When a novelist
finishes a book, she can copyright it. The copyright is a government guarantee that no one
can print and sell the work without the author's permission. The laws governing patents and
copyrights have benefits and costs. The benefit of the patent and copyright laws are the
increased incentive for creative activity. These benefits are offset, to some extent by the
costs of monopoly pricing.
Natural Monopolies
An industry is a natural monopoly when a single firm can supply a good or service to an
entire market at a lower cost than could two or more firms. A natural monopoly arises when
there are economies of scale over the relevant range of output. An example of a natural
monopoly is the distribution of water. To provide water to residents of a town, a firm must
build a network of pipes throughout the town. If two or more firms were to compete in the
provision of this service, each firm would have to pay the fixed cost of building a network.
Thus the average total cost of water is lowest if a single firm serves the entire market. When
a firm is a natural monopoly, it is less concerned about new entrants eroding its monopoly
power. Normally, a firm has trouble maintaining a monopoly position without ownership of
, key resources or protection from the government. The monopolist's profit attracts entrants
into the market, and these entrants make the market more competitive. By contrast, entering
a market in which another firm has a natural monopoly is unattractive. Would-be entrants
know that they cannot achieve the same low costs that the monopolists enjoy because, after
entry, each firm would have a smaller piece of the market.
How Monopolies Make Production and Pricing Decisions
Monopolies versus Competition
The key difference between a competitive firm and a monopoly is the monopoly’s ability to
influence the price of its output. A competitive firm is small relative to the market in which it
operates and, therefore has no power to influence the price of its output. By contrast,
because a monopoly is the sole producer in its market, it can alter the price of its good by
adjusting the quantity it supplies to the market. One way to view this difference between a
competitive firm and a monopoly is to consider the demand curve that each firm faces. A
competitive firm sells a product with many perfect substitutes, the demand curve that anyone
firm faces is perfectly elastic. By contrast, because a monopoly is the sole producer in its
market, its demand curve is the market demand curve. Thus the demand curve will slope
downwards. If the monopoly raises its price there will be less demand and visa versa. The
market demand curve provides a constraint on a monopoly’s ability to profit from its market
power. A monopolist would prefer if it were possible to charge a high price and sell a large
quantity at that high price. The market demand curve makes that outcome impossible. By
adjusting the quantity produced, or the price charged, the monopolist can choose any point
on the demand curve, but it cannot choose a point off the demand curve.
A Monopoly’s Revenue
The first two columns show the monopolist’s demand schedule. If the monopolist produces 1
gallon of water, it can sell that gallon for $10. If it produces 2 gallons, it must lower the price
Why Monopolies Arise
A firm is a monopoly if it is the sole seller of its product and if its product does not have
close substitutes. The fundamental cause of monopoly is barriers to entry: a monopoly
remains the only seller in its market because other firms cannot enter the market and
compete with it. Barriers to entry, in turn, have three main sources:
1. A key resource is owned by a single firm
2. The government gives a single firm the exclusive right to produce some good or
service.
3. The cost of production makes a single producer more efficient than a large number of
producers.
Monopoly Resources
The simplest way for a monopoly to arise is for a single firm to own a key resource. For
example, consider the market for a small town in the Old West. If dozens of town residents
have working wells, the price of a gallon on water is driven to equal the marginal cost of
pumping an extra gallon. But if there is only 1 well in town and it is impossible to get water
from anywhere else, then the owner of the well has a monopoly on water.
Government-Created Monopolies
In some cases, monopolies arise because the government has given one person or firm the
exclusive right to sell some good or service. Sometimes the monopoly arises from sheer
political clout of the would-be monopolist. The government grants a monopoly because
doing so is viewed to be in the public interest. For instance, the US government has given a
monopoly to a company called Network Solutions, Inc. which maintains the database of
all .com, .net, and .org internet addresses, on grounds that such data need to be centralized
and comprehensive. The patent and copyright laws are two important examples of how the
government creates a monopoly to serve the public interest. When a pharmaceutical
company discovers a new drug, it can apply to the government for a patent. If the
government deems the drug to be truly original, it approves the patent, which gives the
company the exclusive right to manufacture and sell the drug for 20 years. When a novelist
finishes a book, she can copyright it. The copyright is a government guarantee that no one
can print and sell the work without the author's permission. The laws governing patents and
copyrights have benefits and costs. The benefit of the patent and copyright laws are the
increased incentive for creative activity. These benefits are offset, to some extent by the
costs of monopoly pricing.
Natural Monopolies
An industry is a natural monopoly when a single firm can supply a good or service to an
entire market at a lower cost than could two or more firms. A natural monopoly arises when
there are economies of scale over the relevant range of output. An example of a natural
monopoly is the distribution of water. To provide water to residents of a town, a firm must
build a network of pipes throughout the town. If two or more firms were to compete in the
provision of this service, each firm would have to pay the fixed cost of building a network.
Thus the average total cost of water is lowest if a single firm serves the entire market. When
a firm is a natural monopoly, it is less concerned about new entrants eroding its monopoly
power. Normally, a firm has trouble maintaining a monopoly position without ownership of
, key resources or protection from the government. The monopolist's profit attracts entrants
into the market, and these entrants make the market more competitive. By contrast, entering
a market in which another firm has a natural monopoly is unattractive. Would-be entrants
know that they cannot achieve the same low costs that the monopolists enjoy because, after
entry, each firm would have a smaller piece of the market.
How Monopolies Make Production and Pricing Decisions
Monopolies versus Competition
The key difference between a competitive firm and a monopoly is the monopoly’s ability to
influence the price of its output. A competitive firm is small relative to the market in which it
operates and, therefore has no power to influence the price of its output. By contrast,
because a monopoly is the sole producer in its market, it can alter the price of its good by
adjusting the quantity it supplies to the market. One way to view this difference between a
competitive firm and a monopoly is to consider the demand curve that each firm faces. A
competitive firm sells a product with many perfect substitutes, the demand curve that anyone
firm faces is perfectly elastic. By contrast, because a monopoly is the sole producer in its
market, its demand curve is the market demand curve. Thus the demand curve will slope
downwards. If the monopoly raises its price there will be less demand and visa versa. The
market demand curve provides a constraint on a monopoly’s ability to profit from its market
power. A monopolist would prefer if it were possible to charge a high price and sell a large
quantity at that high price. The market demand curve makes that outcome impossible. By
adjusting the quantity produced, or the price charged, the monopolist can choose any point
on the demand curve, but it cannot choose a point off the demand curve.
A Monopoly’s Revenue
The first two columns show the monopolist’s demand schedule. If the monopolist produces 1
gallon of water, it can sell that gallon for $10. If it produces 2 gallons, it must lower the price
