PURE MONOPOLY

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Pure monopoly exists when a single firm is the sole producer of a product for which there are no close substitutes. Examples are public utilities and professional sports leagues,

Characteristics

1. A single seller: the firm and industry are synonymous.

2. Unique product: no close substitutes for the firm’s product.

3. The firm is the price maker: the firm has considerable control over the price because it can control the quantity supplied.

4. Entry or exit is blocked.

Barriers to Entry

Economies of scale is the major barrier. This occurs where the lowest unit cost and, therefore, low unit prices for consumers depend on the existence of a small number of large firms, or in the case of monopoly, only one firm. Because a very large firm with a large market share is most efficient, new firms cannot afford to start up in industries with economies of scale. Public utilities are known as natural monopolies because they have economies of scale in the extreme case. More than one firm would be inefficient because the maze of pipes or wires that would result if there were competition among water companies or cable companies. Legal barriers also exist in the form of patents and licenses, such as radio and TV stations. Ownership or control of essential resources is another barrier to entry, such as the professional sports leagues that control player contracts and leases on major city stadiums. It has to be noted that barrier is rarely complete. Think about the telephone companies a couple decades ago; there was no substitute for the telephone. Nowadays, cellular phones are very popular. It creates a substitute for your house phone, causing the traditional telephone companies to lose their monopoly position.

Demand Curve

Monopoly demand is the industry or market demand and is therefore downward sloping. Price will exceed marginal revenue because the monopolist must lower price to boost sales and cannot price discriminate in most cases. The added revenue will be the price of the last unit less the sum of the price cuts which must be taken on all prior units of output. The marginal revenue curve is below the demand curve.

Profit –Maximizing Output

The MR = MC rule will still tell the monopolist the profit – maximizing output. The monopolist cannot charge the highest price possible, it will maximize profit where TR minus TC is the greatest. This depends on quantity sold as well as on price. The monopolist can charge the price that consumers will pay for that output level. Therefore, the price is on the demand curve. Losses can occur in monopoly, although the monopolist will not persistently operate at loss in the long run.

Monopolies will sell at a smaller output and charge a higher price than would pure competitive producers selling in the same market. Income distribution is more unequal than it would be under a more competitive situation, unless the government regulates the monopoly and prevents monopoly profits. If a monopoly creates substantial economic inefficiency and appears to be long-lasting, antitrust laws could be used to break up the monopoly.

Efficiency:

1. Productive efficiency: occurs where P= min ATC. Monopoly firms will not achieve productive efficiency as firms will produce at an output which is less than the output of min ATC. X-inefficiency may occur since there is no competitive pressure to produce at the minimum possible costs.

2. Allocative efficiency: occurs where P = MC. This efficiency is not achieved because price( what product is worth to consumers) is above MC (opportunity cost of product).

It is possible that monopoly is more efficient than many small firms. Economies of scale (natural monopoly) may make monopoly the most efficient market model in some industries. However, X-inefficiency and rent-seeking cost (lobbying, legal fees, etc.) can entail substantial costs, causing inefficiency.

Producer surplus is significant due to lack of competition, consumer surplus may be minimized. This market structure will not contribute to a fair income distribution of our society.

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