The monopolys marginal revenue curve lies below its demand curve

Chapter 14

Monopoly and Antitrust Policy

4.economies of scale so large that one firm has a natural monopoly.

A monopoly firm maximizes profit by producing the quantity of output that makes marginal revenue equal to marginal cost. A monopoly firm’s demand curve is the same as the market demand curve for the product it sells. If the monopolist’s price exceeds its average total cost at the output where marginal revenue equals marginal cost, it will earn an economic profit. Because of high entry barriers, new firms will not be able to enter the market. If other things remain the same, the firm will be able to continue to earn economic profits, even in the long run. Generally, a monopoly will produce a smaller quantity and charge a higher price than would a perfectly competitive industry producing the same good. Because a monopolist’s profit-maximizing price exceeds marginal cost, a monopoly generates a loss in economic efficiency relative to a perfectly competitive market.

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2.Explain the four main reasons monopolies arise. For a monopoly to exist, barriers to entering the market must be so high that no other firm can enter. The government may block the entry of firms by granting a patent or copyright to an individual or firm, or by granting a public franchise that makes one firm the exclusive provider of a good or service. Other barriers include control of a key input, network externalities, and economies of scale.

Chapter Opener: Time Warner Rules Manhattan (pages 472-473)

Time Warner Cable, a division of the Time Warner Company, operates cable television systems in the United States. As the only provider of cable television in Manhattan, it has a monopoly in this market. There are few monopoly firms in the United States because when a firm earns an economic profit, other firms have an incentive to enter the market.

Learning Objective 1 Define monopoly.

A monopoly is a firm that is the only seller of a good or service that does not have a close substitute. A narrow definition of monopoly is that a firm is a monopoly if it can ignore the actions of other firms. Broadly defined, a firm is a monopoly if it can retain economic profits in the long run.

Supports Learning Objective 1: Define monopoly.

Is the Cable Television Monopoly Over?

Sources: “Cable System’s New Weapon In Phone Battle: Going Private,” by Peter Grant, Wall Street Journal, June 21, 2005.

“Cable TV Suffers From High Rate Increases, Lower Satisfaction,” by Robyn Greenspan, Hardware. August 21, 2003.

This problem is about the definition of monopoly, so you may want to review the section “Is Any Firm Ever Really a Monopoly?” which begins on page 474 of the textbook.

Step 2: Answer question (a) by defining monopoly.

A monopoly requires that barriers to entry into the market must be so high that no other firms can enter. There are four reasons entry barriers may be high enough to keep out competing firms:

1.Government can block the entry of more than one firm into a market by granting a patent or copyright or by granting a firm a public franchise. A patent is the exclusive right to a product for a period of 20 years from the date the product was invented. U.S. laws grant copyright protection to creators of books, films and music. State and local governments in the United States have granted public franchises—the legal right to be the sole provider of a good or service—to providers of electricity, natural gas, cable television, and water.

� Helpful Study Hint

Making the Connection “The End of the Christmas Plant Monopoly” and “Are Diamond Profits Forever? The De Beers Diamond Monopoly” describe the source of monopoly for firms in two different markets. The market for poinsettias was a monopoly for many years because the producers kept the production process a secret. Once the secret to the production process was revealed and became widely adopted by producers, the market was very competitive and the price of poinsettias plants fell. The market for diamonds was monopolized by De Beers for a significant number of years. The company maintained its monopoly by buying up new supplies as they were discovered, but the company was not able to buy all of the new supplies. De Beers no longer has a monopoly in the diamond market, but is trying to continue to earn economic profits by labeling their diamonds. Test your understanding by completing end-of-chapter problems 2.9 and 2.10.

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price. If the monopolist earns an economic profit, new firms will not be able to enter the market. Therefore, long-run economic profits can be earned.

Read Don’t Let This Happen to You! to learn why charging a higher price won’t guarantee more profits – even for a monopolist. It may seem logical for Comcast to increase its price for cable services to increase its profit, but the managers of firms must realize that as they increase price, the quantity demanded will fall. As the quantity demanded falls, the firm will no longer be producing the profit maximizing quantity and will no longer be receiving the highest possible profits.

Professional sports leagues such as Major League Baseball and the National Football League negotiate television contracts for all of their teams and they restrict the number of their franchises. In other words, they act as monopolists. But monopoly power does not guarantee a profit to each team. As is true in other industries, poor management or weak consumer demand can lead to economic losses. The Montreal Expos baseball franchise is one example of low consumer demand causing a firm to exit the industry. (The Expos moved to Washington D.C. a few years ago.) But successful franchises such as the Los Angeles Dodgers or the

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closely associated with Joseph Schumpeter. For example, the computer you use replaced the typewriter your parents and grandparents used. However, many economists disagree with Schumpeter and argue that firms that started small, such as Apple and Google, have produced many new products.

Supports Learning Objective 4: Use a graph to illustrate how a monopoly affects economic efficiency.

Comcast Cable

SOLVING THE PROBLEM

Step 1: Review the chapter material.

To calculate the deadweight loss associated with monopoly, we must first find what price and quantity would be in this market if the industry was perfectly competitive. The perfectly competitive quantity will be where price equals marginal cost, which occurs where the demand curve and the marginal cost curve intersect. Shade in the area between the monopoly’s profit maximizing quantity and the perfectly competitive equilibrium and between the marginal cost and demand curves. See the graph below. To calculate this area, we calculate the area of a triangle:

Learning Objective 5 Discuss government policies toward monopoly.

Because monopolies reduce consumer welfare and efficiency, most governments regulate their behavior. Collusion refers to an agreement among firms to charge the same price or to otherwise not compete. Antitrust laws are laws aimed at eliminating collusion and promoting competition among firms. The passage of the first antitrust law was spurred by the formation of various “trusts” in the 1870s and 1880s. Trusts are combinations of firms in several industries that operate independently but are controlled by a common board of trustees.

1.Market definition. A market consists of all firms making products that consumers view as close substitutes.

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Becoming Too Big?” discusses whether the government should allow banks to merge or not. If there are large economies of scale that can be achieved by merging, then these mergers could increase economic efficiency. Regulations have been established by the federal government that will allow banks to merge only if merging means that no individual bank will control more than 10 percent of the deposits in the economy.

Supports Learning Objective 5: Discuss government policies toward monopoly.

Does Microsoft Stifle Innovation?

Step 1: Review the chapter material.

European countries and the European Union have laws to increase and protect competition like those in the United States. To help understand why the European Union agents found Microsoft guilty of impeding competition, it would be useful for you to review the section “Government Policy toward Monopoly,” which begins on page 488 of the textbook.

Key Terms

Antitrust laws. Laws aimed at eliminating collusion and promoting competition among firms.

Market power. The ability of a firm to charge a price greater than marginal cost.

Monopoly. A firm that is the only seller of a good or service that does not have a close substitute.

Vertical merger. A merger between firms at different stages of production of a good.

Self-Test

a.If Macintosh and Linux were not considered close substitutes for Windows
b.If Microsoft charged prices similar to those that Macintosh and Linux charge for their operating systems in order to compete
c.If Macintosh and Linux started to produce operating systems similar to Windows
d.If Microsoft imposes barriers for Macintosh and Linux to enter the market

3.Which type of barrier to entry is the granting of a patent or copyright to an individual or firm considered?

5.The more cell phones in use, the more valuable they become to consumers. Which of the following terms best ascribes to that assertion?

a.Patent
b.Network externalities
c.Control of a key resource
d.Natural monopoly

a.Point A
b.Point B
c.Either point A or point B are associated with a natural monopoly breaking even. d.Neither point A nor point B is associated with a natural monopoly breaking even.

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9.Which of the following statements regarding natural monopoly is true?

a.One firm can supply twice as much output as two smaller firms at the same average total cost. b.One firm can supply the entire market at a lower fixed cost than two or more firms.

11.Which of the following types of firms use the marginal revenue equals marginal cost approach to maximize profits?

a.Perfectly competitive firms
b.Monopolistically competitive firms
c.Monopolies
d.All of the above

a.All price takers
b.All price makers
c.Monopolies only
d.Monopolistic competitive firms only

14.When a firm’s demand curve slopes down and the firm decides to cut price, which of the following happens?

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16.Refer to the table below. How much is the marginal revenue associated with serving seven subscribers per month?

a.The demand curve
b.The marginal revenue curve
c.Both curves
d.Neither curve

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a.$90
b.$72
c.$42
d.$18

21.Assume that an industry that began as a perfectly competitive industry becomes a monopoly. Which of the following describes a change in the market as a result of becoming a monopoly? Compared to when the industry was perfectly competitive, the monopolist will
a.charge a higher price and produce less output.

b.charge a higher price and increase consumer surplus.

a.Those corresponding to point A
b.Those corresponding to point B
c.Those corresponding to point C
d.None of the above

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a.Area A
b.Area B + C
c.Area A + B
d.None of the areas indicated on the graph

26.Refer to the graph below. If the industry changes from being perfectly competitive to being a monopoly, what happens to producer surplus?