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Lecture 10

ECN 104 Lecture Notes - Lecture 10: Income Distribution, Economic Surplus, Dynamic Efficiency

Course Code
ECN 104
Frank Trimnell

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I. Learning objectivesAfter reading this chapter, students should be able to: of
1. List the characteristics of monopoly.
2. Explain how a monopolists sets its maximizing t output and price.
3. Discuss the economic effects of monopoly.
4. Describe why a monopolist prefers to charge different prices in different markets.
5. Discuss the choices facing governments that regulate monopolies.
6. Explain the deadweight loss associated with monopoly.
II. Monopoly: An Introduction
A. Definition: monopoly exists when a single firm is the sole producer of a product for which
there are no close substitutes.
B. There are a number of products where the producers have a substantial amount of monopoly
power and are called “near” monopolies.
C. There are several characteristics that distinguish monopoly.
1. There is a single seller so the firm and industry are synonymous.
2. There are no close substitutes for the firm’s product.
3. The firm is a “price maker, that is, the firm has considerable control over the price
because it can control the quantity supplied.
4. Entry into the industry by other firms is blocked.
5. A monopolist may or may not engage in non-price competition. Depending on the nature
of its product, a monopolist may advertise to increase demand.
D. Examples of monopolies and “near monopolies”:
1. Public utilities—gas, electric, water, cable TV, and local telephone service companies—
are monopolies.
2. The DeBeers diamond syndicate is an example of a “near” monopoly. (See Last Word.)
3. Manufacturing monopolies are virtually nonexistent in nationwide Canadian
manufacturing industries.
4. Professional sports leagues grant team monopolies to cities.
5. Monopolies may be geographic. A small town may have only one airline, bank, etc.
E. Analysis of monopolies yields insights concerning monopolistic competition and oligopoly,
the more common types of market situations.
III. Barriers to Entry Limiting Competition
A. Economies of scale constitute one major barrier. This occurs where the lowest unit costs and,
therefore, lowest unit prices for consumers depend on the existence of a small number of
large firms or, in the case of a 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 (see Figure 10.9 and Figure 10.1).
1. Public utilities are known as natural monopolies because they have economies of scale in
the extreme case where one firm is most efficient in satisfying existing demand.
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2. Government usually gives one firm the right to operate a public utility industry in
exchange for government regulation of its power.
3. The explanation of why more than one firm would be inefficient involves the description
of the maze of pipes or wires that would result if there were competition among water
companies, electric utility companies, etc.
B. Legal barriers to entry into a monopolistic industry also exist in the form of patents and
1. Patents grant the inventor the exclusive right to produce or license a product for
seventeen years; this exclusive right can earn profits for future research, which results in
more patents and monopoly profits.
2. Licenses are another form of entry barrier. Radio and TV stations, taxi companies are
examples of government granting licenses where only one or a few firms are allowed to
offer the service.
C. Ownership or control of essential resources is another barrier to entry.
1. International Nickel Co. of Canada (now called Vale Inco) controlled about 90 percent of
the world’s nickel reserves, and DeBeers of South Africa controls most of world’s
diamond supplies.
2. Aluminium Co. of America (Alcoa) once controlled all basic sources of bauxite, the ore
used in aluminium fabrication.
3. Professional sports leagues control player contracts and leases on major city stadiums.
D. Monopolists may use pricing or other strategic barriers such as selective price-cutting and
1. Microsoft charged higher prices for its Windows operating system to computer
manufacturers featuring Netscape Navigator instead of Microsoft’s Internet Explorer.
U.S. courts ruled this action illegal.
IV. Monopoly demand is the industry (market) demand and is therefore downward sloping.
A. Our analysis of monopoly demand makes three assumptions:
1. The monopoly is secured by patents, economies of scale, or resource ownership.
2. The firm is not regulated by any unit of government.
3. The firm is a single-price monopolist; it charges the same price for all units of output.
B. Price will exceed marginal revenue because the monopolist must lower the price to sell the
additional unit. 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 (Table 10-1 and Figure 10-2).
1. Figure 10-3 shows the relationship between demand, marginal-revenue, and total-revenue
2. The marginal-revenue curve is below the demand curve, and when it becomes negative,
the total-revenue curve turns downward as total-revenue falls.
C. The monopolist is a price maker. The firm controls output and price but is not free of market
forces, since the combination of output and price that can be sold depends on demand. For
example, Table 10-1 shows that at $162 only 1 unit will be sold, at $152 only 2 units will be
sold, etc.
D. Price elasticity also plays a role in monopoly price setting. The total revenue test shows that
the monopolist will avoid the inelastic segment of its demand schedule. As long as demand is
elastic, total revenue will rise when the monopoly lowers its price, but this will not be true
when demand becomes inelastic. At this point, total revenue falls as output expands, and
since total costs rise with output, profits will decline as demand becomes inelastic.
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