Monopoly: “Real World” Relevance
1) Legal; Example: patent
2) “Near” Monopoly; Example: Microsoft, Windows operating system
3) Natural (High fixed costs, low marginal cost); Example: pipelines, electrical power.
● Fixed cost: 10 million (constructing the pipeline)
● Marginal Cost (per barrel of oil): $0.50
● Size of market: 2 million barrels of oil transferring from point A to B
● What is the ATC? (if market is divided evenly among firms)
○ 1 firm: 5.50
○ 10 firms: 50.50
○ 50 firms: 250.50
● If you force competition on this industry, would only push the ATC up.
● Policy response: regulate a single firm in the case of natural monopoly
○ Not to try to create competition
How to Regulate a Natural Monopoly?
● Only makes sense to have one firm, to protect consumers, we can only regulate
● Unregulated Natural Monopoly: Sell Pm and Qm
● Regulation of a Natural Monopoly: P(Regulated) < Pm, Q(Regulated) > Qm
○ Often, P(Regulated) = ATC
■ Price to cover ATC of the monopolist
■ Only allowed to earn the normal rate of profit, zero economic profit - the opportunity cost of invested capital
○ Set P=ATC
■ MR becomes irrelevant
● The monopoly is not allowed to profit maximize
■ Quantity determined by price
○ Observation of regulated natural monopolies.
■ 1) Not Allocatively Efficient
● Value to buyers (P) > MC of producer
■ 2) Monopolist breaks even <=> earns zero economic profit
■ 3) Problem: Monopolist has no incentive to control cost
● There are a lot of natural monopolies
1. Makes no sense to force competition.
2. How government regulates them.
Oligopoly and Monopolistic Competition
2.Oligopoly: Key Example
Features of Oligopoly - Auto Manufacturers (North America) ● 1) Few firms (GM, Chrysler, Ford)
● 2) Face downward-sloping demand curves
○ Should GM raise price of its compact cars?
■ You know that quantity demanded would fall but might be in your
interest, profit wise, to do so
● 3) Mutual Interdependence
○ If GM raises price, what will competitors do?
Oligopolists (few sellers, aware of interdependence) - possibilities
● 1) If engage in cut-throat competition, industry profits may equal competitive level
of profits (zero economic profits)
● 2) If fo