Complete 2 pages of Cornell notes for Chapter 7-4 from page 172-176.
Chapter 7: Market Structures
Section 2: Monopoly
Pure monopoly exists when a single firm is the sole producer of a product for which there are no close substitutes.
They are very desirable from the point of view of a company and, usually, not very desirable for consumers.
Three characteristics define pure monopoly:
1. There is a single seller.
2. There are no close substitutes for the firm’s product.
3. There are barriers to entry.
Whereas the perfectly competitive firm is a price taker, the monopolistic firm is a price maker. That is, it has control over the price.
Examples of monopoly are public utilities such as gas, electric, water, cable TV, and local telephone service companies, and professional sports teams.
Also, monopolies may exist at the local level because of geographic location. Barriers to entry are the main line of defense for incumbent monopolies.
Economies of scale constitute one major barrier. They occur where decreases in unit costs depend on output size. In this case, because a large firm with a large market share is most efficient, new firms cannot afford to enter the market and gain market shares.
Public utilities are known as natural monopolies because they possess such economies of scale.
Barriers to entry also exist in legal forms as patents or licenses.
Patents grant the inventor the exclusive right to produce a product for 20 years.
Franchise and license are granted by the government and allow only one or few firms to operate in a given market.
Example of Franchise:
When National Park Service selects a firm to provide goods and services.
Example of License:
FCC gives radio and TV stations licenses to broadcast in order to manage scarce resources such as airwaves.
Finally, barriers to entry may arise from the exclusive ownership or control of essential resources.
Since there is only one company, the monopolist is a price maker. That is, the company controls output or price – though not both.
Ultimately, its profits depend on its ability to sell, that is, on the market demand for its product.
How does a monopolist decide how much to produce and at what price to sell?
Since there is only one firm, in the case of the monopolist, the market and the company’s demand curves are identical. A monopoly demand is the industry (market) demand and is, therefore, illustrated by a downward sloping curve.
Clearly, the price elasticity of demand plays a crucial role in monopoly price setting.
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.
A monopolist, like any other company, does not care about charging the highest price it can get, it cares about selling as close as possible to the quantity of output that maximize its profits.
If monopoly creates substantial economic inefficiency and appears to be long-lasting, antitrust laws can be used to break up the monopoly.
Ch. 7-3 Monopolistic Competition
Occurs when a group of firms sell closely related, but not identical products. Instead, the products are said to be “differentiated products.”
Examples of monopolistic competition: Books, CDs, automobiles, movies, computer software, restaurants, furniture, and so on.
Characteristics of Monopolistic Competition
• Many relatively small firms offering similar products.
• Thus, the firm has some control over price, but not much.
Monopolistic competition occurs when:
1. There are many producers and many consumers in a given market.
2. Consumers have clearly defined preferences – the goods and services are heterogeneous
3. Freedom of entry.
4. Firms have slight control over price.
5. Products must be differentiated to maintain a competitive edge.
Methods of Product Differentiation
Model or Design Changes
• Physical characteristics
• Service level
• A market structure characterized by a small number of firms whose behavior is interdependent.
Example: Oil companies
• Usually contain significant barriers of entry such as high start-up costs, technology, and government licenses and patents.
Practices that the government finds anti-competitive (illegal):
Price leadership is when the dominant competitor among several leads the way in determining prices, the others soon follow the trend.
Collusion takes place within an industry when the decision of a few firms to collude (work together to control price) can significantly impact the market as a whole. Price fixing is usually the outcome.
• A cartel is a group of firms that agree to coordinate their production and pricing decisions, thereby behaving as a monopoly.
• They are illegal in the United States.
• Organization of Petroleum Exporting Countries (OPEC)
Requirements for Success:
• An agreement on price
• A system of allocating market shares & cuts