Economics
Sesión 6: Monopoly
Luis Maldonado
Perfect competition
Traits:
Multiple sellers and buyers.
Homogeneous product.
No entry barriers.
Consequences:
Firms are price takers (Firms do not have the power to set the
price at a level different from its competitors).
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Monopoly
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Monopoly
Characteristics
Only one seller
No substitutes available
Huge entry barriers
Consequences
The firm sets the price (only constraint is consumer
demand, but not competitors).
Price is higher than in perfectly competitive markets – loss
to consumers
Not optimal solution for society.
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Why there are monopolies?
Entry barriers:
Control of an essential input (infrequent).
Legal barriers - Administrative license (patent, copyright,
license).
Cost structure. Economies of scale (the bigger firm produces
at a lower cost) = natural monopoly.
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Economies of Scale as a Cause of Monopoly
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Demand Curves for competitive and monopoly firms
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Demand Curves for competitive and monopoly firms
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A monopoly‘s total, average and marginal revenue
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Demand and marginal revenue curves for a monopoly
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Profit maximization for a monopoly
Competitive company
P = MR = MC
Monopolistic
company
P >MR = MC
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The monopolist’s profit
Two measures of market
power:
P - Cmg
Lerner Index =
P
P
Markup =
Cmg
Markup
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The inefficiency of monopoly
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Welfare with and without price discrimination
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Welfare with and without price discrimination
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Conclusions on price discrimination
It is only possible if you can separate customers.
... Otherwise would lead to arbitration.
May increase welfare.
All improvement goes to the producer, not the consumer.
Example:
Airlines
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Goals of government intervention
Restore competitive level of prices and output (protect
consumers).
Types of intervention:
Preventing monopoly formation (Competition Policy & Antitrust /
Sherman Act. 1890 in USA)
Regulating price and output (natural monopoly).
Public property.
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Regulating a natural
monopoly
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What is a natural monopoly?
A firm dominates the market due to a size advantage.
Economies of scale (large fixed cost).
There is room for only one firm…
It would be uneconomical to have two or more firms
incurring in the same type of investment.
Huge fixed costs: electricity industry, pharmaceutical industry,
software industry, railroad infrastructure…
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Cost structure of a natural monopoly
Average Total Cost
Marginal cost
Demand
0 Q
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What is the optimal price: P1, P2 or P3?
P
Optimal, in which sense?
Optimal for who?
Optimal for consumers?
P1
P2 Average Total Cost
P3
Marginal Cost
Demand
Marginal Revenue
0 Q1 Q2 Q3 Q
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Marginal-Cost Pricing for a Natural Monopoly
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Apple: Iphone 16
What is the optimal price for consumers of an
P iPhone? 1700€, 500€ or 300€?
P1=1700€
P2=500€ Average Total Cost
P3=300€
Marginal Cost
Demand
Marginal Revenue
0 Q1 Q2 Q3 Q
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CIPLA – Affordable HIV medicines
What is CIPLA’s price or retrovirals? P1,
P P2 or P3?
Do you think that companies like CIPLA
are good for HIV patients?
P1=1700€
P2=500€ Average Total Cost
P3=300€
Marginal Cost
Marginal Revenue Demand
0 Q1 Q2 Q3 Q
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Static versus dynamic efficiency
Static efficiency: aims maximizing the value of the
current consumption and distribution of the good an
forgets about the future evolution of the industry.
Dynamic efficiency: aims at maximizing the value of
the current and future consumption and distribution
of the good, therefore it takes into account the impact of
the price level on the future evolution of the industry and
in particular in relation to the rate of product or process
innovation.
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What is the optimal price: P1, P2 or P3?
P1: Dynamic efficiency price
P1
P3: Static efficiency price
P2 Average total cost
P3
Marginal Cost
Marginal Revenue Demand
0 Q1 Q2 Q3 Q
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Are monopolies always bad? Do we need to regulate them?
Depends:
In markets with no innovation, a natural
monopoly leads to inefficiencies both in the long and
in the short run. Regulation is advisable (e.g.,
railroad infrastructure).
In market characterized by product and/or
process innovation, regulation is more difficult,
and a balance needs to be found between static and
dynamic efficiency.
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Conclusions
Considering that government interference with free
markets has its own costs, it is always preferable to chose
the mildest type of intervention.
Governments should regulate or act against attempts to
achieve a monopoly position not by merit (e.g., policy
competition).
Monopolies are not always bad:
Monopolies by merit should not be prosecuted since the rents obtained by
successful monopolies are the fair reward to past investments.
Some monopolies are unavoidable (natural monopoly) and therefore a
government is left with two choices: to regulate or to take direct control of the
industry.
In markets characterized by product and/or process innovation,
competition is dynamic, and regulation needs to find a balance between
static and dynamic efficiency.
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How to regulate monopolies
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Conclusions:
In a Monopoly:
o A company has all the market power.
o Quantity will still be determined by a decreasing function of
demand
o Important debate on its regulation.
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