Chapter 15

Monopoly and Antitrust Policy

Definition and Characteristics of Monopoly

A monopoly is a market structure where a single firm is the sole seller of a good or service with no close substitutes. This unique position gives the firm significant market power.

• Single seller: Only one firm supplies the product.

• Single product: The product has no close substitutes.

• High barriers to entry: Other firms cannot easily enter the market.

Examples: While true monopolies are rare, firms like Google (search engines), Microsoft (software), and Sirius/XM Radio (satellite radio) have dominant market shares. However, the definition of monopoly depends on how broadly or narrowly the market is defined.

Close Substitutes

A close substitute is a product that can attract customers away from the monopolist by offering a lower price. For example, candles are not a close substitute for electric lights because consumers will not switch even if candles are much cheaper.

Sources of Monopoly Power

Monopolies arise due to significant barriers to entry. The four main sources are:

1. Government blocks entry: Through patents, copyrights, public franchises, or public enterprises.

2. Control of a key resource: Ownership or control over a resource essential for production.

3. Network externalities: The value of a product increases as more people use it.

4. Natural monopoly: Economies of scale are so large that one firm can supply the entire market at a lower average total cost (ATC) than multiple firms.

1. Government Barriers

• Patents: Exclusive rights to produce a product for 20 years. Example: Microsoft Windows.

• Copyrights: Exclusive rights to creative works for the creator's lifetime plus 70 years for heirs.

• Public Franchise: Government designates a single legal provider (e.g., local utilities).

• Public Enterprise: Government itself is the sole provider.

2. Control of a Key Resource

• Rare, but examples include the International Nickel Company (nickel) and major sports leagues controlling stadiums.

3. Network Externalities

• Definition: The usefulness of a product increases with the number of users.

• Examples: Microsoft (operating systems), eBay (online auctions).

4. Natural Monopoly

A natural monopoly occurs when a single firm can supply the entire market at a lower ATC than multiple firms due to large economies of scale.

Explanation: If two firms operate, each would produce less and have higher ATC. Eventually, one firm expands, lowers its ATC, and drives out the other, resulting in a natural monopoly.

Monopoly Pricing and Output Decisions

Unlike perfectly competitive firms (price takers), monopolies are price makers and face a downward-sloping demand curve. They maximize profit by producing where marginal revenue (MR) equals marginal cost (MC):

$MR = MC$

Monopolies can set prices above marginal cost, but if they set prices too high, they lose customers to substitutes (if available).

Comparison with Monopolistic Competition

In monopolistic competition, firms can earn short-run profits, but in the long run, entry of new firms drives economic profits to zero. The demand curve becomes more elastic as substitutes increase.

Short-run: Firms can earn profits if price exceeds ATC.

Long-run: Entry of new firms eliminates profits; price equals ATC.

Monopoly Profits and Efficiency

Monopolies can sustain economic profits in the long run due to barriers to entry. The monopoly graph is similar to the short-run monopolistic competition graph, but profits persist.

Economic Efficiency and Deadweight Loss

Monopolies produce less and charge higher prices than would occur in a competitive market, leading to:

• Reduction in consumer surplus

• Increase in producer surplus

• Creation of deadweight loss (loss of economic efficiency)

Explanation: The area between the demand and MC curves (not captured by the monopoly) represents deadweight loss. Some consumer surplus is transferred to the monopoly as producer surplus.

Market Power

Market power is the ability of a firm to set prices above marginal cost. It is created by barriers to entry and is a defining feature of monopolies.

Antitrust Policy and Regulation

Because monopolies reduce consumer surplus and economic efficiency, governments enact antitrust laws to promote competition and prevent collusion. Examples include:

• Sherman Antitrust Act (1890)

• Clayton Act (1914)

• Federal Trade Commission Act (1914)

Natural monopolies are often regulated by government-imposed price ceilings to prevent excessive pricing.

Summary of Monopoly Effects

• Monopolies reduce consumer surplus and economic efficiency.

• They increase producer surplus and create deadweight loss.

• Antitrust laws and regulation aim to mitigate these effects.

Conclusion: The more intense the competition, the more efficient the market. While some firms have monopoly-like power, most markets have enough competition to limit efficiency losses.