Assumptions of Pure Monopoly

Single Seller (Many Buyers) Heterogeneous good Perfect Information Barriers to Entry

Implications of Pure Monopoly

Recall the old conclusion if there is no price discrimination MR=P(1+1/E) Since E<0, P > MR Thus, we conclude that (since MR = MC, P>MR)

Why We Hate Monopoloy

Because the monopolist is guaranteed a profit? There is no guarantee Whats wrong with profits? Because the monopolist charges too much Yes, but too much in relation to what?

Monopoly, Profit and Entry Barriers

Note that the monopoly may or may not make economic profit If they are profitable, there must be something preventing other firms from entering the market

What is a Barrier to Entry

Useless Definition: Anything that impedes the entry of a new firm into a market. Useful Definition: A cost faced by a potential entrant into the market that was not faced by the incumbent

Sources of Entry Barriers

Legal Barriers Patents, trademarks, copyrights License requirements, exclusive franchises Natural Barriers Economies of Scale (maybe) Capital Requirements First Mover

Measuring Industry Concentration (When is a Monopoly a Monopoly)

The first question is what is an industry? which is harder than you might think. The Dept of Commerce used to use the Standard Industrial Classfication (SIC) and now uses the North American Industry Classification System (NAICS pronounced Nakes) Here is what they say about it
NAICS is a unique, all-new system for classifying business establishments. It is the first economic classification system to be constructed based on a single economic concept. Economic units that use like processes to produce goods or services are grouped together. This "production-oriented" system means that statistical agencies in the United States will produce data that can be used for measuring productivity, unit labor costs, and the capital intensity of production; constructing input-output relationships; and estimating employmentoutput relationships and other such statistics that require that inputs and outputs be used together.

Naics can assign any firm reporting in the Census a 6 digit number. Here is what they mean
NAICS 2-digit 3-digit 4-digit 5-digit 6-digit Sector Subsector Industry Group NAICS Industry National

Natural Monopoly : Industry where it is always less costly for a single firm to produce all the output

Natural Monopoly and Economies of Scale: An Example

Costs Insurance Policy(FC)=$1000 Cost of Single Dose of Vaccine (MC)=$10 Demand: 10 Rich People Willing to Pay $200 90 Poor People Willing to Pay $11 Efficient Solution Give 100 Doses (efficient because the value, $11, is greater than the marginal cost) Problem: To sell 100 doses, the price cant be greater than $11, but at a price of $11, profits=$11x100-$1000-$10x1000=-$900 Conclusion:Natural Monopoly most commonly occurs when there are high fixed costs relative to low marginal costs Problem: It is not possible to charge the efficient price (that is, the price at which everyone who places a higher value on the good than the marginal cost of producing it) without losing money

Serious Examples
Roads, Public Utilities Information

Solutions to The Problem of Natural Monopoly

Price Discrimination Subsidies and/or Public Ownership (e.g., DART) Public Regulation (e.g., PUC) Franchise Bidding (e.g., Cable TV)

Natural Monopoly and the Firm: Single Source Suppliers

Benefits of SSS: Lower transactions costs Pecuniary economies (volume discounts)--much more likely when the supplier experiences real economies. Costs of SSS: Lack of competition ex post (I.e., after the contract is formed).

Opportunistic Behavior and SSS:Midwest Mower v Rexite Casting

Facts Original Contract: MM will purchase 120,000 castings from RC for $.64 per part RC delivers some20,000 and then sends MM a letter saying they refuse to deliver any more unless the price is raised to $.72. MM writes back, saying they agree but under duress When it comes time to pay, MM refuses to pay more than $.64

 Economic Issue Legal Issue: How to interpret an incomplete contract RCs argument: Conditions have changed and it is no longer economical to produce at $.64 MMs argument: So what? The contract is silent on this point, meaning the intent is for you to accept the risk. In fact, this is necessary to keep you from behaving opportunistically

Related examples
Austin Instruments v Loral: a threat to breach a contract in order to coerce signing a new contract GM v Fisher Body: Vertical integration to prevent opportunistic breach