Key Concepts and Summary

Key Terms

barriers to entry the legal, technological, or market forces that may discourage or prevent potential competitors from entering a market copyright a form of legal protection to prevent copying, for commercial purposes, original works of authorship, including books and music deregulation removing government controls over setting prices and quantities in certain industries intellectual property the body of law including patents, trademarks, copyrights, and trade secret law that protect the right of inventors to produce and sell their inventions legal monopoly legal prohibitions against competition, such as regulated monopolies and intellectual property protection marginal profit profit of one more unit of output, computed as marginal revenue minus marginal cost monopoly a situation in which one firm produces all of the output in a market natural monopoly economic conditions in the industry, for example, economies of scale or control of a critical resource, that limit effective competition patent a government rule that gives the inventor the exclusive legal right to make, use, or sell the invention for a limited time predatory pricing when an existing firm uses sharp but temporary price cuts to discourage new competition trade secrets methods of production kept secret by the producing firm trademark an identifying symbol or name for a particular good and can only be used by the firm that registered that trademark

Key Concepts and Summary

9.1 How Monopolies Form: Barriers to Entry

Barriers to entry prevent or discourage competitors from entering the market. These barriers include: economies of scale that lead to natural monopoly; control of a physical resource; legal restrictions on competition; patent, trademark and copyright protection; and practices to intimidate the competition like predatory pricing. Intellectual property refers to legally guaranteed ownership of an idea, rather than a physical item. The laws that protect intellectual property include patents, copyrights, trademarks, and trade secrets. A natural monopoly arises when economies of scale persist over a large enough range of output that if one firm supplies the entire market, no other firm can enter without facing a cost disadvantage.

9.2 How a Profit-Maximizing Monopoly Chooses Output and Price

A monopolist is not a price taker, because when it decides what quantity to produce, it also determines the market price. For a monopolist, total revenue is relatively low at low quantities of output, because it is not selling much. Total revenue is also relatively low at very high quantities of output, because a very high quantity will sell only at a low price. Thus, total revenue for a monopolist will start low, rise, and then decline. The marginal revenue for a monopolist from selling additional units will decline. Each additional unit a monopolist sells will push down the overall market price, and as it sells more units, this lower price applies to increasingly more units. The monopolist will select the profit-maximizing level of output where MR = MC, and then charge the price for that quantity of output as determined by the market demand curve. If that price is above average cost, the monopolist earns positive profits. Monopolists are not productively efficient, because they do not produce at the minimum of the average cost curve. Monopolists are not allocatively efficient, because they do not produce at the quantity where P = MC. As a result, monopolists produce less, at a higher average cost, and charge a higher price than would a combination of firms in a perfectly competitive industry. Monopolists also may lack incentives for innovation, because they need not fear entry.

Self-Check Questions

1 . Classify the following as a government-enforced barrier to entry, a barrier to entry that is not government- enforced, or a situation that does not involve a barrier to entry. a. A patented invention b. A popular but easily copied restaurant recipe c. An industry where economies of scale are very small compared to the size of demand in the market d. A well-established reputation for slashing prices in response to new entry e. A well-respected brand name that has been carefully built up over many years 2 . Classify the following as a government-enforced barrier to entry, a barrier to entry that is not government- enforced, or a situation that does not involve a barrier to entry. a. A city passes a law on how many licenses it will issue for taxicabs b. A city passes a law that all taxicab drivers must pass a driving safety test and have insurance c. A well-known trademark d. Owning a spring that offers very pure water e. An industry where economies of scale are very large compared to the size of demand in the market 3 . Suppose the local electrical utility, a legal monopoly based on economies of scale, was split into four firms of equal size, with the idea that eliminating the monopoly would promote competitive pricing of electricity. What do you anticipate would happen to prices? 4 . If Congress reduced the period of patent protection from 20 years to 10 years, what would likely happen to the amount of private research and development? 5 . Suppose demand for a monopoly’s product falls so that its profit-maximizing price is below average variable cost. How much output should the firm supply? Hint: Draw the graph. 6 . Imagine a monopolist could charge a different price to every customer based on how much the customer is willing to pay. How would this affect monopoly profits?

Review Questions

7 . How is monopoly different from perfect competition? 8 . What is a barrier to entry? Give some examples. 9 . What is a natural monopoly? 10 . What is a legal monopoly? 11 . What is predatory pricing? 12 . How is intellectual property different from other property? 13 . What legal mechanisms protect intellectual property? 14 . In what sense is a natural monopoly “natural”? 15 . How is the demand curve perceived by a perfectly competitive firm different from the demand curve perceived by a monopolist? 16 . How does the demand curve perceived by a monopolist compare with the market demand curve? 17 . Is a monopolist a price taker? Explain briefly. 18 . What is the usual shape of a total revenue curve for a monopolist? Why? 19 . What is the usual shape of a marginal revenue curve for a monopolist? Why?