Monopoly and High Barriers to Entry

Pure monopoly is a market structure characterized by (a) high barriers to entry and (b) a single seller of a well-defined product for which there are no good substitutes. Pure monopoly is at the opposite:nd of the market-structure spectrum from pure competition.

Analysis of pure monopoly is important for two reason;. First, the monopoly model will help us understand the operation:'f markets dominated by a few firms. Second, in a few important industries, such as telephone services and utilities, there is often only a single producer in a market area. The monopoly model will help us understand these markets.

The three major barriers to entry into a market are legal restrictions,  economies of scale, and control of an essential resource.

The monopolist's demand curve is the market demand curve. It slopes downward to the right. The marginal revenue curve for a monopolist will lie inside the demand curve because of revenue losses from the lower price for units that could have been sold at a higher price.

For the elastic portion of a monopolist's demand curve, a Lower price will increase total revenue. For the inelastic portion of the monopolist's demand curve, a price reduction will cause total revenue to decline. A profit-maximizing monopolist will not operate on the inelastic portion of the demand curve because in that range it is always possible to increase total revenue by raising the price and producing fewer units.

A profit-maximizing monopolist will lower price and expand output as long as marginal revenue exceeds marginal cost. At the maximum profit output, MR will equal MC. The monopolist will charge a price along its demand curve for that output rate.

If losses occur in the long-run, a monopolist will go out of business. If profit results, high barriers to entry will shield a monopolist from competitive pressures. Therefore, long-run economic profits for a monopoly are sometimes possible.

Economists are critical of a monopoly because (a) it severely limits the role of demand in the market for a good and thus consumers "'control"  over the producer; (b) the unregulated monopolist produces too little output and charges a price in excess of the marginal cost; (c) profits are less able to stimulate new entry, which would expand the supply of the product until price declined to the level of average production costs; and (d) legal monopoly encourages rent-seeking activity.

Natural monopoly exists when long-run average total costs continue to decline as firm size increases (economies of scale). Thus, a larger firm always has lower costs. Cost of production will be lowest when a single firm generates the entire output of an industry.

In the presence of natural monopoly, there are three policy alternatives: (a) private, unregulated monopoly; (b) private, regulated monopoly; and (c) government ownership. Economic theory suggests that each of the three will fail to meet our criteria for ideal efficiency. Private monopoly will result in higher prices and less output than would be ideal. Regulation will often fail to meet our ideal efficiency criteria because (a) the regulators will not have knowledge of the firm's cost   curves and market demand conditions; (b) firms have an incentive to  conceal their actual cost conditions and take profits in disguised forms  and (c) the regulators often end up being influenced by the firms they are supposed to regulate. Under public ownership managers often can gain by pursuing policies that yield them personal benefits and by catering to the views of special interest groups (for example well organized employees and specialized customers) who will be able to help them further their political objectives.

Even a monopolist is not completely free from competitive pressures. All products have some type of substitute. Monopolists who raise the price of their products provide encouragement for other firms to develop substitutes, which may eventually erode the market power of the monopolist. Some monopolists may charge less than the short-run profit-maximizing price to discourage potentiaL competitors from developing substitute products.

Monopoly profits derived from patents have two conflicting effects on resource allocation. Once a product or process has been discovered, the monopoly rights permit the firm to restrict output and raise price above the current marginal (and average) cost of production However, the possibility of future monopoly rights granted by a patent encourage entrepreneurs to improve products and develop lower cost methods of production.