Microeconomics, Module 11, "Monopoly"
Required reading:
(The attached PDF file has better formatting.)
Updated: June 24, 2005
{The Landsburg textbook is excellent. We say to read certain sections and to skip others. This does not mean that certain sections are better; it means that the homework assignments and exam problems are based on the sections that you must read for this course. Some of the skipped sections are fascinating, but they are not tested.}
We cover monopoly in two modules: Module 11 covers monopoly pricing and Module 12 covers price discrimination. These two modules complete the basic tools for this course; the remaining sections deal with additional topics in microeconomics.
Know the definition of monopoly on the side of page 329; this is the reverse of the definition of a competitive firm. The definition deals with the demand curve facing the firm, not the number of firms in the industry.
Read section 10.1 on pages 330-333. For the price elasticity of demand (pages 332-333), know the formula for the elasticity on the top of page 332. You can skip the examples from the middle of page 333 end of page 334, though they are fun to read.
Read the section on welfare on page 335, including the diagram on page 336; understand the graphical depiction of consumers’ surplus and producers’ surplus under monopoly. Skip the sub-section on "subsidies" on pages 336-338, the section on price ceilings on pages 338-339, and the section on rate of return regulation on pages 340-341. These are theoretical applications of the theory, but no one advocates that the government provide subsidies to monopolists to increase output.
Read section 10.2 on "sources of monopoly power" on pages 341-345. Know the definition of natural monopoly on the side of page 341. From this section, you can skip the sub-section on "the welfare economics of natural monopoly" on pages 342-343 and the sub-section on "the history of photography" on page 344, but read the other sub-sections.
Natural monopoly was a major source of monopoly power until the deregulation of municipal utilities, transportation, and telecommunications in the 1980’s; these industries are more competitive now. Resource monopolies was important before globalization; now it is hard for any firm to control the global supplies of any resource. The closest example we have is the OPEC cartel, though it is not clear how effective OPEC has been in setting oil prices. ALCOA’s ownership of U.S. aluminum supplies is the traditional example of a resource monopoly; it is hard to find a similar example in our generation.
Jacob: You make it sound as though deregulation of airlines has been good. But the result of deregulation of airlines has been the bankruptcy of many firms; is this good?
Rachel: The costs of air travel have fallen 50% (in real terms) since deregulation. The major airlines have been unprofitable because they are inefficient. As they go bankrupt and more efficient lower-cost carriers take their place, consumers gain. The same is true for other industries that have deregulated: prices fall, consumers gain, and inefficient firms go bankrupt. This is the benefit of free markets, not a problem with free markets.
Patents are a source of monopoly power, but they are a net social benefit, not a cost. The U.S. is the major innovator for new drugs, because other countries do not provide the same patent protection that the U.S. does.
Jacob: If not for patent protection, AIDS drugs would not cost so much.
Rachel: One reason we have so few AIDS drugs (and similar medications) is that firms are reluctant to spend the billions of dollars needed for research and development without strong patent protection. If consumer activists rail against drug patents, fewer drugs are developed, and consumers lose. (Suits for medical malpractice and products liability are another reason that development of new drugs has slowed so much in recent years.)
Legal barriers to entry are the major source of monopoly power now. These legal barriers make the salaries of doctors and lawyers the highest professional salaries in the U.S.
Jacob: What are the legal barriers to entry for doctors and lawyers?
Rachel: Only physicians can prescribe drugs; only lawyers can practice law.
Jacob: Do actuaries have any such legal monopolies?
Rachel: Only actuaries can sign certain Statements of Actuarial Opinion. But this is legal monopoly on an activity with such low demand that the effect on actuarial salaries is not material. Actuaries would love a legal monopoly, such as a monopoly on the right to set insurance rates, but this is anti-competitive and will probably never happen.