Unit 2, Lesson 9 notes

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Monopolies are free from the pressure to produce at a socially optimal level because they have no competition to force them to produce at that level. Monopolies have the power to raise prices and limit the supply of their goods, which is something that competitive market firms are unable to do without consequences.

Monopolies can also get away with inefficient production. Why? If the public wants the goods and services that a monopoly provides, they must pay the price the monopoly sets. This means that the monopoly does not have to worry about the most efficient and cost-effective production measures; instead, it just passes on the extra cost caused by the inefficiency to its customers.

How does a monopoly determine at which point it maximizes its profits? A monopoly has fixed costs, variable costs, and marginal costs, just like competitive market firms, so a monopoly will look at its marginal returns and marginal costs to determine its profit maximization. The monopoly will produce enough goods and services to the point where marginal returns (MR) = marginal costs (MC) and no further.

An example of a monopoly is the United States Postal Service (USPS). In 1792, the Private Express Statutes gave the USPS the exclusive right to charge a fee to deliver letters. There are very few exceptions to this. Letters that are considered extremely urgent may be delivered via other services. Even in these cases, however, the USPS has the right to set the minimum price the private competitor must charge. This is a legal barrier against competitors entering the market.

You have already read arguments for monopolies being harmful to the economy. Monopolies can also benefit the economy. There is limited waste of resources, and monopolies can put their large profits toward capital investments and research to improve products and lower costs. For example, in the pharmaceutical industry, patents give monopoly power and encourage development of unique medications to help people. Monopolies can practice price discrimination for certain companies. For example, they might charge a lower price for bulk purchases. Monopolies also have the benefit of economies of scale. This means that their high level of output leads to a decrease in average costs of production, which can in turn lower prices for consumers.

An oligopoly is an economic situation in which there are only a handful of sellers (2, 3, or 4 at most). There are many different industries that are oligopolistic in nature, including soft drink companies, video game consoles, and computer-processing chip designers.

Firms involved in an oligopoly have two basic options in their relationships with each other:

The oligopolistic firms may choose to battle with each other in a no-holds barred economic competition for domination in the market; or

The firms may choose to unite and behave almost exactly like a monopoly would behave.

If the firms choose the first option, the market may gravitate toward socially optimal production levels; on the other hand, if firms choose the second option, the government may use its regulatory powers and treat the oligopoly as a monopoly.

Firms in an oligopoly consider the business behaviors of their competitors when making their own economic decisions. For example, the video game console industry consists of just a few major competitors going after the same market, that of video game players. When one firm lowers the price of a game, it directly influences how the second firm will deal with its version of the same video game. If one firm upgrades its technology (for instance, releases a new console that improves on the previous version), the other firm is forced to either match the upgrade or see its market share suffer.

So what would happen to the market if these firms decided to combine their resources? In this scenario, a situation called collusion would occur. Collusion means that rival firms have decided to cooperate because it will benefit all involved. If these firms collude in the market, there is a very good possibility that the market will become monopolistic in nature; prices will be higher and supply will be lower. Collusion is better for producers because it leads to profits that last as long as the collusion continues. However, collusion is worse for buyers because it leads to higher prices and lower output.