16 Power

Question 1

What are the main three sources of monopoly power?

Answer 1

• Economies of scale (natural monopoly)
• Control of a resource
• Granted by Government ← most common

Question 2

How do economies of scale provide monopoly power?

Answer 2

• When the point of minimum average cost is large relative to size of demand.
• If AC when a single firm serves the market is lower than when two or more firms serve the market, monopoly is likely.
• Best examples are network/infrastructure based industries (telecommunications, water and electricity supply etc.).

Question 3

How goes the government grant monopoly power?

Answer 3

• Patents; time-limited monopoly on new technologies
• Copyright on artistic works, similar to patents
• Local rail franchises
• Use of parts of the radio wave spectrum for mobile phones

Question 4

How do patents reflect economies of scale?

Answer 4

Government realises that new technologies or new drugs need large up-front investments which will be recouped through monopolistic rents.

Question 5

Why do governments grant control of resources?

Answer 5

Sometimes, it makes most sense to just have one company use the resource. The rights to the resources may be allocated as part of a competitive process.

Question 6

Examples of how government granted monopoly power may be exploited

Answer 6

• Disney owns copyright on Mickey Mouse, that should have expired decades ago but have been granted extensions each time they were due to expire.
• Time-Warner claimed that they owned the rights to “Happy Birthday” song, gathering 10s of millions in licensing fees.

Question 7

How is the tax burden different for monopolies than it is for perfect competition?

Answer 7

In competitive markets we saw that the tax burden passed on to consumers was, at worst, 100%. But under monopoly it can be more than 100% as it add a mark-up to the tax.

Whether this happens depends on the shape of the demand curve.

Question 8

Diagram for a specific tax on a monopoly (linear demand)

Answer 8

Question 9

Diagram for a specific tax on a monopoly (convex demand)

Answer 9

Question 10

Diagram for a specific tax on a monopoly (convex demand)

Answer 10

In both cases (linear and convex demand), the tax reduces output. This leads to additional DWL.

So, despite raising tax revenue:

• We might hurt consumers more than the monopolist.
• DWL not solved, if anything it is worsened.

Question 11

What could the government do other than tax a monopolist?

Answer 11

Impose price controls.

It could eliminate DWL. Govt. could just impose marginal cost pricing:

p_r = MC(y_r) = p(y_r)

Now, monopolist is a price-taker, so it sells as much output as it can for the given price.

Question 12

How does natural monopoly come about? Diagram?

Answer 12

If we have a natural monopoly due to high fixed costs the firm might start making a loss.

Question 13

Why might a government granting monopoly power be a correct response? (2)

Answer 13

1. Natural monopolies e.g. in network industries in which one firm can efficiently serve the entire market.
2. The externalities associated with innovation and new knowledge e.g. if knowledge is a public good, standard theory suggests it will be under-produced by the market.

Question 14

Given government exists, what can it do to regulate monopolies?

Answer 14

• Tax output? Worsens DWL.
• Price controls? Yes, saw this could be effective.
• Lump sum taxes or fees? Doesn’t affect DWL around the monopoly but could be a useful source of revenue for other government activities.

So another role of government is to monitor and regulate anti-competitive behaviour. An important aspect of this concerns merger activity.