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Again Replicate the Graph From 9.1. Suppose

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Affiliate ix. Monopoly

9.one How Monopolies Class: Barriers to Entry

Learning Objectives

By the end of this section, you will be able to:

  • Distinguish between a natural monopoly and a legal monopoly.
  • Explicate how economies of scale and the command of natural resources led to the necessary formation of legal monopolies
  • Analyze the importance of trademarks and patents in promoting innovation
  • Identify examples of predatory pricing

Because of the lack of contest, monopolies tend to earn significant economic profits. These profits should attract vigorous contest as described in Perfect Competition, and notwithstanding, because of 1 particular characteristic of monopoly, they do not. Barriers to entry are the legal, technological, or market forces that discourage or prevent potential competitors from entering a market. Barriers to entry can range from the simple and easily surmountable, such every bit the cost of renting retail space, to the extremely restrictive. For example, at that place are a finite number of radio frequencies available for broadcasting. In one case the rights to all of them have been purchased, no new competitors tin enter the market.

In some cases, barriers to entry may pb to monopoly. In other cases, they may limit competition to a few firms. Barriers may block entry even if the firm or firms currently in the market place are earning profits. Thus, in markets with significant barriers to entry, it is not true that abnormally loftier profits will attract new firms, and that this entry of new firms will eventually cause the price to decline so that surviving firms earn only a normal level of turn a profit in the long run.

There are two types of monopoly, based on the types of barriers to entry they exploit. One is natural monopoly, where the barriers to entry are something other than legal prohibition. The other is legal monopoly, where laws prohibit (or severely limit) contest.

Natural Monopoly

Economies of scale can combine with the size of the market to limit contest. (This theme was introduced in Cost and Industry Construction). Effigy ane presents a long-run average cost curve for the airplane manufacturing industry. Information technology shows economies of scale up to an output of eight,000 planes per year and a price of P0, so abiding returns to scale from 8,000 to twenty,000 planes per year, and diseconomies of scale at a quantity of production greater than 20,000 planes per yr.

Now consider the market demand curve in the diagram, which intersects the long-run average toll (LRAC) curve at an output level of half dozen,000 planes per year and at a price Pi, which is college than P0. In this situation, the market place has room for merely ane producer. If a 2d firm attempts to enter the market at a smaller size, say by producing a quantity of 4,000 planes, and then its average costs will be college than the existing firm, and it will be unable to compete. If the 2nd firm attempts to enter the market at a larger size, like viii,000 planes per year, then information technology could produce at a lower average cost—but information technology could not sell all eight,000 planes that information technology produced because of bereft need in the market place.

The graph represents a natural monopoly as evidenced by the demand curve intersecting with the downward-sloping part of the LRAC curve.
Figure ane. Economies of Calibration and Natural Monopoly. In this market, the demand bend intersects the long-run boilerplate cost (LRAC) curve at its downward-sloping part. A natural monopoly occurs when the quantity demanded is less than the minimum quantity information technology takes to exist at the bottom of the long-run boilerplate toll curve.

This situation, when economies of scale are big relative to the quantity demanded in the market, is called a natural monopoly. Natural monopolies often arise in industries where the marginal cost of adding an boosted client is very low, once the fixed costs of the overall system are in place. Once the main water pipes are laid through a neighborhood, the marginal cost of providing h2o service to another dwelling house is fairly low. Once electricity lines are installed through a neighborhood, the marginal toll of providing additional electrical service to one more home is very low. It would be costly and duplicative for a second water company to enter the market and invest in a whole 2nd set of chief water pipes, or for a second electricity company to enter the market place and invest in a whole new set of electrical wires. These industries offer an example where, because of economies of calibration, 1 producer can serve the entire market more efficiently than a number of smaller producers that would need to make duplicate physical capital investments.

A natural monopoly can also arise in smaller local markets for products that are difficult to send. For example, cement product exhibits economies of scale, and the quantity of cement demanded in a local area may non be much larger than what a single plant tin produce. Moreover, the costs of transporting cement over land are high, and and then a cement plant in an surface area without access to water transportation may be a natural monopoly.

Control of a Concrete Resources

Another type of natural monopoly occurs when a company has command of a deficient concrete resource. In the U.South. economic system, one historical example of this pattern occurred when ALCOA—the Aluminum Company of America—controlled most of the supply of bauxite, a key mineral used in making aluminum. Back in the 1930s, when ALCOA controlled most of the bauxite, other firms were simply unable to produce plenty aluminum to compete.

As another instance, the majority of global diamond product is controlled past DeBeers, a multi-national visitor that has mining and production operations in S Africa, Botswana, Namibia, and Canada. Information technology also has exploration activities on iv continents, while directing a worldwide distribution network of crude cutting diamonds. Though in recent years they have experienced growing competition, their impact on the rough diamond market is nevertheless considerable.

Legal Monopoly

For some products, the government erects barriers to entry by prohibiting or limiting competition. Nether U.S. law, no organization but the U.Southward. Post is legally allowed to deliver first-class mail service. Many states or cities accept laws or regulations that allow households a choice of only one electric company, 1 h2o company, and one visitor to pick up the garbage. Most legal monopolies are considered utilities—products necessary for everyday life—that are socially benign to have. Every bit a result, the regime allows producers to become regulated monopolies, to insure that an appropriate amount of these products is provided to consumers. Additionally, legal monopolies are often subject field to economies of scale, and so it makes sense to allow only one provider.

Promoting Innovation

Innovation takes time and resources to reach. Suppose a visitor invests in research and evolution and finds the cure for the mutual cold. In this globe of near ubiquitous data, other companies could accept the formula, produce the drug, and because they did non incur the costs of inquiry and development (R&D), undercut the toll of the visitor that discovered the drug. Given this possibility, many firms would cull not to invest in enquiry and evolution, and as a consequence, the earth would take less innovation. To prevent this from happening, the Constitution of the United states specifies in Article I, Section 8: "The Congress shall have Ability . . . To Promote the Progress of Science and Useful Arts, past securing for limited Times to Authors and Inventors the Exclusive Right to their Writings and Discoveries." Congress used this ability to create the U.S. Patent and Trademark Office, also every bit the U.South. Copyright Role. A patent gives the inventor the sectional legal right to make, apply, or sell the invention for a limited time; in the United states, exclusive patent rights last for 20 years. The thought is to provide limited monopoly power then that innovative firms tin can recoup their investment in R&D, but and then to permit other firms to produce the product more cheaply in one case the patent expires.

A trademark is an identifying symbol or proper noun for a particular good, similar Chiquita bananas, Chevrolet cars, or the Nike "swoosh" that appears on shoes and athletic gear. Roughly 1.9 meg trademarks are registered with the U.S. regime. A firm can renew a trademark over and over over again, as long every bit it remains in active use.

A copyright, according to the U.S. Copyright Office, "is a class of protection provided past the laws of the United States for 'original works of authorship' including literary, dramatic, musical, architectural, cartographic, choreographic, pantomimic, pictorial, graphic, sculptural, and audiovisual creations." No ane tin reproduce, display, or perform a copyrighted work without permission of the author. Copyright protection commonly lasts for the life of the author plus 70 years.

Roughly speaking, patent police force covers inventions and copyright protects books, songs, and fine art. Simply in sure areas, like the invention of new software, information technology has been unclear whether patent or copyright protection should apply. At that place is too a body of constabulary known as merchandise secrets. Even if a visitor does not have a patent on an invention, competing firms are non immune to steal their secrets. One famous trade hole-and-corner is the formula for Coca-Cola, which is not protected nether copyright or patent police, but is but kept clandestine past the company.

Taken together, this combination of patents, trademarks, copyrights, and trade secret law is chosen intellectual belongings, because it implies ownership over an idea, concept, or prototype, not a concrete piece of property like a house or a car. Countries around the globe have enacted laws to protect intellectual holding, although the time periods and verbal provisions of such laws vary beyond countries. There are ongoing negotiations, both through the World Intellectual Property Arrangement (WIPO) and through international treaties, to bring greater harmony to the intellectual property laws of different countries to determine the extent to which patents and copyrights in 1 state volition be respected in other countries.

Regime limitations on competition used to be even more common in the Usa. For well-nigh of the twentieth century, only one phone visitor—AT&T—was legally allowed to provide local and long distance service. From the 1930s to the 1970s, one set of federal regulations limited which destinations airlines could choose to fly to and what fares they could charge; another fix of regulations express the interest rates that banks could pay to depositors; yet another specified what trucking firms could charge customers.

What products are considered utilities depends, in part, on the available technology. Fifty years ago, local and long distance telephone service was provided over wires. It did not make much sense to accept multiple companies edifice multiple systems of wiring across towns and across the country. AT&T lost its monopoly on long altitude service when the technology for providing telephone service inverse from wires to microwave and satellite manual, so that multiple firms could apply the same transmission mechanism. The aforementioned thing happened to local service, specially in recent years, with the growth in cellular phone systems.

The combination of improvements in production technologies and a general sense that the markets could provide services adequately led to a wave of deregulation, starting in the late 1970s and standing into the 1990s. This moving ridge eliminated or reduced authorities restrictions on the firms that could enter, the prices that could exist charged, and the quantities that could be produced in many industries, including telecommunication, airlines, trucking, banking, and electricity.

Around the world, from Europe to Latin America to Africa and Asia, many governments continue to command and limit competition in what those governments perceive to be key industries, including airlines, banks, steel companies, oil companies, and telephone companies.

Visit this website for examples of some pretty bizarre patents.


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Intimidating Potential Competition

Businesses have developed a number of schemes for creating barriers to entry by deterring potential competitors from entering the market. One method is known equally predatory pricing, in which a house uses the threat of sharp price cuts to discourage competition. Predatory pricing is a violation of U.S. antitrust law, but it is difficult to evidence.

Consider a large airline that provides most of the flights betwixt ii item cities. A new, pocket-size first-up airline decides to offering service between these ii cities. The large airline immediately slashes prices on this route to the bone, then that the new entrant cannot brand any money. Afterwards the new entrant has gone out of business, the incumbent firm can heighten prices once again.

Afterward this pattern is repeated once or twice, potential new entrants may decide that it is not wise to try to compete. Modest airlines frequently accuse larger airlines of predatory pricing: in the early on 2000s, for example, ValuJet defendant Delta of predatory pricing, Frontier accused United, and Reno Air defendant Northwest. In 2015, the Justice Section ruled against American Express and Mastercard for imposing restrictions on retailers who encouraged customers to use lower swipe fees on credit transactions.

In some cases, large advertising budgets tin can also act every bit a way of discouraging the competition. If the only style to launch a successful new national cola drink is to spend more than than the promotional budgets of Coca-Cola and Pepsi Cola, not also many companies will try. A firmly established make name tin be hard to dislodge.

Summing Upward Barriers to Entry

Table 1 lists the barriers to entry that have been discussed here. This list is non exhaustive, since firms have proved to exist highly creative in inventing business practices that discourage competition. When barriers to entry be, perfect contest is no longer a reasonable description of how an industry works. When barriers to entry are loftier enough, monopoly can result.

Barrier to Entry Government Role? Example
Natural monopoly Government often responds with regulation (or ownership) Water and electric companies
Control of a concrete resources No DeBeers for diamonds
Legal monopoly Aye Post office, past regulation of airlines and trucking
Patent, trademark, and copyright Yes, through protection of intellectual property New drugs or software
Intimidating potential competitors Somewhat Predatory pricing; well-known brand names
Table 1. Barriers to Entry

Key Concepts and Summary

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

Self-Check Questions

  1. Classify the post-obit 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.
    1. A patented invention
    2. A pop but hands copied restaurant recipe
    3. An industry where economies of scale are very small compared to the size of demand in the market
    4. A well-established reputation for slashing prices in response to new entry
    5. A well-respected brand proper name that has been carefully congenital up over many years
  2. Classify the following equally a regime-enforced barrier to entry, a barrier to entry that is non authorities-enforced, or a state of affairs that does not involve a barrier to entry.
    1. A metropolis passes a law on how many licenses it will effect for taxicabs
    2. A city passes a police force that all taxicab drivers must pass a driving safety test and have insurance
    3. A well-known trademark
    4. Owning a spring that offers very pure water
    5. 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 separate into four firms of equal size, with the thought that eliminating the monopoly would promote competitive pricing of electricity. What do you lot anticipate would happen to prices?
  4. If Congress reduced the period of patent protection from xx years to 10 years, what would likely happen to the amount of private research and development?

Review Questions

  1. How is monopoly different from perfect competition?
  2. What is a barrier to entry? Give some examples.
  3. What is a natural monopoly?
  4. What is a legal monopoly?
  5. What is predatory pricing?
  6. How is intellectual holding different from other property?
  7. By what legal mechanisms is intellectual property protected?
  8. In what sense is a natural monopoly "natural"?

Disquisitional Thinking Questions

  1. ALCOA does not take the monopoly power it once had. How do you suppose their barriers to entry were weakened?
  2. Why are generic pharmaceuticals significantly cheaper than proper name brand ones?
  3. For many years, the Justice Department has tried to break up big firms like IBM, Microsoft, and almost recently Google, on the grounds that their large market share made them substantially monopolies. In a global market, where U.S. firms compete with firms from other countries, would this policy brand the same sense as it might in a purely domestic context?
  4. Intellectual property laws are intended to promote innovation, just some economists, such as Milton Friedman, have argued that such laws are not desirable. In the United States, at that place is no intellectual property protection for nutrient recipes or for fashion designs. Because the country of these two industries, and bearing in mind the discussion of the inefficiency of monopolies, can you call back of any reasons why intellectual property laws might hinder innovation in some cases?

Bug

Return to Effigy ane. Suppose P0 is $10 and P1 is $eleven. Suppose a new business firm with the same LRAC curve as the incumbent tries to interruption into the market by selling iv,000 units of output. Judge from the graph what the new business firm'due south boilerplate cost of producing output would be. If the incumbent continues to produce half-dozen,000 units, how much output would be supplied to the market by the two firms? Estimate what would happen to the marketplace price as a result of the supply of both the incumbent business firm and the new entrant. Approximately how much profit would each business firm earn?

Glossary

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 authorities controls over setting prices and quantities in sure industries
intellectual property
the body of police including patents, trademarks, copyrights, and trade underground constabulary that protect the right of inventors to produce and sell their inventions
legal monopoly
legal prohibitions against competition, such as regulated monopolies and intellectual holding protection
monopoly
a situation in which one business firm produces all of the output in a market
natural monopoly
economic conditions in the industry, for example, economies of scale or command of a critical resource, that limit effective competition
patent
a government dominion that gives the inventor the exclusive legal correct to brand, use, or sell the invention for a express time
predatory pricing
when an existing house uses abrupt merely temporary cost cuts to discourage new competition
trade secrets
methods of product kept secret past the producing business firm
trademark
an identifying symbol or name for a particular good and can only be used by the business firm that registered that trademark

Solutions

Answers to Self-Bank check Questions

    1. A patent is a government-enforced barrier to entry.
    2. This is non a barrier to entry.
    3. This is non a barrier to entry.
    4. This is a barrier to entry, simply it is non authorities-enforced.
    5. This is a bulwark to entry, just information technology is not directly government enforced.
    1. This is a government-enforced barrier to entry.
    2. This is an instance of a government police, simply perhaps it is non much of a barrier to entry if most people can pass the safe test and get insurance.
    3. Trademarks are enforced by authorities, and therefore are a bulwark to entry.
    4. This is probably non a barrier to entry, since at that place are a number of unlike means of getting pure water.
    5. This is a barrier to entry, but it is non government-enforced.
  3. Because of economies of scale, each firm would produce at a higher boilerplate cost than before. (They would each have to build their ain power lines.) Equally a result, they would each accept to enhance prices to cover their higher costs. The policy would neglect.
  4. Shorter patent protection would make innovation less lucrative, so the amount of inquiry and development would probable decline.

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Source: https://opentextbc.ca/principlesofeconomics/chapter/9-1-how-monopolies-form-barriers-to-entry/

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