Monopoly

From Hobson's Choice

A condition in which there is only one seller for a particular item. Pure monopoly is an exotic condition, since there is frequently at least some prospect of substitution. The "severity" of monopoly may be expressed by the slope of the demand curve; if demand is not very elastic with respect to price, then the slope of the demand curve will be steep, reflecting little reduction in the quantity demanded for any unit increase in price.

As a representation of the social consequences of monopoly, the slope of the demand curve is probably inadequate since it does not capture declines caused by insufficient income. Hence, a monopoly in (say) rice will represent a reduction in quantity demanded with an increase in price, but the reduction will be caused by insufficient income (and possible famine).

1 Economic Properties of Monopoly
- 1.1 Price Discrimination and Consumer Surplus
2 Notes
3 See Also
4 External Links

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Economic Properties of Monopoly

Click for larger image

The chart on the right illustrates the extreme case of a monopoly. The demand curve is sloped, representing the fact that the market for the firm is the entire market for that product (or a major portion thereof); unlike a firm under conditions of competition, the market price at which a monopolist may sell the good is strongly determined by its sales volume. Unlike a firm under conditions of competition, when a monopolist increases output (i.e., "moves to the right" on the chart shown), it reduces the price it is able to charge for its product. The shaded rust-colored area represents the rents captured by the monopolist from the consumer. There are two forms of social cost borne by society: the reduced employment of resources, particularly labor but also prior investments in capital by other people; and the reduced output, which permits economic rents to the monopolist.

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Price Discrimination and Consumer Surplus

In the second case, we have the more extreme case still of monopoly with price discrimination.

In first degree price discrimination, the monopolist extracts extraordinary rents not by reducing output below the market rate, but by using detailed information about customers to charge them different prices. For example, in rural areas where customers may not be able to shop around for lower prices offered to other customers, the monopolist can charge higher rates. The lower rates might reflect urban areas, where the customer faces more substitute goods or alternative suppliers. Real-life examples of monopoly with price discrimination appear in the health insurance market of the United States, where insurance policies and terms vary dramatically depending on the degree to which the markt segment is captive, making health insurance essentially a form of regressive income taxation. Businesses with small numbers of employees, or individual consumers of insurance, are subject to much higher costs than are large consumers. Historically, transport of goods and people have practiced different strategies of price discrimination; most notably, the Standard Oil company and its allies succeeded in achieving a monopoly in oil production in the 1880's using discriminatory rebates from the Erie and Central New York Railroad.^[1]

In the chart, the monopolist is able to divide the market for the product into 8 sectors, each of which pays a different price for the same item. Because each good can be sold at eight different prices, there is no meaningful concept of marginal revenue: the firm is essentially rationing the good and pocketing each consumer's individual surplus. In many cases where the monopolist is also a monopsonist, it can capture the surplus of its suppliers as well. Since there is ample additional revenue to be made for all values of p down to p*, this particular monopolist not only produces at maximum output, it may tend to "give the product away" at sharply reduced rates when it overshoots output.

Second degree price discrimination occurs if unit prices vary with the number of units bought, but all customers are subject to the same nonlinear price function.^[2] This is so commonly used because often, segmenting and targeting some markets may be impossible. Also, second degree price discrimination does not require a monopoly. It can be used when the monopolist is not in a position to know the customer's individual demand preferences.

Third degree price discrimination is where each customer pays the same linear price function, but the linear price function varies from location to location. This is typically used with big-ticket items such as autos and furniture. Actually, we mentioned health insurance above, something which is very heavily influenced by the location of the customer as well as everything else about the customer. Another example is cosmetics, in which the same parent company has multiple brands with entirely different prices in different markets.

Price discrimination does have the social benefit of transferring consumer surplus to the producer; this allows producers to subsidize entrants to the market, such as air travel (which became widespread in the 1970's as a result of extremely cheap tickets offered to college students). As networked booking systems like Apollo allowed travel agents to use elaborate methods to extract rents from affluent customers, it permitted the airlines to act as a single monopoloid firm, and to offer lower rates to younger passengers. As college students entered the labor force, they were able to pay regular prices, subsidizing younger waves of students. Another benefit is that some companies that offer an essential service, such as rail transport in the 19th century, can ensure that they are able to handle peak loads, even though they may be operating at <60% capacity most of the time. Workers can be paid while the firm is in a slow period, as with freight forwarding.

However, there are obvious consequences as well. The loss of customer surplus is dealt with in the article on supply and demand; it's not as straightforward an issue as it may seem, because in theory, the surplus they lose as consumers could return to them as producers, i.e., as workers and entrepreneurs. However, the loss of privacy and the administrative costs of discrimination do represent a very real cost to society. Another issue is that price discrimination is more likely to target the vulnerable than the rich; in the unlikely event that the rich can also be compelled to hand over their consumer surplus, then the monopolist is replicating some of the unpleasant aspects of a command economy. The monopolist can also use the rents to engage in longrun anticompetitive behavior, such as making market entry impossible for potential rivals. In short, the monopolist takes over many of the basic functions of the market and the state.

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Notes

↑ David Ira Rosenbaum, Market dominance: how firms gain, hold, or lose it and the impact on economic performance, Greenwood Publishing Group (1998), p.18; this was vital to the defeat of the Pennsylvania RR & Empire Refining Company's efforts to carve out a recovery-transport-refining network separate from the Standard monopoly.
↑ Wolfstetter (1999), p.24.

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