We know that competition between suppliers is good for the consumer, because the competing sellers struggle to get more customers by cutting price, adding supplemental services, improving product quality and other things that consumers value.  Referencing the Post on how markets work, more competition is good because:

• the value that consumers put on output is = to the additional resource cost of producing it.
• Consumers have many choices.
• Firms don’t have excess profits. Extra profits result in the expansion or entry of other firms and compete excess profits away.
• The firms that survive over time will be low cost, efficient organizations because those that aren’t will be put out of business.
• The quantity of goods bought and sold tends to go up with more suppliers (more competition) and price tends to lower. Lower prices let more consumers buy the produce.

Monopoly power occurs when firms (products) dont “compete” in the eyes of consumers. There are perceived differences products in the eyes of customers; brand, quality, location, and maybe aspects of functionality. Firms that have monopoly power have down-sloping demand curves and have autonomy to set their own price. With lower prices, they can sell more (though at a lower profit margin) and with higher prices they tend to usually sell less (though at a higher profit margin). Another way of saying this is that customer loyalty exists with firms with monopoly power—– the firm will lose some but not all customers if they raise price. In a truly competitive market the market itself determines the price. And if any seller tries to set a somewhat higher price, nobody would buy. In competition every seller sells exactly the same thing (a commodity). In a monopoly power situation, the sellers (one or more) are selling differentiated products. Buicks, chevrolets, ford, toyota, and honda are “competitors” for the car buyer’s business, but there are differences (real and imaginary) that create limited loyalty, allowing the firms some limited pricing autonomy.

This is monopoly power. And, sometimes there really is only one firm that is selling something (a particular new drug, or access to the electric grid).

Monopoly pricing

Like all suppliers, firms are assumed to price in a way allows them to make the most profit (net income).  If we have a firm making mulch to sell to gardening stores in our suburb they may have monopoly power and face a down-sloping demand curve according to the following schedule of their revenue and cost situation. They need to choose a preferred output level—-and the corresponding price that customers would pay for that quantity of mulch.

Price	Output level	Total Revenue	Marginal Revenue	Total cost	Marginal cost	Profit
100	10 tons	1000		1000		0
90	11.5	1035	35	1020	20	15
80	13.3	1065	30	1044	24	21
70	15.6	1091	25	1069	25	22
60	18.4	1105	16	1095	26	10
50	22.2	1110	5	1125	30	(5)

They should choose to produce at the output level where profit is highest. Here, the profit maximizing output level is  15.6 tons. What price do they charge to get customers to buy the exact amount they want to produce?  $70

Note on the chart that we have marginal cost (the additional cost of producing the additional quantity of mulch) and the marginal revenue (the additional revenue they get by selling the additional quantity).      The profit maximizing output level is always where MR =MC.      Graphically, this looks like:

Monopoly Pricing

The competitive solution (no monopoly power) is where demand = supply (marginal cost). That situation is shown by the arrows. The competitive solution would have a larger output level and a lower price than the solution of firms with some monopoly power. What do firms with some monopoly power do? They restrict output levels in order to raise price (and margins). They ration the consumption of the product to those of us willing or able to pay more. This is what’s bad about monopoly power.

Can firms facing less competition charge any price they want? Sure. Can they force consumers to pay any price they might want? No. They are disciplined by the demand of consumers. If price is higher, people will buy less because they must forego purchasing other things as prices rise. —- Firms can force customers to pay any price—without a gun!

What if another firm enters this industry tomorrow? What would be altered? We would observe more competitive pressures:

• Consumers would have more choices.
• Both firms might try to increase efforts to retain their customers = better service.
• Both firms may be forced to give bigger discounts to get customers = lower prices.

As a result of these things, prices fall, profit margins fall and the total amount of the mulch sold to consumers will increase. We move in the direction of the competitive equilibrium. What happens when one competitor leaves or is purchased by another firm? We move away from the competitive equilibrium resulting in higher prices and lower volumes of mulch sold.

Monopoly power (down-sloping demand curves) causes price rationing regarding who gets the consumer’s business. Those willing to pay the most, get the product. Those unable or unwilling to pay more don’t get it. Monopoly power raises prices and cuts consumers out of the market who would have purchased during more competitive conditions. This is sometimes perceived by society as a “problem” if the product is seen as a necessity by the poor. Social actions remedy this problem by controlling price (rent controls), by giving vouchers to the poor to buy the item (food stamps) or by government taking over the firms that supply the product (public schools).

Industry Groups

Economists have created market categories to describe prototypical situations of monopoly power or competition.    These groups are:

• Perfect competition: So many sellers that adding or subtracting some won’t matter to the equilibrium market price. Every seller sells the exact same undifferentiated product. Price is set in the overall market and each seller can sell all they want at that market price. eg. The demand curve facing each firm is horizontal at the prevailing market price and is perfectly elastic. Generally, agricultural products and extractive products fit this as an example.
• Monopolistic competition: Many sellers each having a somewhat differentiated product. Most retailing is like this. Gas stations, convenience stores, grocery stores, hardware stores, coffee shops, etc. They usually sell the same products as the others, but have geographical differentiation and may have some service differentiation. They can raise price and lose customers or lower price and pick up new ones. Demand curve is flat, but negatively sloped. They have some (little) monopoly power.
• Oligopoly: A few firms in an industry rivalry. When one does something, the others react in some way. Generally, demand curve is flatter above the current price, and steeper below the current price (kinked). If a firm raises price, rivals may let them do it to gain customers that flee from the higher price. If the firm lowers price, the others may have to follow them. Auto, steel cell phone plans, and computer manufacturing are like this. The kinked demand theory suggests that firms in such rivalry situations are reluctant to change price due to fear of being worse off if they do (up or down).
• Monopoly: One firm with a demand curve that is the same as the market demand curve. It could be flat or steep, as dictated by consumers. They face competition only from related products and from consumer purchasing choice. Generally, if a monopolist is making lots of profit, other firms will try to enter the industry to compete, and the firm’s monopoly power will decrease.A natural monopoly  occurs when a new firm enters the market, causing a price war. The result will be one firm’s exit of the industry. There is only room for one optimally sized firm in the market. Special cost situations such as enormous fixed costs and average costs are falling with respect to output in the region of the demand curve. More than one firm could survive if the demand for the product increased significantly.

These market situations display different levels of competition and monopoly.  In the last three levels of situations; industry structures, the suppliers all have some degree of monopoly power (down-sloping demand curves). Profits can be made in all industries, competitive pressures occur in each as do threats of new entry. Consistent profits tend to be zero in perfectly competitive industries because market forces are responsible for price changes and price will settle where P=MC. No firm is able to make excess profits and no inefficient firm can survive in perfect competition.

The other three industry groups have firm-abilities to set price because demand is downsloping. Profits tend to be higher when the firm’s demand is steepest, which reflects loyalty of customers. When profits are high, other firms try to enter and compete them away. Only “barriers to entry” represent a source of persistent excessive profits in any industry.

The chart below briefly summarizes the situation in these industry structures.

Industry Types