Holt 7525-9 S15_IT

Chapter 22 Monopoly
Of the four market structures, monopoly is at the opposite extreme from perfect competition. A
perfect competitor has no ability to affect market price (no market power). A monopoly has
maximum market power.
Monopoly – a firm that is the lone seller of a product with no close substitutes.
Example 1: Darla’s Delectable Donuts has a unique recipe for donuts that is unlike any of the
other 73 donut shops in town. Does this make Darla’s a monopoly? No. There are many close
substitutes available. To be a monopoly, a firm must be selling a product with no close substitutes
available.
Monopoly and Barriers to Entry
As the lone seller in a market, a monopoly is in a good position to earn economic profit. If a
monopoly earns economic profit, the economic profit would tend to attract new firms into the
market. In order for a monopoly to maintain its position as the lone seller in the market, there will
need to be factors blocking the entry of new firms into the market. These factors, called barriers
to entry, can also limit the number of firms in an oligopoly market (see Chapter 23).
Barriers to Entry – factors that block the entry of new firms into a market.
Barriers to entry are classified into three general types:
1. Legal barriers. Legal barriers are created by government action. Examples include;
a. Public franchise. The government grants one firm an exclusive right to provide a good or
a service to a market. In the past, public franchises were sometimes granted to the family,
friends, and political cronies of the top government officials as a way to enrich them. This
still occurs today in many countries. See the appendix at the end of the chapter on
corruption and public franchise.
In the U.S., granting a firm a public franchise is often part of the regulation of a natural
monopoly. In a natural monopoly market, one firm will be granted a public franchise to
serve that market, but will then be subject to government regulation. Natural monopoly
results from economies of scale and is defined later in the chapter.
b. Patent. A patent is a government granted monopoly on the production and sale of an
invention granted to the inventor. Most patents are legally effective for 20 years from the
date of application. Developing new inventions is often very costly and uncertain of
success. The monopoly position granted by a patent is a reward for inventive behavior.
Patents are a way to encourage invention.
Example 2A: Stephanie Kwolek worked as a research chemist with the DuPont Company from
1946 until 1986. During this time, she earned 17 patents for DuPont. The most famous product of
her research was a synthetic fiber five times stronger than steel that she patented in 1966. The
product generates hundreds of millions of dollars in sales revenue each year and is used in a
wide variety of products, including; automobile tires, brake pads, parachutes, safety helmets, and,
most famously, bulletproof vests. The product is marketed under the brand name Kevlar.
Example 2B: Patents can be very valuable. Eli Lilly and Company held various patents on
Prozac beginning in 1974. On August 9, 2000, the Court of Appeals for the Federal Circuit held
the last of the Prozac patents to be invalid. On August 10, the value of Eli Lilly and Company
stock dropped by nearly one-third. Competition from generics meant that Prozac prescriptions
would drop by 90% in the next year.
FOR REVIEW ONLY - NOT FOR DISTRIBUTION
22 - 1 Monopoly