MONOPOLY-Microsoft Corporation

Monopoly is an industry that composed of a single seller of a product with no close substitutes and with high barriers to entry.

For example, Microsoft Corporation

Characteristics of monopoly

v  Single seller

Ø  the firm which is also known as the monopolist and the industry are one and the same.

v  Price maker

Ø  the firm is able to choose a profit maximizing price from a range of prices imposed by market conditions and competition.

v  No close substitute for the product

Ø  this is because there is no close substitutes for its product, the monopoly faces a little competition.

v  Barriers to entry for new firms

Ø  It is legal or natural constraints that protect a firm from potential competitors.

Barriers to entry is the firms which already possess market power can maintain the power either by restricting other firms from producing an exact duplicate of their product or by restricting firms from entering the industry.

Example of barriers to entry

Ø  Patents/Copyright
-A patent is granted by the government, giving the exclusive right to the inventor to sell a new period of some period of time. A copyright is an exclusive right to the author or composer of literary or artistic work and it valid for a limited time period.

 

Ø  Economies of scale
-It is enjoyed by the existing firm that produces large output. The size of large firm provides the advantage of having a lower average cost in production.

 

Ø  Ownership of scarce raw materials
-If a firm governs the supply of important inputs to produce a particular product, this will serve as a barrier to entry until an alternative source of the inputs is found or an alternative technology not requiring the input is developed.

 

 

Well, Let me tell you why Microsoft is a Natural Monopoly

Microsoft has a great reason to establish and maintain a monopoly, if it could do so without true competition forcing it to reduce prices. Software is unlike any other business. Because the marginal cost of software is virtually zero (and in the case of OEM distribution and volume licensing actually is zero, since the licensee pays for any packaging and distribution), its average total cost continually declines with volume, and because expanding the number of software units only involves making copies, there are no diseconomies of scale and no necessity to increase fixed costs. Because marginal cost is so low, average total cost continually declines as it asymptotically approaches marginal cost, and unlike many other industries, average total cost never rises. Thus, Microsoft is a natural monopoly.

Sales figures and cost of development for software are hard to come by, especially with multiple versions and constant upgrades becoming available, but consider this. According to Microsoft (Microsoft Office Now Fastest-Selling Business Application Ever), Microsoft sold more than 20 million licenses of Microsoft Office 97 in less than a year, at the average of rate of 60,000 per day! Furthermore, Microsoft already had an installed base of 55 million for its desktop applications prior to the release of Office 97 (Microsoft Office 97 Released to Manufacturing). With the number of computer users still growing rapidly during the late 90's, it certainly is not unreasonable to assume that Microsoft sold at least 50 million copies of Office 97 in the 2 ½ years between its initial release on November 19, 1996 and the release of Office 2000 on June 10, 1999. (An average rate of 60,000 copies per day for 933 days yields 55,980,000 copies, so 50,000,000 is a conservative number.) Let's further assume that Microsoft received an average of $200 per copy, not an unreasonable figure considering that MS Office prices ranged from a little over $200 to over $400 for an upgrade, depending on version, and almost double that for a full version. Let's further assume that it cost Microsoft $50 million dollars to develop Office 97. Again, not unreasonable when you consider that Office 97 was an upgrade to Office 95, so it wasn't like they were creating the software from scratch. The cost could be considerably less than this, because, (1) as I have already argued, Microsoft's goal is to add as little value as possible to each upgrade; and (2) much of the code between programs is shared, thus reducing costs even more. Multiplying price per copy by the number of copies sold yields a staggering $10 billion in revenues. (It has recently been reported that Microsoft receives 40% of its revenue from Office; thus, that's almost $10 billion in ONE YEAR!) Subtract the cost of development and the cost of packaging yields $9.7 BILLION in profit! That's a staggering profit margin of 97%! The profit earned per unit sold is more than 33 times what the unit cost! Of course, Microsoft as a company doesn't earn this much profit or have a margin this high, because it is diluted by fixed costs, administrative and marketing expenses, and the company's other, less profitable, endeavors and other monopolizing efforts, but, nonetheless, its profit margin as a whole for 1999 was 39.4%, far higher than most other companies. In the last 5 years, Microsoft's profit margin has increased from 24.5% in 1995 to 39.4% in 1999 and this trend will only continue as Microsoft sells more software to a wider, worldwide market, simply because the marginal cost of software is very little, so the average total cost of each unit continually declines! (Compare Microsoft's profit margin and growth to super-efficient Dell Computer (page still available, but displayed info reflects latest data), which has an average profit margin of less the 8.5%!)

Monopoly in the short run:

Situation A:
Microsoft Corporation  is earning economic profit when P>ATC or TR=TC.
MC=MR when Q1  is produced. So Q1 is known as profit maximizing level of output. At this output level, price which is denoted as P1 is greater than ATC which is denoted as AT C1.

Total revenue=Economic profit + Total costs

Since TR>TC, Microsoft Corporation is earning economic profit.

 

Situation B:

Microsoft Corporation is earning normal profit when P=ATC or TR=TC

MC=MR when Q1 is produced. So Q1 is known as profit maximizing level of output. At this output level, price which is denoted as P1 is equals to ATC which is denoted as C1

Total revenue: Area A

Total cost: Area A

Since TR=TC, Microsoft Corporation is earning normal profit and the economic profit is equals to zero.

Situation C:

 Microsoft Corporation is incurring economic loss when P<ATC or TR<TC

MC=MR when Q1  is produced. So Q1 is known as profit maximizing level of output. At this output level, price which is denoted as P1 is less than ATC which is denoted as C2

Total revenue :Area B

Total cost: Area B

Since TR<TC,Microsoft Corporation is facing economic loss and the loss area is A.

Monopoly in the long run:

In the long run, the output that maximizes the profit is when the long run marginal costs curve (LMC) curve intersects with the marginal revenue curve of that monopoly.

As the below diagram shown how the  long-run equilibrium of a monopoly is achieved. Observe that in the long-run, the Microsoft Corporation is still able to gain supernormal profit. This condition occurs for company that obtain monopoly power through the granting of license by the government. Pressure towards profit does not occur. This causes the supernormal profit enjoyed to remain even in the long-run. From the diagram above, it is clearly shown that the continuous long-run average costs curve faces decline. This means that the Microsoft Corporation obtains cost advantage compared to its competitors. In the long-run as well, the Microsoft Corporation can experience normal profit or decrease in profit. Competitors might create substitute inputs for the input controlled by the monopolist. Competing firms supplying outputs that have similar use as the output supplied by the monopolist can also emerge in the long-run. This causes the profit gained by the monopolist to decline.