Micro Chapter 13 - Monopoly

Monopoly

a market served by a single seller of a product with no close substitutes

Elasticity vs perfect market

demand is more elastic in monopoly than a perfectly competitive market

Demand Curve Monopolist

Downward sloping

more points about monopoly

the firms have significant control over price, multiple consumers, barriers to entry

Reasons to be a monopoly

Entry to market is blocked by technological or legal barriers eg. patents, trademarks, copyrights etc. or may be a natural monopoly

natural monopoly

one that occurs when a firm benefits from economies of scale. more likely to occur when market is small or fixed costs are necessarily high eg. utilities like electricity, water, sanitation

The monopolist

has market power, price maker, supply side of the market, complete control, chooses prices based on consumer willingness to pay

Factors that lead to a monopoly

1.Control over key inputs. 2. economies of scale. 3. patents. 4. network economies. 5. government licenses

1. Exclusive control over important inputs

no guarantee of permanent monopoly power, reliant on preferences eg. mined vs synthetic diamonds

2. Economies of Scale

when LAC is downward sloping, least costly way to serve a market is to put production in just one firm. if price of an input falls when the industry output expands ( pecuniary economy) this does not give rise to a natural economy.

3. Patents

protect inventions, exclusive benefit from all exchanges involved in the invention, generally leads to higher prices for the consumers, allows for other inventions after a lot of expenses. Without a patent, competition would force prices down to marginal cost and pace of innovation would be slowed

4. Network Economies

product becomes more valuable as greater number of consumers use it. Some extreme cases function like economies of scale as a source of natural monopoly eg. Microsoft

5. Government Licenses or Franchises

many markets so laws prevent anyone but government-licensed from doing business

Importance of 1. exclusive control

production processes change so inputs are only a transitory source of monopoly

Importance of 3. Patents

inherently transitory

Importance of 4. Network economies

once firmly established may result in a persistent economies of scale - natural economy, more people who own the product-> the more effective it is

Importance of 5. Government licenses

can persist for extended periods, merely an implicit recognition of scale of economies

Importance of 2. Economies of scale

the most important factor

Total Revenue curve

slope of the total cost curve at any output is equal to the marginal cost at that output level

Monopolistic revenue curve

To sell a larger amount of output it must cut prices for both marginal and preceding units, TR passes through origin as no output = no revenue, as price falls the TR does not rise linearly with output but reaches a max value and quantity corresponding to midpoint of demand curve, then falls after. TR reaches max when price elasticity of demand is -1

Marginal Revenue

slope of total revenue is equal to MR at output level

Optimal conditions

profit maximised level when MR = MC

MR on a graph

when Q is left of the midpoint, gain > loss from lower price where MR > 0, Q is to the right, gain < loss from lower price and when MR = 0, gain and loss are equal

Slope of marginal revenue curve

twice that of the demand curve. MR curve cuts horizontal axis just below the midpoint of the demand curve and from then, MR is negative

Fixed Costs input?

they do not impact the profit maximising output level however they do impact the overall level of profit

inelastic vs elastic region?

profit maximising must lie in elastic region as further price increased need to lead to both revenue costs to decrease

profit maximising mark up

(P-MC)/P = 1/|E|

Shutdown condition

no quantity for which demand lies above the AVC. Still if P<AVC then shutdown

relationship between MR and P

MR < P

Increases output, price decreases and the effects on revenue…

Revenue increases by the extra output times the price, revenue decreases by the output times the change in area

Supply Curve

no real supply curve, use supply rule which is to equate MR and MC

Adjustments in the long run

SMC must pass through intersection of LMC and MR, profit maximising when LMC = MR which is the optimal capital stock in the long rise giving rise to the SMC curve

Downward pressure on profits that gave rise to the monopoly come under attack in the long run

competing firms developing substitutes, staying away from patents to avoid issues

Persistent economic profits

a declining long run average may result in persistent cost advantage over rivals, economic profits may be highly stable over time which is similar to monopolies from government licenses

dynamic efficiency of monopoly

open to firms with access to sufficient funds, short term gain -> long run welfare loss due to lack of new products or cost saving techniques

Policies Towards Natural Monopoly

1. state ownership and management. 2. private ownership with government price regulation. 3. competitive bidding by private firms to be sole provider. 4. vigorous enforcement of antitrust laws to prevent monopoly. 5. Laissez-faire, hands off policy

1. State Ownership and Management

efficiency requires that P = MC so in monopoly when MC is below ATC, the only alternative is to charge more than MC so the state could take over the industry- if they can avoid X - inefficiency then this is best

State Ownership positives

government not bound like a private firm to earna profit, ability to set P = MC and absorb economic losses, motivated by large fixed costs

State Ownership negatives

weakens incentive for cost-conscious and efficient management, an organisation that does not act energetically to curb costs- exhibits X-inefficiency

X-inefficiency

a condition in which a firm fails to obtain maximum output from a given combination of inputs, found in private firms, the extenct will depend on economic incentives, why it may be more common in government.

2. State Regulation of Private Monopolies

putting ownership in private hands while providing guidelines or regulations that limit pricing discretion. 1- set P = MC, results in the firm making an economic loss and the firm would have to be subsidies by the government. 2- set P = AC, firm is constrained to zero economic profit, we don't get P = MC but the next best option,

State Regulation of Private Monopolies pros and cons

if the price and subsidy are set correctly, firm has an incentive to reduce X-inefficiency otherwise economic loss would be made. If P is too low, firm has incentive to reduce quality and may go out of business. If P is too high, firm will earn economic profit. Firm have incentives to overstate its costs if this will result in it being able to set a higher price

3. Exclusive Contracting for Natural Monopoly

main issue is firms know more than regulators including cost function. Contracting out approach- make smaller firms bid for opportunity to fill the market and bit true value of operating instead of distorted incentives from regulation

Exclusive Contracting for Natural Monopoly issues

always tempting to go for the lowest bid regardless of the quality, underestimating costs may force the company to go bankrupt mid-contract

Vigorous Enforcement of Antitrust Laws

examples of laws set in place in order to reduce monopolies? Supporters insist it will not impede natural monopolies however may postpone time when economies of scale are fully noticed. responses- only prevent those mergers where significant costs saving would not be realised

Vigorous Enforcement of Antitrust Laws example

Article 102- Treaty on the Functioning of the European Union- prohibits firms holding a dominant position on a determined market to abuse the position eg. charging unfair prices, limiting production or refusing to innovate. Article 101- limits agreements between companies that would restrict competition

Laissez-faire Policy

doing nothing and letting the monopolists produce what they want at their desired prices with the objectives of efficiency and fairness. Depends on inferior, normal or luxury good eg necessities have desire for intervention. As from inferior to luxury -> fairness objection is less pronounced and efficient will diminish due to the relevant market becoming smaller as we move towards luxury goods

Price Discrimination

monopolists charge different prices to different buyers. allows firms to transfer some gains from consumers to their own profits

Third Degree

different consumer groups are charged different prices based on their observable characteristics in completely separate markets. eg. student, senior. requires ability to separate markets and prevent resale

Arbitrage

purchase of something for costless risk free resale at a higher price

Second degree

Price varies according to quantity consumer or product version but not the buyer eg. bulk discounts, tiered pricing where consumers self select by choosing from different pricing options. requires options that are likely to appeal to different type of consumers

First Degree

Monopolist charges each consumer the maximum price they are willing to pay, capturing all the consumer surplus and turning into extra profit. requires knowledge on willingness to pay

Hurdle Model of Price Discrimination

bundles price and quantity, induce elastic buyer to identify themselves and set up a price at discount to see who goes for it. Logic - those who are more sensitive to price will be more likely to jump/ do extra to get the lower price eg. waiting for a sale

Efficiency Objection

those who value the product more highly than the value of resources required to produce it

Fairness Objection

monopolist extracts the consumer surplus, make it available to those who would not have purchased otherwise, main aim to increase profit by more consumer surplus, main objection to monopoly is more acute

Social Costs of Monopoly

likely to exceed deadweight loss, the larger the transfer from consumers to firm, the larger the social cost

how to determine if a firm has monopoly power

check the cross-price elasticity of demand - how demand for one product changes when the price of a close substitute changes

Profit maximising condition that MR = MC in the monopolistic is…

necessary but not sufficient

most common form of state regulation of private monopolies

a simple cap on prices

what must price equal if state regulation sets a cap on prices so that the price level will not be as low as in the case of perfect competition

average cost

what will price equal if state regulation sets a cap on prices to a point where the firm could make an economic loss and have to be subsidised

marginal cost

problems relating to lack of information regulators have about firms and their costs can be avoided using

exclusive contracting