4.1 - TP & imperfect competition: H & F monopoly case

Previous assumptions used for modelling

1st best world

• perfectly competitive markets

  • P = MC

  • S = D in equilibrium

  • No markup - P/MC = 1

Mark ups in reality

Mark ups exist - >1

Therefore there is imperfect competition to some degree

Recent decades show mark ups trending upwards

Home monopolist example - Assumptions (no FT)

Single firm selling homogenous good

Firm is a price maker - influence over p

• P > MC (mark ups)

Given that D is downwards sloping, to sell more it has to lower p

• Extra Q = P down → revenue donw

• MR is below D

Home monopolist example - no trade equilibrium graph

Home monopolist example - no trade equilibrium graph explained

A - Monopoly equilibrium

B - Perfect comp equilibrium

MR = MC - profit max

• lower Q & higher p that in perfect competition

Home monopolist example - Assumptions with FT

H is small country - faces fixed world p (p^w)

• X Supply curve

D curve the monopolist faces is no longer just dom D as p^d>p^w will have 0 demand

Since increasing Q =/ price decrease → MR constant & = p^w

Home monopolist example - FT graph

Home monopolist example - FT equilibrium graph explained

A - no trade monopoly equilbrium

B - FT equilibrium

Under FT monopolist takes fixed p^w

• Set p = MR (in this case = MC)

• Q = S1

Consumers D D1 at price p^w so M needed to cover dom deficit

Same result as under perfect competition

Home monopolist example - Trade with tariff graph

Home monopolist example - Trade with tariff graph explained

B - FT equilibrium

C - Equilibrium when tariff present

With p^w increased to p^w+t

• S increases (S1 → S2)

• D decreases (D1 → D2)

• M falls (M1 → m2

Still same result as under perfect comp (including losses)

Home monopolist - Trade with tariff welfare effects

Home monopolist - Trade with quota assumptions

Choose quota that restricts M to same as under tariff (M2)

Effective D curve = D - quota

• can be seized by F firms

Monopolist can still influence p

• chooses profit max for residual D

Home monopolist - Trade with quota graph

Home monopolist - Trade with quota graph explained

With quota, the monopolist sets Q where new MR = MC (E)

• S = S3 P = P3 D = D3

• M same as under tariff (M2)

Under FT monopolist produces as B

Under tariff monopolist produces at C

Home monopolist - Trade with quota welfare

With Quota, monopolist sets p at p3

• p3 > p2 → CS falls & so DWL rises

PS increases

As P increases, QR increases (P3 - pw * M2)

• with H monopoly QR > tax revenue with tariff

• however QR can be wasted on rent seeking activity + can go to F firms

DWL under quota > tariff

Foreign monopolist - Assumptions

F firm exports as a monopoly

No competing H firms

• not realistic but makes analysis easier

F monopoly profit max in X market

• MR_H = MC_F

Foreign monopolist - effect of a tariff graph

Foreign monopolist - effect of a tariff graph explained

A - FT equilibrium

B - Effect of tariff equilibrium

MC increases by t

Foreign monopolist - welfare effect of tariff

CS falls: -(c+d)

Govt revenue: c+e

• Home welfare = e - d (same as large country case with perfect comp)

Exporter P falls (P1 → P3)

• TOT gain for H: e