Download Market Structure of Monopolies

Market Structure of Monopolies
A. Definition
B. Comparison between Perfect Competition and Monopoly
I. Allocative Efficiency
II. Productive Efficiency
III. Dynamic Efficiency
A. Definition
1
The monopolist market is the opposite of perfect competition. In the market structure where there is only one supplier of a certain good. 1
B. Comparison between Perfect Competition and Monopoly
2
Taking the perfectly competitive market as a whole, it can be seen the effect of the aggregation of the different
competitors´ behaviors in the market and conclude that the equilibrium point in a competitive market is reached
where:
Demand = Supply = Marginal Costs = Marginal Income
The red triangle represents the consumer surplus (prices that consumers don’t have to take because the market already assigned a price for that
quantity) and the producer surplus, in yellow (the prices between the supply curve and the competitive price, which the producers do not have to
take for their goods because the market already have assigned that price). 2
3
In comparison, monopolist is the total market 3 and it has to take into consideration three model assumptions.
1. The monopolist assigns the price in the market. It is not a price-taker, but a price-setter.
2. It has to sell all its products at a single price.
3. The price for the good is lower if it produces more quantity.
The most important consequence of monopolies is that the price is settled not where the demand curve intersects the supply curve, but where its
own marginal income (it means, the incomes that it receives for the next unit produced) meets with its own marginal cost curve.
The result of the maximizing behavior of a monopolist is that the price of the good is far superior than the normal competitive market price and,
because of this, many consumers will not be able to buy the product, so the consumer surplus is diminished, probably the producer surplus is
better but the overall result is that there is less quantity in the market and there is an overall loss for society (deadweight loss), because of this,
the monopoly is not allocative efficient compared to a competitive market. 4
4
As a matter of fact, Economy, as the science which deals with the distribution of scarce resources, 5
teaches that most monopolies do reduce the overall society surplus and welfare.
In the comparison between monopolies and competitive markets, it’s possible to analyze three different efficiency types where both models attain
opposing results, thus affecting their respective accomplishments in relation to societal welfare.
I. Allocative Efficiency
5
Allocative Efficiency can be defined as the maximization of the overall welfare of the participants in the considered market.
This maximization of welfare, relies on two parameters, the first one the consumer surplus, is the resources that buyers of a product don’t have to
spend in order to acquire the product, on the other hand the producers´ welfare is the relation between the price received by the producer for a
certain amount of good supplied to the market and its willingness to supply that same amount at a lower price.
The result of the maximizing behavior of a monopolist is that the price of the good is far higher than the normal competitive market price, and
because of this, many consumers will not be able to buy the product, so the consumer surplus will diminished whereas, probably, the producer´s
surplus increases. Nevertheless, the overall result is that there is less supply in the market and there is an overall loss of welfare for society (“dea
dweight loss”). Thus, the monopoly is not allocative efficient compared to a competitive market. 6
II. Productive Efficiency
6
The productive efficiency tries to answer the question if the market is producing with the best quality using the best technologies that actually exist
or may be developed without significant efforts.
The difference between competitive markets and monopolies arises immediately. Because of competition, competitors have to invest in
enhancing production technologies to fulfill the market´s expectations in order not be closed down. In contrary, when dealing with monopoly,
(because the monopolist is the market and high barriers of entry prevent the appearance of other competitors) it can maintain low levels of
production and R&D disregarding the rest of
the market participants, because of this, normally monopoly firms have a poor technology improvement in relation to competitive markets firms. 7
Also, monopolies can use resources to artificially maintain its own market dominance; it is the so called “rent seeking” behavior. 8 So, as a
conclusion, monopoly does not mean any improvement in productive efficiency when compared to perfect competition markets
III. Dynamic Efficiency
9
7
Any human activity has a long term dimension and economy and entrepreneurship are no exceptions. Contrary to the static efficiencies (allocative
and productive) that refer to a single-point-in-time equilibrium, dynamic efficiency is centered on the path to reach future equilibria and the
evaluation of present-day decisions under long-term efficiency parameters. Therefore, D-efficiency deals with the correct assignment of resources
in the present in order to secure that the other two efficiencies are met in the future.
8
The Austrian Economic School was the first to conceptualize what is now known as “dynamic efficiency” in the 1920s. Under the leadership of
Von Mises and later Hayek; these theoreticians tried to explain what drives innovation, research and development in market-driven economies.
This school of economic thought argued that the entrepreneurial function was never static and was also inextinguishable. Human creativity cannot
be stopped; it will always come up with new techniques, technologies, organizational paradigms …etc., that will “rock the boat” of development in
order not to remain in a “steady state”.
For the Austrian school the best way to boost D-efficiency was to secure proper functioning of markets, that is to say, perfectly competitive ones
left alone from state run interferences.
9
Setting aside this last idea, it is useful to analyze the debated relationship between monopolistic market structures and the D-efficiency paradigm.
However, one must first consider two aspects: first, in order to achieve D-efficiency investments in risky enterprises are required, second, not
every player in the market is incentivized in the same way to this kind of investments. Let us now analyze the two extremes.
Some argue that perfect competition is not the best alternative to achieve the desired D- efficiencies. The reason is simple as every supplier in the
market is on the edge of incurring in loses (Market Price = Marginal Costs) and the “extraordinary benefits” are impossible, no player is able to
invest in future development of product, services, techniques, technologies, organizational improvements…specially when the expected returns
are not secured and anyway, due to the perfect information, would not be very profitable. Rationality would lead to a general stagnation.
On the other hand, monopoly-market-structure is also not optimal to achieve D-efficient goals, mainly because of the lack of incentives to innovate
once your position in the market is secured. The idea is very simple, if the monopolist is already making the most profit that can be made in a
market and his position is secured by law or by other factors (extremely high barriers to entry, for instance); what is the point in trying to improve
the product or the service offered in the captive market? So, the monopolist has the financial means to achieve D-efficiency but lacks the
incentives to do so, preferring to spend the obtained surplus otherwise.
However, many authors suggest that old-state-run monopolist may submit to this rule, but other monopolist won´t. The point is that in very highly
technified and research-driven markets the existence of monopolies (this situation must have been achieved by shear competitive ability and not
in unlawful ways) might be the best solution possible because they show in the highest degree possible the two preconditions to attain
D-efficiency: financial resources, and the so called “innovation drive”.
1 Jones, Alison and Sufrin, Brenda, EU Competition Law Text, Cases and Materials, Fourth Edition, Oxford, 2011, p. 9, para. 3
2 Mankiw, Gregory, “Principios de Economía”; Second Edition Mac Graw Hill , Spain, 2002, p. 96.
3 Ibid., p. 200.
4 Ibid., p. 201-202.
5 “Here then, is the unity of subject of economic science, the forma assumed by human behavior in disposing scarce means”. Definition by
Lionel Robbins “An essay of the nature and significance of the economics science” Second Edition Mcamillan and Co, London 1945, p. 15.
Pdf link: http://mises.org/books/robbinsessay2.pdf (date of last access: 27.01.2014).
6 Ibid. 1, p. 201-202.
7 Leibestein, Harvey “Allocative Efficency vs „X- Efficency” American Economic Review, Volume 56 Issue 3 (June 1966), p. 412.
8 Tullock, Gordon (1967). "The Welfare Costs of Tariffs, Monopolies, and Theft". Western Economic Journal 5 (3): 224–232. doi:10.1111/j.1465-
7295.1967.tb01923.x (date of last access: 20.01.2014).
9 Huerta de Soto Ballester, Jesús,“ La Teoria de la eficiencia dinámica”, Revista de procesos de Mercado, nº1 , 2004, p. 110-123, http://www.u
ao.edu.co/sites/default/files/HUERTA.PDF (last access: 4.12.2013).
Publication Note
Responsible: Free University of Berlin represented by its President.
Authors: Roa Bogotá, Juan Carlos; Neves Takabatake, Mariane; Cordero Martínez, Fernando; Weber, Constanza
Stage of work: Final
outgoing links
http://dx.doi.org/10.1111%2Fj.1465-7295.1967.tb01923.x
http://en.wikipedia.org/wiki/Digital_object_identifier
http://mises.org/books/robbinsessay2.pdf
http://www.uao.edu.co/sites/default/files/HUERTA.PDF
incoming-links