Download Monopoly

Quick Quiz
• Illustrate the movement from shortrun loss to long run normal profit under
perfect competition
GUESS
WHO?
Monopoly
Monopoly
Pure Monopoly- only one firm in the industry
Working Monopoly- 25% + market share
A monopolist has the power to determine either:
The price at which they sells his product;
The quantity they wishes to sell
The monopolist cannot determine both as they cannot determine
Demand
What determines monopoly power?
• the availability of close substitutes from rival industries
• ability to maintain barriers to entry
Key Features of Monopoly
• There is one firm, which is also the industry
• It produces a unique good/ service
• There are complete barriers to entry and exit from the
industry.
• Customers have only 1 firm to buy from, as there are no
direct substitutes- Limited Choice
• The Firm is a ‘Price Maker’
• The Firm has the ability to earn abnormal profits in the
long run
• Low levels of economic efficiency- productive and
allocative efficiency not achieved
Short- run and long run abnormal profits
under Monopoly
Rectangle Pabc= Abnormal Profit
MC
Cost/
Price
AC
P
c
a
b
D= AR
Q
MR
Output
Long run equilibrium
The monopolist can maintain abnormal
profits in the long run if :
There are barriers to entry and exit.
These may be
- artificial (e.g. patent, brand loyalty) or
- natural (e.g. economies of scale)
Barriers To Entry
Economies of scale and High sunk costs
A clearly differentiated product with brand loyalty
Brand proliferation: In many industries multi-product firms engaging
in brand proliferation can give a false appearance of competition to
the consumer. This is common in markets such as detergents,
confectionery and household goods – it is non-price competition.
Legal/ regulatory barriers eg Patents are legal property rights to
prevent the entry of rivals. They are generally valid for 17-20 years
and give the owner an exclusive right to prevent others from using
patented products, inventions, or processes. The owners of patents
can sell licences to other businesses/. Statutory monopolies- those
granted legal protection from competition eg Post Office in UK. In the
past companies such as the Hudson’s Bay Company and the East India
Company were granted the sole right to trade in certain areas. Many
public utility companies providing water, gas and electricity have been
granted local monopoly powers, but are subject to some regulation.
 Ownership/control of key factors of productionUntil recently, DeBeers controlled the world’s supply
of uncut diamonds, and there was no way that new
firms could enter the market because of the
agreements that DeBeers had with mining companies
and governments in those parts of the world where
diamonds are mined. The monopoly has lasted for
many years, and is only now starting to break down
 Other barriers- aggressive trading tactics- eg. Limit
pricing (predatory pricing), the threat of aggressive
merger and takeover, ownership/control of retail
outlets and intimidation.
Monopoly Cont. Tues 6th March
Efficiency and Monopoly
•
•
•
•
Recall output levels for
Productive Efficiency?
Allocative Efficiency?
Draw the monopoly diagram and label 3
output levels
Output and Efficiency under Monopoly
Rectangle Pabc= Abnormal Profit
MC
Cost/
Price
AC
P
c
a
b
D= AR
Q MR Qp
Qa
Output
Monopoly and elasticity
P
C
R
Monopolist will always operate
on the elastic section of a
demand curve where MR is
positive.
PED = >1
PED = 1 (TR
unchanged)
MR
AR = D
QUANTITY
Comparing PC and Monopoly
Efficiency
Allocative efficiency
P = MC
i.e the price a consumer is prepared to
pay = cost to society of producing an
additional unit, assuming no external
costs
Under PC, P = MC
Under monopoly, P > MC
Productive Efficiency
Firms are productively efficient if they
are producing at the lowest point on
their lowest possible AC (ATC) curve.
Looking at the l/r AC curve firms are
producing at their MES
Under PC firm is operating at min ATC
Under monopoly, firm operating at > min
ATC
A Comparison between Pure Monopoly
and Perfect Competition
Price/
Revenue/
Cost
Pm
Pc
Loss of consumer
surplus- PcPmac
Deadweight
welfare loss abc
a
b
c
AC =MC
Assume- constant costs
for both industries
AC=MC= Industry Supply
Curve
MR
Qm
Qc
AR=D
Output
A Comparison between Pure Monopoly
and Perfect Competition
Price/
Revenue/
Cost
EoS moves monopoly onto AC1,
output= Q1 and P=P1
Consumers benefit from
monopoly compared to PC
a
Pm
b
Pc
c
AC =MC
P1
AC1 =MC1
MR
Qm
Qc
Q1
AR=D
Output
Profits
Under PC, (AR =) P = AC i.e. long run
normal profit is made
Under monopoly (because of barriers to
entry) P>AC (AR> AC) i.e. Long run
abnormal profits can be made
Does the consumer always lose from
monopoly?
If a monopolist faces identical costs to
a perfectly competitive industry, and
can prevent entry, a monopoly will
result in
Higher prices
Lower output
‘Advantages’ of monopoly
Supernormal profits provide an incentive and
a source of funds for process and product
innovation:
• New technologies that may reduce costs i.e.
LRAC under monopoly < LRAC under perfect
competition.
• New products increase consumer choice
• E of S can lead to greater output and lower
prices than under PC
Natural Monopoly
• A natural monopoly is characterised by
increasing returns to scale at all levels of
output. Thus the LRACs continue to fall as
output expands.
• Due to high sunk costs and economies of scale
it is not efficient to have more than one firm
providing goods or services in this market.
• Some examples of industries that are close to
being natural monopolies are BT, Royal Mail,
Camelot and the National Grid.
Natural Monopoly
Price/
costs/
revenue
PE
MR
AC
MC
QE
AR = D
Output
Monopoly and Efficiency
• Using the article ‘Monopoly’ ET Jan 2005
• Add to your notes on the advantages
and disadvantages on monopoly.
• Ensure you have explained the concepts
of static and dynamic efficiency
Output and Efficiency under Monopoly
Rectangle Pabc= Abnormal Profit
MC
Cost/
Price
AC
P
c
a
b
D= AR
Q MR Qp
Qa
Output
Price Discrimination
Examples of Price Discrimination?
Price Discrimination
• First Degree- a firm charges each consumer for each
unit the maximum price they are prepared to pay for
that unit (eg. stall- holders in street markets?)
• Second Degree- a firm charges customers different
prices according to how much the purchase. It may
charge a high price for the first x units, a lower price
for the next number units and a lower price for the
next number of units (eg electric companies in some
countries charge a high price for first so many kw
then a lower price for additional kw)
• Third degree- where consumers are grouped into 2 or
more independent markets and a separate price is
charged in each market eg. Bus fares
Conditions necessary for price
discrimination
• Firms must be price makers
• Markets must be separable- consumers
must not be able to buy in low price
market and re- sell in high price market
• PED must differ in each market
Diagram for Price discrimination
£
Market A
£
Market B
Total Market
£
MC
Pa
AC
Pb
MR
O
QA
AR
MR
O
QB
AR
MR
O
T
AR = D
Output
Assume costs of production are identical for both markets
The firm needs to allocate production so that MR is identical for each market if it is to
maximise profit
The profit maximising monopolist will produce at where MC=MR across the whole market,
at output level 0T
This output is then split across 2 markets, so that MR is equal in both markets
In each market a price will be charged based on the AR curve
Abnormal profit earned from splitting the market is higher than it would have been if the
market had not been split.
Handout
• Who Gains from Price Discrimination?
• ET Sept 2005
Price Discrimination and the
Public Interest
• Price discrimination is likely to increase
output and make the product available to
more people.
• Distribution- those paying the higher price
may feel it is unfair, those paying the lower
price will have a higher consumer surplus than
the otherwise would have had, they are able
to consumer more and some may be able to
obtain a good or service that they could
otherwise not afford.
• Competition- A firm may use price discrimination
to drive competitors out of business- predatory
pricing (pricing below AC), eg. Cross- subsidising
bus routes. On the other hand, a firm may use
profits from high priced market to break into
new markets and withstand a possible price war,
thus competition is increased.
• Profits- higher profits and prices could be seen
as an undesirable re-distribution of income in
society, however, higher profits could be reinvested= innovation or lower cost in future
(maybe leading to lower prices?)
handout
• P209
• Price discrimination in the cinema
Alternative Objectives of the
Firm
• Profit Maximisation
• Optimum Output (productively efficient level of output due to
Govt intervention?)
• Socially Optimum output (allocatively efficient due to Govt
intervention?)
• Normal Profit (Gov intervention?)
• Predatory Pricing Output (above normal profit below profit
max
• Sales Revenue Maximisation (when is sales revenue (total
revenue maximised?)
• Sales Maximisation
• Profit Satisficing
Sales Revenue Maximisation
• High sales revenue – increase market share,
easier to borrow money, increased market
power
• Output should be where MR=0, where TR will
be at a peak
• Output likely to be greater than Profit Max
point
• Extra sales after the unit where MR=0
contribute nothing to TR, therefore it is the
sales revenue maximisation output
Sales Maximisation
• Maximises volume of sales rather than revenue
• Unlikely to increase output beyond a point
where TC=TR (don’t want to make a loss)
• Growth of the firm
• May be the objective for managers (pay rise
and other benefits)
• Could conflict with shareholder objectives –
want larger dividends, managers want to reinvest profits into the firm
• Long run- both parties may be happy if sales
maximisation policies have increased market
share and raised long-run profits
Profit Satisficing
• Managers aim for a level of profit that
will keep shareholders happy
• Managers may be unwilling to accept
extra responsibility and pressure for
more competitive policies
• May also wish to satisfy other
stakeholders
Sales Revenue
Maximisation
Profit
Maximisation
£
Costs/
Revenue
TC
TR
Profit
Satisficing
Min
p
Total
q1
qp
qr q3
p
Output
• Handout-Profit maximisation
• Question
Contestable Markets
:a
market is perfectly contestable if
1. the cost of entry and exit by potential rivals are zero
2. entry can be made very rapidly
A market is less contestable if there are:
Economies of Scale if market demand is =/> MES, then
the firm is likely to be a natural monopoly
Sunk Costs: a firm’s investment e.g. specific capital,
cannot be employed in alternative uses
PC and Contestable Markets
• ET Nov 2005
• Q4