Lecture 2 Monopolies Flashcards
What do govts spend a lot of resources on?
- Regulating markets where firms have market power
- Screening cartel formations to avoid firms’ colluding
- Supervising mergers and acquisitions
- Promoting competition in general
What causes monopolies?
- Legal fiat
- A patent
- Sole ownership of resource
- Formation of a cartel
- Large EOS
What does econ theory assume?
All firms want to maximise their profits.
What is the profit function?
Π(y)=p(y)y−c(y)
p(y) = Price as a function of output y
c(y) = Cost as a function of output y
y = Output level
In simple terms it is Total revenue - Total cost
Marginal revenue
Is the rate of change of revenue as the output y increases. Calculated as the derivative of the total revenue
Economic implication of MR
As firm increases production, the additional revenue of producing one more unit decreases because the price typically falls with increased output, as there are more products for sale.
Marginal cost
The rate of change of total cost as the output level y increases
Markup pricing
Output price is the marginal cost of production
plus a “markup.”
How is after-tax profit, (1-t) P(y*), maximized?
By maximizing before-tax profit, P(y*).
So a profits tax has no effect on the monopolist’s
choices of output level, output price, or demands for
inputs.
Quantity tax
A quantity tax of £t/output unit raises the marginal
cost of production by £t.
* So the tax reduces the profit-maximizing output
level, causes the market price to rise, and input
demands to fall.
* The quantity tax is distortionary
Pareto efficient
A market if it achieves the maximum possible gains to trade
Pareto inefficiency
When a market does not achieve the maximum possible gains to trade.
How does a natural economy occur?
Arises when the technology of production has sufficiently intense EOS for a monopolist to supply the whole market at a lower production cost than is possible with more than one firms in the market.
Where do natural monopolies occur
Exist in industries with large fixed costs and small marginal costs or marginal costs which are rising slowly.
How does a natural monopoly deter new entrants
Use predatory pricing where existing firms set price low when new entrants appear causing negative profits leading to exit.
