Lecture 2- Monopoly Flashcards
Characteristics of a firm operating in a Monopoly market?
Has market power
Has unique products
Is a price maker
High barrier to entry- legal market power (Governments), natural barrier (Access to resources)
What is the marginal output rule?
If the firm does not shut down, it should produce output at a level where marginal revenue is equal to marginal cost.
For profit maximisation, what is the shut down rule?
If for every choice of output level the firms average revenue are below their average economic cost then the firm should shut down.
Describe the relationship between marginal revenue and demand for a firm operating in a monopoly.
When the firm is a price maker, the MR curve lies below the demand curve everywhere except an output level of 0.
Explain the effect of a tax rise on a monopoly.
The increase in tax will shift the marginal cost curve upward.
This will increase the price, however decrease the quantity sold.
Despite this price increase, the monopolist’s profits decrease because: The firm produces less output, losing profits from the reduction in quantity sold. The firm must pay the tax on each unit sold.
Why is regulating a monopoly necessary?
Market inefficiencies- Monopolies restrict the output to increase profits leading to a inefficient allocation of resources (deadweight loss)
Natural monopolies- Some industries, like utilities, have high fixed costs and economies of scale, making competition inefficient.
Government oversight: Regulations intervene to control prices and output to avoid consumer exploitation while ensuring the monopoly remains financially liable.
In a regulated monopoly where is total surplus maximised
Marginal costs = Demand
What are some challenges in regulating monopolies?
At the efficient level (xT) , D= MC, but this may lead to losses. Regulators compromise by allowing a higher price, where D = AC, ensuring 0 economic profit.
Information Asymmetry- Regulators often lack accurate information about the monopolists true costs. Firms know the regulators often use cost information to set prices and so:
Firms may strategically misreport costs to manipulate regulations in their favour, leading to higher profit maximising prices.
What important points should governments need to consider when regulating monopolies?
- It must be allowed to earn non-negative profits.
- It will use its private information to its own advantage.
- Regulatory controls may have unintended consequences.
What is price discrimination?
When a firm charges different prices for the same good to different consumers (senior citizens, students).
What are the necessary conditions needed for profitable price discrimination?
- The firm must be a price maker
- The firm must identify consumer groups.
- Consumers must not engage in arbitage- ocurs when low-priced buyers resell goods to high-priced consumers, undermining price discrimination.
What is first degree price discrimination?
The practice of selling each unit of output at a price equal to the buyers maximal willingness to pay for that unit.
What is 2nd degree price discrimination?
The firm charges different prices for different quantities or versions of the same product, based on the amount consumer or quality selected.
e.g. 3 carrots for 2 in a supermarket.
What is 3rd degree price discrimination?
Identifying separate groups of buyers and charging different prices to these groups. (Student discounts)
