market power Flashcards
what is a monopoly and where does it lie on the competition spectrum?
it lies at the other end of the spectrum to perfect competition
monopolies are a firm that is the only seller of a product without close substitutes
when does a firm have monopoly power?
if it is the dominant seller in a market and as a result is able to exert some control over the market
e.g. microsoft has no close competitors (75% market share) and google (about 70%)
we often assume there is only 1 seller because it can choose the market price of its product, a monopoly is a price maker
why do monopolies arise?
a fundamental cause of monopoly is barriers to entry
what are the barriers to entry firms?
- only the monopoly owns a key resource (not often a reality)
- the government gives a single firm the exclusive right to produce a good or service (e.g Sweden has an alcohol retail monopoly)
- the costs of production are such that a single producer is more efficient than a large number of producers (e.g. water distribution)
- a firm is able to gain control of other firms in the market and thus grows in size e.g. facebook
what does a monopolists demand curve look like?
not perfectly elastic
(downward sloping):
- if monopoly raises the price, consumers will buy less
- if monopoly reduces the quantity of output it sells, the price per unit of output increases
a monopoly can choose any point on the demand curve
how do monopolies make production and pricing decisions?
a monopolies marginal revenue is always lower than the price of the good
when a monopoly increases the amount it sells, this has 2 effects on revenue:
- output effects: q is higher -> tends to increase total revenue
- input effects: p is lower -> tends to decrease total revenue
total revenue may increase or decrease (marginal revenue positive or negative) depending on whether the output effect or price effect is dominant
what quantity should monopolies produce?
their objective is to maximise profit so compare MR and MC of each unit produced
optimal quantity: MR=MR
after the monopoly chooses the quantity of output such that MR=Mr, it uses the demand curve to find the price at which each unit of good will be sold.
P>MC
what is the difference in price in competitive firms and monopoly firms?
competitive firms produce Q: P=MR=MC
monopoly firms produce Q: P>MR=MC
do monopolies produce a good allocation of resources?
consumer’s standpoint: undesirable because it charges high prices
producer’s standpoint: desirable because it allows high profits
how can policy makers solve the monopoly problem?
in monopolies there is no optimal allocation of resources
policy makers’ goal: maximise social welfare
policy makers’ tools: policies (laws, regulations…)
to solve the monopoly problem:
- trying to make monopolised industries more competitive
- regulating behaviour of monopolies
- turning some private monopolies into public enterprises
- doing nothing at all
what is the welfare cost of monopolies?
less is produced and sold at higher prices than under perfect competition => the total welfare is greater under perfect competition than under monopoly
the difference between the socially optimum surplus and the surplus obtained with a monopoly is the welfare cost of the monopoly or the monopoly deadweight loss
*there is no DWL in competitive markets
what is an oligopoly?
market structure in which only a few firms offer similar or identical products e.g. beer market
where does imperfect competition lie on the spectrum and what does it involve?
most real firms:
- do compete (not monopolies)
- are not price takes, they have some market power (not perfect competition)
imperfection competition lies in the middle consisting of monopolistic competition and oligopoly
what are realistic market structures?
somewhere in between perfect competition and monopoly: facing competition but not so high to make them price takes -> imperfect competition
what is monopolistic competition?
market structure in which many firms sell similar (not identical) products e.g. books/restaurants
