Monopolies Flashcards
Define a monopoly
A monopoly is the sole seller of a product that does not have any close substitutes
What are three barriers to entry that could create a monopoly?
Monopoly Resources: there is only one single resource of a particular good/service - generally more related to areas than entire economies
Consider rare gems, diamonds etc
Government Regulation: governments can grant the exclusive rights/access to produce a particular good or service to one company
Governments can do this by simply granting the rights via a legal/patent system – consider Aus Registry rights to .com.au websites
The Production Process: a production process can have very high startup or fixed costs
In these instances, it may not make sense to have more than one producer – consider the telecommunications provision of landlines
This is known as natural monopolies – there are no artificial barriers in place, it is just the nature of the good
In a natural monopoly, the massive scale of the fixed costs will mean that the Average Total Cost is always decreasing, and a single company will always be operating at economies of scale
What is the key difference between a monopoly and perfect competition?
The key difference between a competitive firm and a monopoly is the monopoly’s ability to influence the price
Given that the monopoly is the only firm selling a good or service without any close substitutes, it can alter the price by adjusting how much it sells
In a monopoly, firms are PRICE MAKERS
What stops the monopolist from setting extremely high prices?
The monopolist would like to sell as much as they can at a price as high as they can
BUT they are constrained by the market demand curve
The higher the price they set, the less people will be willing to buy
On the demand curve, demand will also be average revenue
Where does marginal revenue fit into monopolies?
The marginal revenue (MR) is the additional revenue generated from selling an additional unit of the good/service
Unlike in perfect competition, for a monopolist to sell an additional unit – they have to decrease the price
Therefore, the MR curve is always decreasing as quantity increases
The MR is less than the price of the good, and thus it will sit below the demand curve
Thus, in a monopoly, the point where TOTAL REVENUE is maximised is when MR=0
How does a monopolist sell more products?
The marginal revenue curve for a monopolist always sits below market demand curve
This is due to both the quantity effect and the price effect
To sell more, firms need to decrease price and all units are sold at the lower price, meaning that marginal revenue is less than average revenue
How does a monopolist profit maximise?
A monopoly maximises profit by producing the quantity at which marginal revenue equals marginal cost
BUT it uses its market power by setting the price where the market demand curve can handle it (what the market is willing to pay)
This is how a monopolist can be defined – by their ability to set the price above the marginal cost of production
Is it possible for a monopoly to make long-run economic profits?
The free entry and exit of perfect competition means that firms cannot make long-run economic profits
The absence of competition means that monopolies CAN
Does a monopoly create a dead-weight loss?
If we cared only about maximising social welfare (total economic surplus), production would be where the value of the good or service is equal to the cost
This is when Marginal Benefit = Marginal Cost
In perfect competition, D=S, MB=MC; a situation of equilibrium that maximises the profits of firms and the surplus of society
BUT in a monopoly, firms will equal where MR = MC, but MR no longer equals MB
This means that firms will no longer be operating where surplus is maximised
What is first degree price discrimination?
There is no single price for the good that is being sold
An example of this is housing prices
Anything sold in an auction tends to look like this, because it is easier to elicit a consumer’s maximum willingness to pay
Firms will charge for every unit until marginal cost equals marginal benefit
In this case, marginal revenue curve will be equal to demand curve
Because every consumer is paying their willingness to pay, CS is zero
Producer surplus becomes the entirety of total economic surplus
Overall, this is a boon for the economy, as deadweight loss has been removed due to the increase in production
What is second degree price discrimination?
Price is based on product or purchase characteristics
There tends to be groups of prices, in particular towards bulk buying
The law of demand says that if consumers are buying less, they are willing to pay more
Consider consumer ‘nudging’ to buy more in bulk deals – it decreases the price earned by the monopolist but means that they sell more overall
What is third degree price discrimination?
Goods may be identical – this time the emphasis is on the consumer characteristics
Queensland theme parks have different prices for locals & tourists
This means that locals have a more elastic demand curve as opposed to tourists, who have a more inelastic demand curve
This results in a higher price being set for the tourists than set for the locals
The group with the more inelastic demand curve ends up with the higher price
However, this form of price discrimination requires some mechanism to identify the different groups and a form of regulation to keep the groups separated
What is average total cost price regulation?
If firms are concerned that Pm is too high, they will use ATC pricing
This will lead to firms setting the price at PA, where ATC=MB
At Pm, the firm was making a small profit
When ATC pricing is used, we remove profits from our monopoly
By moving marginal benefit closer to marginal cost, this increases economic surplus and decreases the size of the DWL due to the economy producing more
It decreases the producer surplus, but this is offset by the larger increase in consumer surplus
This has decreased the price for vulnerable groups
How do governments determine Average Total Cost?
They have to ask the companies
This can lead to distortions, as companies are unlikely to give accurate numbers
This gives firms less of an incentive to reduce production costs, as governments will accordingly reduce the price
There is no incentive for innovation or efficiency
What is marginal cost pricing regulation?
Set PMC where MC=MB/D
This results in negative economic profits for monopolies, as their price is now below their average total cost of production
This will result in monopolies having to exit the market in the long-run
The only solution is to subsidise
There is absolutely no deadweight loss under marginal cost, as the market is producing the efficient amount of the good/service
However, because governments need to subsidise, consumers need to be taxed, creating a dead-weight loss in another industry
