Monopolies Flashcards
What is a monopoly and what are its key features(3)?
Monopoly (in the strictest sense of the term) has 3 key features:
1. There is 1 firm in the industry
2. There are barriers to entry that prevent other firms from entering the market (EoS, legal barriers etc.)
3. The monopolist is a short run profit maximiser
In reality, we talk about firms having “monopoly power”, where their market share is so large that they can effectively act as if they are a monopoly. In a legal sense this can occur from a market share of 25%
What do the revenue costs look like in a monopoly?
As there is 1 firm in the market, the market demand curve is also the monopolists demand curve. As D curve is the AR curve, this means the monopolist faces a downward sloping AR curve. The MR curve starts at the same point on the y axis as AR, however it falls twice as quickly/has double the gradient.
The logic to this is that to increase sales, the firm must reduce the price, however they don’t get just a lower price from the last customer but also from all the previous customers, thus MR falls by more than AR
As MR is the gradient of TR, we can see that TR rises at a slowing rate, peaks at MR=0, then falls at an increasing rate (upside down parabola, peaks at MR=0).
MR<0: increasing Q leads to increasing TR => D is elastic
MR>0: increasing Q leads to decreasing TR => D is inelastic
MR=0: increasing Q leads to no change in TR => D is unitary
What does the monopoly diagram look like?
Diagram:
The Monopoly Model
Qπmax at MC=MR, to determine the price, go up to AR.
Supernormal profit if AC
How efficient is a monopoly?
Monopolies are neither productively nor allocatively efficient
What is a natural monopoly?
Natural monopoly - where economies of scale are so large (relative to demand) that even one firm will not be able to achieve the full economies of scale and reach MES. This tends to occur in industries with massive fixed costs, such as the railway industry or water supplies
Diagram:
LRAC below AR
or
EoS diagram showing 2 firms way above MES and 1 firm closer
What could be the alternative objectives of a firm operating in a monopoly?
A monopolist may not profit maximise in SR, particularly if the market is not a pure monopoly but one dominated by a firm with a large market share.
The most common alternative objective is to grow market share. Market share can be measured in 2 ways, by revenue or by volume of sales, hence we say a firm may TR max or Sales max.
TR max is where MR=0
Sales max can be at a price of 0 or below, but that would not be sustainable. Instead we say that Sales max is where the firm only makes normal profit.
AR=AC
Satisficing - operating at a quantity between profit max and TR max. This happens when there is a divorce of ownership and control.
What is a divorce of ownership and control?
Divorce of ownership and control is when the owners of the firm have different objectives from managers/directors.
The owners (shareholders) may want to profit maximise (to maximise their divedends), however they have little say in how the firm is actually run on a day-to-day basis.
The managers/directors often prefer market share as an objective, there is prestige in running the ‘largest’ company, their bonuses may be linked to market share and growth may give the business a degree of long term security.
However although the directors run the business they are still answerable to/appointed by the shareholders, so need to consider their views.
This is not always the case! For example managers’ bonuses can be tied to profits, not market share, or managers may be shareholders themselves as well.
Similarly, shareholders can gain from rising share prices, and these tend to rise when a firm’s long term prospects look good, in other words when its market share is rising.
In LR both owners and directors want to maximise profits. Differences may only be in SR, with owners more interested in current profit and directors in LR profit (future).
In ‘not for profit’ businesses there is less likely to be a conflict as they might agree on social objective.
In recent years there has been a rise in “shareholder activism”.
What is price discrimination and what are the conditions(4) for it?
Price discrimination is where a business charges different prices to different customers. The firm must face the same costs in providing the product, if it charges different prices because it faces different marginal costs this is “price differentiation”.
Conditions for price discrimination:
- Firm must be a price setter (not a price taker)
- They must be able to easily separate the markets (by age, time, income)
- The buyers in the different markets must have different PEDs
- The firm must be able to prevent the resale of the product (arbitrage)
The basic idea is that there is one set of cost curves for the total output of the firm but then two separate AR/MR curves for each submarket. This means that while the AC & MC are the same, the profit maximising quantity and so the price charges will be different. In the less elastic market price will be higher than ‘single price’ while in the more elastic market price is lower. (Use 3 diagrams to show this, marking the MC and AC on the ‘single market’ diagram and then carrying the lines onto the other two diagrams, where the AR and MR curves will be different.)
Who gains(4) and who loses(1) from price discrimination?
Winners:
- The firms: in the less elastic market they gain by charging a higher price bit only losing a few customers. In the more elastic market they gain by charging a lower price, but gain a lot of customers.
- Customers: in the elastic market customers pay a lower price and have a higher consumer surplus. In addition some wouldn’t even have bought the good at a single price, but now they do.
- Possibly the product can only be produced with price discrimination.
- The extra profits may be used for R&D and consumers will gain
Losers:
- Customers: in the less elastic market they pay a higher price and lose consumer surplus.
Why are monopolies considered bad?(4)
- Monopolies are inefficient
A monopoly is neither productively (min AC) nor allocatively (MC=AR) efficient, whereas perfect competition is both in LR.
2. Monopolies lead to a net welfare loss In a monopoly a firm operates at MC=MR. In a perfectly competitive market each firm operates at the allocatively efficient point and makes normal profit in the LR. This means the whole market is at the allocatively efficient/normal profit point. Diagram: Monopoly diagram but with a simplifying assumption that MC=AC and is a straight line. Two points are marked on the diagram: the monopoly equilibrium and the competition equilibrium. The top triangle is divided into 3 sections, A, B, C. In perfect competition: - no supernormal profit - consumer surplus = ABC => Total benefit = ABC In a monopoly: - supernormal profit = B - consumer surplus = A => Total benefit = AB So C is the bet welfare loss (deadweight loss) in a monopoly
- X-Inefficiency is possible with monopolies
X-Inefficiency is “organisational slack” - where a firm ‘wastes’ money. A monopolist is often ‘safe’ and making large supernormal profit, so there is less of an incentive to keep costs low/avoid wastage. On a graph, x-inefficiency is operating at an AC above the AC curve - Monopolies are often low quality/poor choice
Why can monopolies be good?(2)
- Supernormal profit may benefit consumers
The possibility of supernormal profit means that the firms may be willing to invest in R&D/new innovations (e.g. drugs/patents). They also provide the funds for future investment, which can mean lower AC/prices in LR and/or even more products. In this way monopolies may be more “dynamically efficient” than competition. - Economies of Scale may allow a monopolist to charge a lower price than perfect competition
If EoS are huge and then a monopolist will have lower LRAC and be able to charge a lower price than perfect competition and still make supernormal profit. This is most likely to occur in a natural monopoly, where even 1 firm with 100% market share cannot exploit all possible EoS (e.g. water supply). Use either a diagram with high AC/MC that don’t cross (AC had not crossed MC yet as even 1 firm with 100% market share can not exploit all possible EoS), or a diagram with the simplified assumption of AC=MC but with two cost curves, the huger for competition and lower for monopoly, or the EoS LRAC curve, showing competition high up the curve and monopoly near MES.
