Monopoly

Question 1

When does a pure monopoly exist?

Answer 1

1) One seller in the market for some commodity or service and there are NO close substitutes
2) Seller has considerable control over the price. A monopolist is a price maker or a price searcher.
3) There are barriers to entry which protect the monopolist from potential competitors

Question 2

Entry Barriers

Answer 2

1) ECONOMIES OF SALE
- Imply that large firms have a per unit cost advantage (NATURAL MONOPOLY)
2) PATENTS and COPYRIGHTS
- Legal barrier created by the government.

Patent: initial developers of product have exclusive control over that product fro the time period of the patent.

3) EXLUSIVE CONTORL OVER A NECESSARY INPUT
- Example: Accoa (produced bauxite, controlled aluminum, the government ruled that they had to split up)
4) PUBLIC FRANCHISES
- Government gives exclusive rights to a single firm
5) STRATEGIC BARRIERS
- Monopolist creates or heightens entry barriers
- Excess capacity (buy a bunch of equipment you don’t need to scare those who want to enter)
- Excess advertising

Question 3

Profit Maximization for the Monopolist

Answer 3

Firm chooses the Q where MR=MC

To get the price, you go through the MR=MC intersection until you meet with the DEMAND curve (Profit is the square between the point that it meets the Demand curve, and the ATC curve)

Question 4

The Steps for Profit Maximization for the Monopolist

Answer 4

1) Find the output where MR=MC. This output is the profit max output. CALL IT Q*
2) At Q, get the value of the price by going up to the demand curve. PRICE IS P
3) At the quantity, Q*, get the value of AVC. Check the SHUT DOWN RULE.

(If P* AVC, the firm produces Q*)

4) Find the ATC associated with Q*
5) Calculate the maximum profits

Profit=(P* - ATC) Q*

Question 5

Economic Wastes of Monopoly

Answer 5

Note: While most economists favour monopolies, JOSEPH SCHUMPETER had a different opinion

He states that firm of all, entry barriers are not a serious problem

They can be circumvented by technological change

Monopoly profits induce innovation

“Monopoly is the most powerful engine of progress and in particular the long run expansion of total output”

Question 6

Why do economists hate monopolies?

Answer 6

Because they are NOT allocatively efficient because P>MC.

Question 7

Economic Wastes of Monopolies 1 (Dead Weight Loss)

Answer 7

DEAD WEIGHT LOSS

The loss of allocative efficiency caused by a monopolist producing less than the socially efficient level of quantity. (Much of this comes from the work of Arthur Herberger)

Most economists agree on the problem of dead weight loss, the others are more controversial

Question 8

Economic Wastes of Monopolies 2 (X-Ineffiency)

Answer 8

X-INEFFIENCY (From the works of Harvey Leibenstein)

Monopolists are wasteful since they have no competition to keep them cost efficient. The result is that the monopolists ATC may be higher than the lowest possible cost.

Why would a monopolist allow costs to rise?

Answer is managers may have goals such as corporate growth, an easier work life, avoidance of business risk or giving jobs to incompetent relatives. Or a firm may simply become lethargic and insert since the firm is sheltered from competitive forces.

Question 9

Economic Wastes of Monopolies 3 (Rent Seeking)

Answer 9

RENT SEEKING (From the work of Gordon Tullock)

The monopolists profit box will draw other firms to the industry. The monopolist, then, will spend part (or most) of that box making sure entrants do not enter this market.

Entrants will spend resources attempting to get part o the monopoly profits.

Thus, profit box could represent a lower bound of waste to society generated by the monopolist using resources to maintain the monopoly and entrants using resources trying to attain the profit box.

Question 10

Policy

Answer 10

1. CONTROL THEIR BEHAVIOUR

Competition Act (In Canada)

• 1986, and amended in 1999
• Replaces the COMBINES INVESTIGATION ACT (1910)
• Does not make monopolies illegal
• However, it prohibits certain acts
• Mergers must be approved by the government
• Government prohibits actions like predatory pricing (Gov can press charges)
• Price fixing, resale price maintenance, exclusive dealing

(CIA is a criminal act, actions are illegal if they “unduly” lessen competition.)

2. PRICE REGULATION

i) FIRST BENEFIT SOLUTION
- Force monopolists to charge competitive price and produce the competitive quantity

(But there are 2 problems…

1) INFO PROBLEMS: regulators does not know MC, the firm has an incentive to misrepresent the MC.

2) Possible that the competitive position results in profit 0
- Fair rate of return pricing

Question 11

Monopolistic Competition

Answer 11

1) There are many firms
2) Easy entry and exit
3) Firms compete by selling similar but differentiated products

For a monopolistically competitive firm, its demand curve is less elastic than a perfectly competitive firms but more elastic than the demand curve of a Monopolist

Ex. Restaurants

1) Type of product (food)
2) Theme and decor are different
3) Price is different
4) Service is different
5) Location is different

Question 12

What is a Monopsony?

Answer 12

A market where there is only one buyer

In a labour market, the buyer is a wage searcher

We know in all cases a firm chooses labour at the point where MFC L = MRP L

If the firm is a price taker in the labour market, MFC = W

With a monopsonist, MFC > W