Monopoly Flashcards
Why do monopolies arise?
Arise because of barrier to entry
What kinds of barriers to entry are there?
- Technical Barriers
- Possess some ownserhip of special knowledge or low cost production methods
- May own a unique resource
- Natural Monopolies
- Legal Barriers
- Legal protection provided by a patent
- Exclusive franchise or license
What are natural monopolies?
- If production of a good exhibits decreasing AC over wide range of output: IRTS, large scale firms will be more efficient
- Usually have some high fixed/set up cost
What is the operation of a monopoly?
- Set Q where MC = MR
- Face downward sloping demand curve with MR twice as steep
What is supply for a monopoly?
Equilibrium position changes as demand changes, therefore there is no supply curve but rather a supply decision
What is true of a monopolies profit?
- +π can persist because of barrier to entry
- π not guaranteed though
- Monopolist doens’t operate at minimum efficient scale (minATC)
What is wrong with a monopoly?
- Produce too little
* Higher prices than perf comp: redistribution of wealth
How can a monopoly lead to a redistribution of wealth?
- Redistribution of wealth relative to perf comp
- Consumer surplus is transferred to monopoly profits
What is the size of market power?
Ability of the firm to set P > MC
What does the degree of market power depend on and what does this imply?
- Depends on demand curve shape
- Elastic: limited market power
- Inelastic: more market power
- MC = MR( = p(1 + 1/E))
- P/MC = (1/(1-(1/|e|)))
- No other factors involved in degree of market power
- Implies that there are some monopolies with very little market power
What is the Lerner Index?
- (P-MC)/P
- (P-MC): Markup
- (P-MC)/P = 1/|e|
- Therefore, 0 ≤L.I. ≤ 1
- 0: no power
- 1: complete power
What is first degree price discrimination and what are the results?
- Each individual consumer pays their own maximum willingness to pay
- Ends up producing the efficient level of output: productively efficient
- CS: 0
- IF AC=MC LONG RUN NO FC then CBQe0 is their costs
- PS: ABC = π if no FC
What is second degree price discrimination and what is required of it?
- May be able to seperate consumers into 2 or more groups - charge each group a different amount: geography, age etc
- Requires limits on arbitrage
What is third degree price discrimination?
- aka non-linear pricing
- Allows consumers to self select themselves into different groups
- Seeing different amounts of a good for different prices (changing average per unit cost)
- Version 1: Two Part Pricing
- Version 2: Quantity Discount LECTURE 29 NOTES
What is two part pricing and it’s consequences?
- Entry fee + per unit price
- DWL disappears
What defines natural monopolies?
- Decreasing average costs over high quantities of output
- Not efficient to increase the number of firms - can’t increase competition, must regulate price
Broadly how can a natural monopoly be regulated?
- Price Regulation
* Rate of Return Regulation
What options are there for price regulation of a natural monopoly?
- MC Pricing
- ATC Pricing
- Two Tier Pricing System
What is MC pricing?
- P = MC is thought to be the best way to get the efficient level of output (Q*) and no DWL
- If regulated so that Pr = MC, monopoly will take PR (where MC=MB(D)), set = MC and produce Qr
- ATC > Pr, Loss incurred
- To maintain viability of production, monopoly will have to be subsidised
What is ATC pricing?
- Firm produces where MB(D) = ATC
- 0π, some DWL, higher quantity produced than Qm but lower than under MC pricing
What is a two tier pricing system in regards to regulating monopolies?
Monopoly price profits to subsidise MC pricing
What is rate of return regulation?
- Allow monopolies to recoup the opportunity cost of their capital investments
- Can change a price > MC and allows them to earn a ‘fair’ rate of return on investment
- Gives an incentive to overcapitalise
What is the Lerner/Elasticity Relationship?
(P-MC)/P = 1/|e|
