PC and Monopoly

Question 1

What is the spectrum of market structures?

Answer 1

Perfect Competition (infinite number of companies)
Imperfect Competition1/Monopolistic Competition
Imperfect Competition2/Oligopoly
Monopoly (single company)

Question 2

What are the characteristics of Perfect Competition?

Answer 2

Many buyers and sellers
Homogenous products
Perfect information
Free entry and free exit
Individual firms are price takers

Question 3

Does PC exist? Give examples

Answer 3

Not really in real world but shows the effects of extreme competition
Very similar: wheat, oats, milk, large markets (Grand Bazaar)

Question 4

How do a firm operating in PC maximise profits?

Answer 4

Select output which maximises the difference between total revenue and total costs (abnormal profits)
Easier to do a marginal analysis MC=MR

Question 5

What is the profit maximising rule?

Answer 5

If MR>MC profits rise if output is expanded, TR is increased greater than total costs
If MR

Question 6

What profits are generated in PC SR?

Answer 6

Abnormal profits because demand is greater than average costs, so the total cost per unit is less than the price received

Question 7

What happens with PC SR production and costs?

Answer 7

SR firm can make losses as well as abnormal profits
Losses when TC>TR
The extent of losses the firm face are limited
Costs incurred whether production goes ahead or not

Question 8

When should firms shut down?

Answer 8

When the average variable costs cannot be covered, loss is only extent of fixed costs - because it is indifferent if it produces or not, running or not it loses the fixed costs

Question 9

What is the difference between SR and LR in PC?

Answer 9

In the short run it can earn abnormal profits
But this makes the market attractive
There are no barriers to entry, so new firms set up production
Industry capacity increases, shifting out the industry supply curve
Price received by each firm falls
The firms compete away individual firm profitability
Long run - only normal profits (if losses are made in the SR firms will leave competing away losses, only making normal profits in the long run

Question 10

What is productively efficient?

Answer 10

technologically efficient, all economic of scale - production at the bottom of AC

Question 11

What is allocatively efficient?

Answer 11

correct amounts from societies point of view, balancing society’s marginal benefit with marginal cost they pay - price equals MC

Question 12

What are the characteristics of Monopoly?

Answer 12

Single firm supplies the entire market
No close substitutes
Very large barriers to entry
Monopolists are price makers e.g. water suppliers (monopoly in each area), national grid

Question 13

How does the monopoly demand curve show gain and loss?

Answer 13

Down the demand curve loss gets bigger as price decreases

Question 14

How is the MR curve related to TR curve?

Answer 14

Slope of TR is the MR curve

When MR is zero TR is maximised

Question 15

What is Marginal Revenue?

Answer 15

The change in total revenue that results from one-unit increase in quantity

Question 16

Why is TR maximised at MR=0?

Answer 16

As price decreases MR also decreases so there is less additional revenue and it reaches a peak, then when MR becomes negative TR decreases at a greater rate

Question 17

Is monopoly diagram different in the long run?

Answer 17

No changes, no force to cause changes because there are no competing firms

Question 18

What are the differences between PC and monopoly?

Answer 18

in PC equilibrium where industry demand = industry supplied
Monopoly is the industry so monopoly demand = industry demand
in PC MC = SR supply curve
Monopoly firms MC curve = sum of all PC MC curves so = market supply
PC MC=MR equilibrium where supply = demand
Monopoly produces Q at MC=MR but sets price higher at the point on demand curve

Question 19

What are the outcomes of monopolistic market structures?

Answer 19

Higher prices
lower levels of production
(probably) abnormal profit
redistribution of welfare from consumers to the monopolist - consumers lose out due to higher price/ lower production (lower consumer surplus) and monopolist gains via abnormal profits (producer surplus)

Question 20

Is monopoly desirable?

Answer 20

Consumers pay more + consume less than PC efficiency concerns
- not allocatively efficient as price not equal to MC
- not productively efficient as don’t produce at bottom of LRAC
PC is society’s preferred market structure

Question 21

What is consumer surplus?

Answer 21

Total amount in excess of the market place that consumers would have been willing to pay to get the good

Question 22

What is producer surplus?

Answer 22

Total amount of revenue in excess of the marginal costs of production that firms get at the market price (roughly equivalent to excess profits)

Question 23

How does producer surplus change from monopoly to PC?

Answer 23

There is a loss from the money previously received not now generated (MR=MC not demand)
There is an increase by additional sales under PC prices above what the firm was willing to receive

Question 24

How does consumer surplus change from monopoly to PC?

Answer 24

Increase by difference they have to pay versus what they were willing to pay
Increase as more units of production at lower price than they were willing (would pay higher)

Question 25

What does the deadweight loss in monopoly measure? and what do governments do?

Answer 25

How much worse off people are paying the monopoly price than the competitive price, hence governments want to promote market rivalry to enhance overall welfare (SURPLUS)

Question 26

What are the two ways in which governments encourage rivalry?

Answer 26

Monitoring business conduct:
- have active bodies that seek out abuses of monopoly power (e.g. competition and markets authority in UK)
- look for anti-competitvite conduct like excess pricing, predatory pricing or collusive practises
- they have the power to require changes, fine firms, or even break-up firms that have been found to have been operating “against the public interest”
Merger Policy:
- the competition and markets authority can investigate mergers
- can require competition remedies or even prevent them taking place e.g. RyanAir didn’t take AerLingus
- prevent very concentrated market structures from emerging

Question 27

Is there a downside to rivalry? (benefits of concentrated structures)

Answer 27

• excess profit can lead to increase innovation and provide resources and rewards to incentivise
• degree of monopoly profits necessary to encourage firms to invest in developing new products/ production processes
• most governments participate in establishing patent systems to allow a limited pay off to innovation by awarding an absolute barrier to entry to the innovator