T2 1.1: Monopoly Flashcards
Define a monopoly?
An industry structure where there is only one firm in the market, a monopolist
2 points on how a monopolist can set prices?
- price setter, not price taker
- price they set is constrained by the demand curve
What is a monopolists profit function?
Max(wrt y): r(y)-c(y)
What is the optimality condition?
at the optimal level of output, marginal cost (MC) equals marginal revenue (MR)
What happens to revenue if output increases?
• Sells more -> gains the price multiplied by the new units of output: pΔ𝑦
• Increasing output REDUCES the price -> loses the difference in price multiplied by the units of output that were already being sold: yΔp (with Δ𝑝 < 0)
• Unlike the competitive case, there is no gain in market share from reducing price.
tf: Δ𝑟 = pΔ𝑦 +𝑦Δ𝑝
Using Δ𝑟 = pΔ𝑦 +𝑦Δ𝑝, what is marginal revenue?
Δ𝑟/Δ𝑦 = pΔ𝑦/Δ𝑦 + 𝑦Δ𝑝/Δ𝑦 = 𝑝+𝑦Δ𝑝/Δ𝑦
What is PED?
A measure of the responsiveness of demand for a good when its price changes
See my notes and show i can prove optimality condition in term of elasticity
NOW
Where will a monopolist operate in terms of demand elasticity?
They will operate only where demand is elastic tf absolute value of it>1
What is the markup price and how is it determined?
Firms set output so MC=MR, then charge the maximum possible price for that output level
How do we know a monopolist will always charge a price above MC?
Since they operate where absolute value of elasticity is greater than 1, tf 1/value is less than one; using equation in notes for markup, we see that must be tf greater than 1 so when multiplied by MC for price, shows price also must be greater than MC
See diagram
Bottom of my notes p1
Where is the profit maximising output level? (see diagram)
The profit maximising output level is found where the mark-up adjusted MC curve crosses the demand curve.
What is the Lerner index?
An index measuring the degree of a firm’s monopoly power
Prove the lerner index is equal to 1/|ε(y)|
see slides
What determine a firms level of monopoly power?
The smaller the PED (less elastic) at the profit maximising output, the greater the markup and tf the larger the firm’s degree of monopoly power
What will the makeup of a market with elastic demand be?
Elastic demand results in smaller markup and tf less monopoly power
Define economic efficiency?
Where no change in output can be made that improves the welfare for anyone without being at the expense of others (eg. perfect competition)
Explain, using a diagram, why perfectly competitive markets are efficient?
See notes:
All potential surplus is being exploited tf market is efficient
Explain, using a diagram, why monopoly markets aren’t efficient?
Monopolies charge prices above the efficient level and produce output below the efficient level tf producers gain and consumers lose out. (SEE DIAGRAM) CS is reduced by A, PS is reduced by B, tf DWL=A+B (see slide 33)
What is a pareto improvement?
An action that makes no one worse off and makes at least one person better off
Why doesn’t the monopolist increase its output (charging for an extra unit where P>MC)?
Because the monopolist would have to lower the price on all the existing units of output they produce. These units are “inframarginal” units of output.
When do natural monopolies occur?
When the efficiency condition P=MC means providing an output level that isn’t profitable, but is socially preferable
Often when FIXED COSTS are high and MC are small (eg. gas mains system)
Draw a diagram showing a natural monopoly when using MC pricing and explain?
See notes for diagram. It shows the AC minima is to the right of the demand curve, tf P=MC is below average cost tf production is not at competitive equilibrium
What is the solution to the pricing problem faced by natural monopolies? Use a diagram to explain
(see notes for diagram)
Use average cost pricing; price and quantity are determined by the intersection of the AC curve and the demand curve. Regulators view as a fair way to regulate behaviour of NM, since price falls above p(c) and below p(m)
Problem with average cost pricing?
Due to poor governance/corruption, problems can arise when determining how much p’ should be above p(c)
Another solution to natural monopoly problem?
Nationalise the natural monopoly, charge P=MC and use public money to subsidise losses
3 causes of monopoly and explained?
1) Market structure (high MES relative to demand) (see slide 41!!!)
2) Historical dominance (if a firm has always dominated it may be natural for them to continue dominating)
3) Law (legal monopolies enshrined by patents)
4 cases where a monopoly market is acceptable?
1) Natural monopolies
2) Patents (providing a ST monopoly -> increase in R&D and investment)
3) When duplication is wasteful (eg. railway tracks)
4) Economies of Scale - when a monopoly charging with SNP is still cheaper than a PC market
6 types of monopoly?
CNELGP Cartels Natural monopoly driven by market structure Economic monopoly Legal/technical monopoly Geographical monopoly Platform monopoly
What is a cartel monopoly?
When powerful firms conspire to reduce output and increase price
What is a natural monopoly driven by market structure?
Only 1 firm can be sustained in market
What is an economic monopoly?
Arises due to economies of scale and tf huge efficiency of the producer and tf unmatchable low prices (entry deterrent)
What is a geographical monopoly?
Geographical restrictions can give ordinary firms monopoly power (eg. petrol station on a motorway)
What is a platform monopoly (and examples)?
When a platform connects users together, tf as more members join its usefulness increases (eg. Uber, Amazon, Facebook)
Huge amounts of data gives these firms market power, despite them not tending to sell output
See
Regulate? • Economics of data privacy • Can consumers really opt out of engaging with Platform Monopolies? • Google chooses to enter markets that generate new data (e.g. Alexa)
Let them be? • The promise of years of monopoly rents provides a powerful incentive to innovate. The profits monopolies can bring allow bold long-term plans and ambitious research projects that “firms locked in competition can’t dream of”. (Guardian, 2017) • Difficult challenges to regulation – international companies; how to regulate the internet.
Draw diagram showing a tax on a monopoly, assuming constant MC?
See notes
With linear demand, how much of the tax is passed on to the consumer? Prove it. Also see notes on rest of stuff
1/2
see proof and notes
Note about monopolist regarding MC and budget constraint/demand curve
Unlike under perfect competition, the monopolist does not need to set price equal to marginal cost. However, the monopolist is still constrained by the Demand Curve.
