Week 6 - Pricing With Market Power 1 Flashcards
Characteristics of a Monopoly Market
1) Single Seller = High Concentration (100%)
2) No close substitute = Product is Unique
3) Must be barriers to entry (competition is restricted by mechanisms)
Examples of Legal Barriers to Entry
- Exclusive right over a goods production (patent, copyright)
- Public franchise (Australian Post); Government licences (Taxis, practice of medicine)
Why are there monopolies?
Natural Barriers to Entry:
- Control over an essential input not available to other firms
- Monopolist might simply have a lower cost of production that effectively allows them to prevent other firms from entering the market
- Technology/level of demand makes one producer more efficient than a number of producers
What is a Natural Monopoly
Results from a situation where a single firm can supply an entire market at a lower cost than 2+ firms could supply at the market
Examples of a Natural Monopoly
Telecommunications network, electricity transmission, tap water provision
What implies a natural monopoly?
Declining LR ATCs:
- Substantial economies of scale (a ‘natural’ barrier to entry)
- Often large capital costs (infrastructure), with now low supply MCs
Characteristics of Monopoly Market (Price searcher or Price Maker)
1) Only one seller = monopolist can decide price of their products to maximise profit
2) Demand curve for a monopoly firm is the same as demand curve for market since 1 seller
3) Monopolist is price maker, hence demand curve is downward sloping (market curve)
Describe the Market Power of a Monopolist
1) Firm with a low price elasticity of demand for its output can raise price and not lose all customers
2) Can raise prices above level existing in perfectly competitive industry and not lose all customers
Total Profits is
TR - TC
How does changing quantity impact price
- q increases by 1 unit = price falls by same amount
- q decreases by 1 unit = price increases by same amount
What causes a trade-off for a monopolist
Selling less q for a higher p or selling more q for a lower p
MR incorporating effects
Output and Price Effect
What is the Output Effect?
As you sell more units, you obtain extra revenue from additional units sold
What is the Price Effect?
As you sell more units, price falls and you lose revenue on the existing units sold
Impact of the MR effects
MR is not the same as P, MR < P
Impact of profit greatest (Qb) where difference between TR and TC is greatest
Profits are maximised when a monopolist sets MR = MC
Why are profits maximised for a monopolist when MR = MC
If MR > MC, monopolist can increase profit by selling one extra unit
If MR < MC, profit falls from selling last product, so better off not selling that unit
Compare profit maximisation for competitive and monopolist firms
Competitive, P = MR = MC
Monopolist, P > MR = MC
Impact on Elasticity on Demand and MR Curves
1) When Demand = Elastic:
- Small decrease in price leads to a large increase in quantity demanded, TR increases = MR is positive
2) When Demand = Inelastic:
- Small decrease in price leads to small increase in quantity demanded, TR decreases = MR is negative
What will a profit maximising monopolist never do
Produce at an output in the inelastic range of its demand curve
How to derive the MR Curve?
dTR/dQ, for TR = p * q
What can we determine once we know the profit-max output
The price to be charged (from the demand curve)
What is a summary of a Monopoly?
1) A monopolist will not charge the highest possible price (maximise profit not price)
2) Monopolist will not maximise profits per unit, but total profits, where MR = MC
3) Monopolies are not always making profit, losses are possible (sometimes weak demand or high costs)
Economic Effects of a Monopoly (assuming same cost curve and no economies of scale)
Monopolist charges a higher price (pM) and produces a smaller quantity (qM), compared to the competitive industry (pC, qC)
What is Deadweight Loss (DWL)
Surplus loss from the restriction of output (occurs as Monopolist restricts qM < q*, below the competitive level)
What is Rent Seeking Behaviour
Activity of trying to obtain a monopoly in order to order economic profit
What does Rent Seeking Behaviour Imply
A firm is willing to spend up to the monopoly profit in order to obtain a monopoly (Buying a monopoly, Creating a Monopoly, Creating Barriers to Entry)
