Flashcards in Monopoly Deck (12)
When does a pure monopoly exist?
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
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)
Profit Maximization for the Monopolist
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)
The Steps for Profit Maximization for the Monopolist
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*
Economic Wastes of Monopoly
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"
Why do economists hate monopolies?
Because they are NOT allocatively efficient because P>MC.
Economic Wastes of Monopolies 1 (Dead Weight Loss)
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
Economic Wastes of Monopolies 2 (X-Ineffiency)
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.
Economic Wastes of Monopolies 3 (Rent Seeking)
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.
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
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
1) Type of product (food)
2) Theme and decor are different
3) Price is different
4) Service is different
5) Location is different