Monopoly (0)

Monopoly
Market Power
In pure competition sellers are “ price takers.”

• No seller (or buyer ) has the ability to influence the market price .
  

In most markets , at least one or more of the conditions required for pure competition are violated. This gives sellers or buyers the ability to influence the market price and allocation of resources
Pure competition results in an optimal allocation or resources given the objective of an economic system to allocate resources to their highest valued uses or to allocate relative scarce resource to maximize the satisfaction of (unlimited) wants in a cultural context .
Pure competition is the ideal that is be benchmark to evaluate the performance markets.
The economic theory of

• monopolistic competitive markets,
  
• oligopoly and
  
• monopoly
  

is used to suggest the nature of problems that may exist when firms or agents have market power and are able to distort prices away from the purely competitive optimum .
The existence of market power is tied to the demand conditions the firm faces. If their product is (or can be differentiated), consumers may have a preference for one firm’s output relative to others.
A negatively sloped demand function (less than perfectly elastic) allows the firm to raise its price and not have its sales fall to zero .
In pure competition, the firms may all try to influence market demand but individual producers do not advertise their own product.

• Many agricultural markets are close to pure competition.
  
• In many cases some producers try to differentiate their products .
  

In pure competition, the firms’ outputs are homogeneous.

• If the firm has is no opportunity to differentiate their product they have no incentive to advertise and to try to influence the demand for their product.
  
• If a product can be differentiated by altering the characteristics of the good or simply by convincing the consumers that the product is different , the firm achieves market power.
  

Market power is the ability to have some control over the price of the good offered for sale .
Advertising can be used to differentiate a product or increase the demand for a product.

• The crucial factor is the demand for the firm’s output must be negatively sloped: the firm becomes a “price maker .”
  

The extent to which a firm is a price maker (i.e. has market power) is partially determined by the price elasticity of demand in the relevant price range.
Note that when the seller selects a price (price maker) the demand function determines the quantity that will be purchased .

• The conditions of entry or barriers to entry (BTE) are also important determinants of market power.
  

If there are significant BTE, a firm or firms may be able to sustain above normal profits over time because other firms are prevented from entry to capture the above normal profits.
Monopoly is the market structure that is usually associated with the greatest market power.

• The monopolist produces a good with no close substitutes (increased probability the demand is relatively inelastic) and there are barriers to entry.
  

Firms in monopolistic competition or imperfectly competitive markets are more likely to have limited market power because there are many firms with differentiated products (there are substitutes) and there is relative ease of entry and exit into the market
Market power is the ability of an agent to influence the price of a good they sell or buy and to alter the allocation of resources.
Sources of market power:

• monopoly, oligopoly, monopolistic competition
  
• monopsony, oligopsony
  
• Institutional structure ( laws , regulations customs)
  

Market Power among Sellers

• Monopoly - a single seller of a good with no close substitutes and barriers of entry.
  
• Oligopoly - a market characterized by significant barriers to entry and “a few “sellers who recognize their interdependence in the market; products may be homogeneous or differentiated.
  
• Monopolistic competition - a market with a large number of sellers and relatively free entry; each firm “differentiates” its product.
  

Other Forms of Market Power

• Monopsony - a single buyer of a resource or good.
  
• Oligopsony - a market characterized by “a few” buyers” of a resource or good.
  
• Bilateral monopoly - a market where a monopolist sells to a monopsonist.
  
• Cartel - an organization of sellers who engage in collusion to control output and price.
  

Monopoly
A monopoly

• single seller
  
• the good produced and sold has no close substitutes
  
• barriers to entry prevent others from competing
  
• in the short, run the firm can alter the price and output; the firm is a “price maker” (or “price setter ”)
  

Barriers to Entry (BTE)
Social or political institutions or economic conditions that prevent firms from entry into a market.
There are three major types of barriers to entry: economic, legal and deliberate.

• laws, regulations, patents, copyrights, trademarks, . . .
  
• location , natural ability, information, economics of scale (natural monopolies)
  

Economic Barriers:Economic barriers include economies of scale, capital requirements , cost advantages and technological superiority
Economic Barriers
Economies of scale: Monopolies are characterized by declining costs over a relatively large range of production .
Declining costs coupled with large start up costs give monopolies an advantage over would be competitors.

• Monopolies are often in a position to cut prices below a new entrant's operating costs and drive them out of the industry.
  

Further the size of the industry relative to the minimum efficient scale may limit the number of firms that can effectively compete within the industry.

• If for example the industry is large enough to support one firm of minimum efficient scale then other firms entering the industry will operate at a size that is less than MES meaning that these firms cannot produce at an average cost that is competitive with the dominant industry
  

Capital requirements:
Production processes require

• large investments of capital, or
  
• large research and development costs or
  
• substantial sunk costs limit the number of firms in an industry.
  

Large fixed costs also make it difficult for a small firm to enter an industry and expand.
Technological Superiority:
A monopoly may be better able to

• acquire,
  
• integrate
  
• use the best possible technology in producing its goods while
  
• entrants do not have the size or fiscal muscle to use the best available technology.
  

No Substitute Goods:

• A monopoly sells a good for which there is no close substitutes. The absence of substitutes makes the demand for the good relatively inelastic enabling monopolies to extract positive profits.
  

Control of Natural Resources:

• A prime source of monopoly power is the control of resources that are critical to the production of a final good.
  

Legal and Deliberate Barriers
Legal Barriers:

• Legal rights can provide opportunity to monopolize the market in a good.
  
• Intellectual property rights, including patents and copyrights, give a monopolist exclusive control over the production and selling of certain goods.
  
• Property rights may give a firm the exclusive control over the materials necessary to produce a good.
  

Deliberate Actions :
A firm wanting to monopolize a market may engage in various types of deliberate action to exclude competitors or eliminate competition. Such actions include:

• collusion,
  
• lobbying governmental authorities, and
  
• force .
  

Government - granted Monopoly
A government-granted monopoly (also called a "de jure monopoly") is a form of coercive monopoly by which a government grants exclusive privilege to a private individual or firm to be the sole provider of a good or service;

• potential competitors are excluded from the market by law, regulation , or other mechanisms of government enforcement.
  
• Copyright, patents and trademarks are examples of government-granted monopolies.
  

Barriers to Exit
In addition to barriers to entry and competition, barriers to exit may be a source of market power.
Barriers to exit are market conditions that make it difficult or expensive for a firm to leave the market.

• High liquidation costs are a primary barrier to exit.
  
• Market exit and shutdown are separate events.
  

The decision whether to shut down or operate is not affected by exit barriers.

• A firm will shut down if price falls below minimum average variable costs.
  

Natural Monopoly

• A natural monopoly is a firm which experiences increasing returns to scale over the relevant range of output.
  
• A natural monopoly occurs where the average cost of production “declines throughout the relevant range of product demand.”
  

The relevant range of product demand is where the average cost curve is below the demand curve. When this situation occurs it is always cheaper for one large firm to supply the market than multiple smaller firms.
In fact, absent government intervention such markets will naturally evolve into a monopoly.
An early market entrant who takes advantage of the cost structure and can expand rapidly can exclude smaller firms from entering and can drive or buy out other firms.
A natural monopoly suffers from the same inefficiencies as any other monopoly. A profit seeking natural monopoly will produce where marginal revenue equals marginal costs.

• Regulation of natural monopolies is problematic.
  
• Breaking up such monopolies is counter productive
  

The most frequently used methods dealing with natural monopolies is government regulations and public ownership.

• Government regulation generally consists of regulatory commissions charged with the principal duty of setting prices.
  
• To reduce prices and increase output regulators often use average cost pricing.
  

Under average cost pricing the price and quantity are determined by the intersection of the average cost curve and the demand curve.

• This pricing scheme eliminates any positive economic profits since price equals average cost.
  
• Average cost pricing in not perfect . Regulators must estimate average costs.
  

Firms have a reduced incentive to lower costs. And regulation of this type has not been limited to natural monopolies
Market Power
When a firm faces a negatively sloped demand function for their product, they can raise the price above MC and reduce output
Buyers are willing to purchase a good so long as marginal benefits are equal to or greater than the price, they buy until MB =P

• MB = P > MC; The benefits of the last unit sold exceed the costs of producing that unit.
  

Demand and Marginal Revenue

• The demand and AR are the same thing.
  
• MR is the change in TR associated with a change in quantity sold.
  

A marginal value is less than the average, the average is decreasing. On a graph , when the AR is decreasing, MR must be below the AR.
When a demand function is negatively sloped it is the same as AR decreasing. Therefore , in the absence of price discrimination, MR will lie below the Demand function.