Copyright 2002, Pearson Education Canada2 Imperfectly Competitive Industry and Market Power zAn imperfectly competitive industry is one in which single firms have some control over the price of their output. zMarket power is an imperfectly competitive firm’s ability to raise price without losing all demand for their product.
Copyright 2002, Pearson Education Canada3 Pure Monopoly zAn industry with a single firm: ythat produces a product for which there are no close substitutes, and yin which significant barriers to entry prevent other firms from entering the industry to compete for profits.
Copyright 2002, Pearson Education Canada4 Barriers to Entry zA barrier to entry is something that prevents new firms from entering and competing in imperfectly competitive industries. Examples include: ygovernment franchises are monopolies by virtue of government directive. ypatents are a barrier to entry that grant exclusive use of the patented product or process to the inventor. yeconomies of scale and other cost advantages yownership of a scarce factor of production (DeBeers)
Copyright 2002, Pearson Education Canada5 Firms with market power must decide: z How much output to produce z How to produce output z How much to demand in each input market z What price to charge for output
Copyright 2002, Pearson Education Canada6 Price and Output Decisions in Pure Monopoly Markets zBasic assumptions: yEntry to the market is strictly blocked. yFirms act to maximize profits. yThe monopolist cannot price discriminate (all buyers pay the same price)
Copyright 2002, Pearson Education Canada7 Demand in Monopoly Markets zWith only one firm in the monopoly market, there is no distinction between the firm and the industry. In a monopoly, the firm is the industry and therefore faces the industry demand curve. The total quantity supplied is what the firm decides to produce. zFor a monopolist, an increase in output involves not just producing more and selling it, but also reducing the price of its output in order to sell it.
Copyright 2002, Pearson Education Canada8 Marginal Revenue Facing a Monopolist (Table 13.1) zAt every level except one unit, the monopolist’s marginal revenue is below price. This is because to sell more output and raise total revenue the firm lowers the price for all units sold.
Copyright 2002, Pearson Education Canada9 Marginal Revenue and Total Revenue (Figure 13.4) zA monopoly’s marginal revenue curve bisects the quantity axis between the origin and the point where the demand curve hits the axis. zA monopoly’s MR curve shows the change in total revenue that results as a firm moves along the segment of the demand curve that lies exactly above it.
Copyright 2002, Pearson Education Canada10 Price and Output Choice for a Profit- Maximizing Monopolist (Figure 13.5) zThe profit-maximizing level of output for a monopolist is the one where MR = MC. zBeyond that point, where marginal cost exceeds marginal revenue, the firm would reduce its profits. zRelative to a competitively organized industry, a monopolist restricts output, charges higher prices, and earns economic profits.
Copyright 2002, Pearson Education Canada11 Price and Output Choice for a Monopolist Suffering Losses in the Short Run (Figure 13.6) zIt is possible for a profit-maximizing monopolist to suffer losses in the short run. zAt 10,000 units variable costs are covered but the business will fail in the long run.
Copyright 2002, Pearson Education Canada12 Comparison of Monopoly and Perfectly Competitive Outcomes (Figure 13.8) zQuantity produced by the monopoly will be less than the competitive level of output, and the monopoly price will be higher. zRemember that the MC curve is also the supply curve for the entire industry.
Copyright 2002, Pearson Education Canada13 Welfare Loss of Monopoly (Figure 13.9) zThe triangle ABC roughly measures the net social gain from moving to 4000 units under perfect competition or the social loss that results when monopoly decreases output to 2000 units.
Copyright 2002, Pearson Education Canada14 Collusion zCollusion is the act of working with other producers in an effort to limit competition and increase joint profits. zSuccessful collusion leads to the same market outcome as the monopoly.
Copyright 2002, Pearson Education Canada15 Rent-Seeking Behaviour zRent-seeking behaviour refers to actions taken by households or firms to preserve extranormal profits. zThis includes actions such as government lobbying and has two important implications: yit comsumes resources without producing social value ycan lead to government failure
Copyright 2002, Pearson Education Canada16 Government Failure and Public Choice Theory zGovernment failure occurs when the government becomes the tool of the rent seeker and the allocation of resources is made even less efficiently by the intervention of government. zPublic choice theory is an economic theory that proceeds on the assumption that the public officials who set economic policies and regulate the players, act in their own self-interest, just as firms do.
Copyright 2002, Pearson Education Canada17 Natural Monopoly zA natural monopoly occurs in an industry that realizes such large economies of scale in producing its product that single-firm production of that good or service is the most efficient. zEconomies of scale must be realized at a scale that is close to total demand in the market.
Copyright 2002, Pearson Education Canada18 Natural Monopoly (Figure 13.10) zAverage cost declines until a single firm is producing nearly the entire amount demanded in the market. zWith one firm producing 500,000 units the average cost is $1 and when five firms each produce 100,000 units the average cost is $5.
Copyright 2002, Pearson Education Canada19 Regulating a Natural Monopoly zAcknowledging a single firm as a natural monopoly and allowing it to operate under the protection of a government franchise essentially requires that the government becomes involved in regulating the firm.
Copyright 2002, Pearson Education Canada20 Regulating a Natural Monopoly (cont.) zGovernments have three possibilities in regulating a natural monopoly: yset the price equal to marginal cost in which case the monopolist will always suffer a loss yset a price ceiling which is a maximum price per unit above which the producer of a good or service cannot legally charge yuse average-cost pricing where the price is set to cover the average cost per unit including a fair return
Copyright 2002, Pearson Education Canada21 The Problem of Regulating a Monopoly (Figure 13.11) zAn unregulated monopolist produces where MC = MR, at 400,000 units. zIf prices were set at MC the firm would always suffer a loss. zA compromise would be to set prices at $0.75 which covers costs and allows a normal profit rate.
Copyright 2002, Pearson Education Canada22 Market Power in Input Markets: Monopsony zMonopsony is a market in which there is only one buyer for a good or service. zAn example is the market for labour in a one company town. zMarginal factor cost is the additional cost of using one more unit of a given factor of production.
Copyright 2002, Pearson Education Canada23 Monopsony vs. Perfect Competition in a Labour Market (Figure 13.12) zFor a monopsonist the marginal cost of hiring one more worker is higher than the wage rate, since the firm increases all wages to attract the new worker. zThe monopsonist only hires up to the point where MRP L = MFC. zWages are held below MRP L and less labour is hired than under perfect competition.