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The economics of market power 1. Monopoly 1. Monopoly definition definition price, output & profit price, output & profit 2.The welfare effects of monopoly.

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Presentation on theme: "The economics of market power 1. Monopoly 1. Monopoly definition definition price, output & profit price, output & profit 2.The welfare effects of monopoly."— Presentation transcript:

1 The economics of market power 1. Monopoly 1. Monopoly definition definition price, output & profit price, output & profit 2.The welfare effects of monopoly 2.The welfare effects of monopoly comparison with perfect competition comparison with perfect competition 3.Competition policy 3.Competition policy

2 1. Monopoly Competitive world Competitive world high profits - new entrants high profits - new entrants losses - exits\closure losses - exits\closure prices determined by the market prices determined by the market small firms - no market power small firms - no market power Monopoly Monopoly theory: single firm = industry (100% of the market) theory: single firm = industry (100% of the market) practice: 25% or more of the market practice: 25% or more of the market

3 1. Monopoly A) The consequences of monopoly A) The consequences of monopoly price, output & profit price, output & profit Figure 1 Figure 1 Profit maximisation: MC=MR Profit maximisation: MC=MR Level of profit: AR - AC (supernormal profit) Level of profit: AR - AC (supernormal profit)

4 £ Q O MC AR QmQm MR AR a Profit maximising under monopoly

5 Barriers to entry B) Sustaining a competitive advantage B) Sustaining a competitive advantage No, or few, substitutes. Little competition No, or few, substitutes. Little competition Barriers to entry Barriers to entry (i) Economies of scale (cost advantage) (i) Economies of scale (cost advantage) (ii) Government policy e.g. patents (ii) Government policy e.g. patents (iii) Ownership of know-how (iii) Ownership of know-how technological, organisational, etc. technological, organisational, etc.

6 Barriers to entry (iv) Ownership of natural resources (iv) Ownership of natural resources oil, diamonds, etc. oil, diamonds, etc. (v) Distinctive capability e.g. being innovative (v) Distinctive capability e.g. being innovative (vi) Aggressive tactics (vi) Aggressive tactics e.g. limit pricing e.g. limit pricing …. supernormal profit in the long run …. supernormal profit in the long run

7 2. The welfare effects of monopoly Competitive market versus monopoly Competitive market versus monopoly static effects static effects see figure see figure Pm > Pc : consumer surplus, producer surplus Pm > Pc : consumer surplus, producer surplus Qm < Qp : consumers have less choice Qm < Qp : consumers have less choice deadweight loss deadweight loss costs & X-inefficiency e.g.nationalised industries costs & X-inefficiency e.g.nationalised industries

8 £ Q O MC Q1Q1 MR AR = D P1P1 Equilibrium of industry under perfect competition and monopoly: with the same MC curve

9 Dynamic effects profits - investment in R&D (large sunk costs) profits - investment in R&D (large sunk costs) large size - scale economies - lower costs - lower price large size - scale economies - lower costs - lower price Different MC curves Different MC curves

10 £ Q O Q1Q1 MR P1P1 MC monopoly Equilibrium of industry under perfect competition and monopoly: with different MC curves AR = D

11 3. Competition policy Monopoly is not always bad! Monopoly is not always bad! Government policy Government policy rules regarding the conduct of business rules regarding the conduct of business assumes: competition maximises consumer welfare assumes: competition maximises consumer welfare balance: competition versus MES balance: competition versus MES EU policy (McAleese) & UK policy EU policy (McAleese) & UK policy

12 UK Policy Competition Act (1998) Competition Act (1998) Competition Commission Competition Commission investigate mergers & acquisitions investigate mergers & acquisitions Chapter I prohibitions Chapter I prohibitions investigate agreements (written or not) which restrict or distort competition (e.g. tacit collusion) investigate agreements (written or not) which restrict or distort competition (e.g. tacit collusion) Chapter II prohibitions Chapter II prohibitions conduct of firms i.e. abuse of market power conduct of firms i.e. abuse of market power Appeals Tribunal - legal Appeals Tribunal - legal DGFT - dawn raids DGFT - dawn raids

13 Conclusion Firms strive for larger profits & market domination Firms strive for larger profits & market domination mergers & acquisitions mergers & acquisitions growth growth barriers to entry barriers to entry Market failure Market failure justifies government intervention justifies government intervention competition policy competition policy


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