MONOPOLIES
Single seller (pure monopoly) – industry with only one dominant company Cartel agreement – group of producers who enter a collusive agreement to restrict output in order to raise prices and profits Concentration ratio – degree of measuring monopoly in industry: percentage of output from largest firms (above 60%)
High barriers of entry and exit ◦ Legal barriers – patents, copyrights, trademarks ◦ State control over industry ◦ Economies of scale – firm is producing large quantities that other firms cannot compete with ◦ Natural monopolies: only enough economies of scale available in the market to support one firm ◦ Brand loyalty ◦ Anti-competitive behaviour ◦ Sunk costs Producer sovereignty Form of market failure (forces of supply and demand do not control the market) Monopsony: one buyer/few large buyers (such as the government)
Price Discrimination Q1Q1 P1P1 D1D1 MR 0 MC -Units of products that cost the same to produce are sold for different prices to different consumers -One condition for price discrimination is that the supplier must have some monopoly power -Gas, electricity, telephone services, rail travel Consumer Surplus
Large economies of scale (more output and lower prices) Research and development – leads to new products Purchasing Economies Specialization Technical Economies
Charge at higher prices and produce at lower outputs Absence of competition – inefficiency Control supply and don’t control demand ◦ Quantity sold determined by demand curve ◦ Still have greatest producer sovereignty
Demand curve in a monopolistic market structure is the demand curve of the whole industry Monopolist has to reduce price to sell more of the product (downward sloping demand curve) Price-maker: can change price by alternating supply
Monopoly: Price and Marginal Revenue (-) (+) Q1Q1 Q2Q2 P1P1 P2P2 D1D1 -To sell one more unit, the monopolist has to lower the price from P 1 to P 2 -Marginal Revenue = 1 x P 2, which is less than P 1 : this explains that MR < P -Loss of revenue on 0Q 1 for each unit sold -Marginal Revenue = 1 x (P 2 – 0Q 1 ) x fall in price MR 0
Price Effect D A B MR Quantity demanded Price P Q1Q2 P1 P2 C Q3 Quantity Effect Total Revenue Quantity of airport goods/services demanded Quantity effect dominates price effect Price effect dominates quantity effect TR Quantity Demanded
Monopoly: Marginal Cost Q1Q1 P1P1 D1D1 MR 0 MC -Since MR will always be less than D, and the monopolist will want to produce where MC=MR, MC < D. -Since the MC curve is below demand, this indicates that the industry can expand
Supernormal Profit P1P1 D=AR MR MC 0 AC SNP -The firm will produce at PQ and will earn a total revenue of P x Q. Whatever is below the AC curve will cover both accounting costs and accounting profits, and whatever is above the AC curve and below the demand curve will be the firm’s SNP. -This shows resource allocation inefficiency. Q
Monopoly Profit Monopoly Profit D MC Price Quantity P CS Deadweight loss MR Deadweight loss (loss of mutually beneficial transactions that could have occurred had a monopoly not dominated the industry) and little consumer surplus
Argues that it is the threat of competition rather than actual competition which determines a monopoly’s price and output. Monopoly’s are aware of other potential competition when they are making too much SNP, so in theory, they lower their prices to make the market unattractive to potential rivals resulting in more efficient production
If a firm is under the impression that a market is perfectly contestable, it will lower its price to P 2. With low prices, efficiency, and the possibility of improvement, another firm will not be able to enter and take over the market P1P1 D=AR 0 LRAC SNP Q Q1Q1 P2P2
Normal Profit P1P1 D=AR MR MC 0 AC Q -The firm will continue to produce at P x Q, but here TR = total profit, so the firm only makes normal profit, allowing it to continue business. -There is more efficiency at this stage
Loss P1P1 D=AR MR MC 0 AC Q -Firm would not produce here because it would always be making losses (AC>AR)