Monopoly and Monopolistic Competition (Monopoly (What is it? (How does a…
Monopoly and Monopolistic Competition
What is it?
A monopoly is a firm that is the sole seller of a product without close substitutes.
The fundamental cause of monopoly is barriers to entry
A monopoly remains the only seller in its market because other firms cannot enter the market and compete with it.
How does a monopoly arise?
A single firm to own a key resource
In practice, monopoly resources are rare
Government created monopolies
The government has given one person or firm the exclusive right to sell some good or service.
a single firm can supply a good or service to an entire market at a lower cost than could two or more firms.
Monopoly versus competition
How does a monopoly firm make price and output decisions?
A monopoly’s marginal revenue
When a monopoly increases the quantity it sells, this has two effects on total revenue (P × Q):
The output effect
more output is sold, so Q is higher, which tends to increase total revenue.
The price effect
the price falls, so P is lower, which tends to decrease total revenue.
A monopolist’s marginal revenue is always less than the price of its good.
Profit maximisation for a monopoly
To maximise profit, a monopolist produce at where marginal revenue (MR) = marginal cost (MC) (true for all firms!)
If MR > MC, the extra revenue from selling one more unit exceeds the extra cost. The firm should increase output to increase profit.
If MR < MC, the extra revenue from selling one more unit is less than the extra cost. The firm should decrease output to increase profit
If MR = MC economic profit is maximised.
A monopoly’s profit
How do its decisions affect economic welfare?
The welfare cost of monopoly
There is a welfare cost of monopoly because a monopolist produces less than the socially efficient quantity of output.
The welfare cost is measured by the deadweight loss.
A monopolist’s profit is not in itself necessarily a problem for society. It is a part of the total surplus.
If a monopoly firm has to incur additional costs to maintain its monopoly position, e.g., lobbying to maintain its monopoly position, then these costs are a part of the welfare cost of monopoly
Why do monopolies try to price discriminate?
Price discrimination is the business practice of selling the same good at different prices to different customers.
A price-discriminating monopolist charges each customer a price closer to his or her willingness to pay than is possible with a single price.
Consequences of price discrimination
Price discrimination increases the monopolist’s profit and raise economic welfare.
The increase in welfare shows up as higher producer surplus rather than higher consumer surplus.
Lower prices for children, students and senior citizens
Lower price for a ticket with less flexible conditions, such as limits on the ability to change flights or cancel the booking at the last minute; suitable for passengers travelling for personal reasons.
cheaper than the well-known brands, attractive to customers who are simply interested in buying the cheapest product available.
Lower prices to customers who buy large quantities,
A customer’s willingness to pay for an additional unit declines as the customer buys more units.
What is it?
Attributes of monopolistic competition
E.g., CDs, films, computer games, restaurants, piano lessons, furniture, etc.
Each firm produces a product that is slightly different from those of other firms, and each firm faces a downward-sloping demand curve.
Free entry or exit
Firms can enter or exit the market without restriction.
The number of firms in the market adjusts until economic profits are zero.
Monopolistic competitors in the short run
Because of product differentiation, each firm faces a downward sloping demand curve.
The profit-maximising quantity is at where MR = MC.
makes a profit if P> ATC
Makes a loss if P<ATC
The long-run equilibrium
When firms are making profits, new firms enter the market.
Entry increases the number of products and, therefore, reduces the demand faced by each firm already in the market.
Conversely, when firms are making losses, firms in the market have an incentive to exit.
Customers have fewer products from which to choose, which expands the demand faced by those firms that remain in the market.
Compare the outcome under monopolistic and under perfect competition
Compared with perfect competition, monopolistic competition has
Firms produce on the downward sloping portion of their average total cost curves.
Output is lower than the efficient scale
a price mark-up
Price exceeds marginal cost
an extra unit sold at the posted price means more profit for the firm
Welfare effects of monopolistic competition
Deadweight loss of monopoly pricing:
caused by the mark-up of price over marginal cost.
The number of firms in the market may not be ideal
The product-variety effect:
Consumers get some consumer surplus from the introduction of a new product.
The business-stealing effect:
The entry of a new competitor takes customers away from existing firms
No easy way for public policy to improve market outcome
Inefficiencies are hard to measure and fix.
the debate about advertising and branding
The amount of advertising varies across industries
About 1-2% to total revenue for the economy as a whole
10-20% revenue for differentiated consumer goods, e.g. cereals, cosmetics.
Critics of advertising
Firms advertise in order to manipulate people’s tastes.
Creates a desire that otherwise does not exist.
Advertising impedes competition
Build brand loyalty by implying that products are more different than they truly are.
Making the demand for a particular brand less elastic so the firm can charge a higher markup.
brand names cause consumers to perceive differences that do not really exist.
Brand names are useful for consumers to ensure that the goods they are buying are of high quality.
providing information about quality when quality cannot be easily assessed beforehand
giving firms incentive to maintain high quality as firms want to maintain the reputation of their brands.
Defense of advertising
Advertising provides information to consumers
Advertising increases competition
More informed consumers likely to switch to better suppliers.
New entrants can use advertising to attract customers.
Advertising as a signal of quality
What the advertisements say is not as important as the fact that consumers know ads are expensive.
Expensive advertising will only be profitable if the product is high quality and consumers buy repeatedly.
The four types of market structure