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Chapter 13: Monopoly, How to regulate a natural monopoly:
Marginal cost…
Chapter 13: Monopoly
A market with a single firm that produces a good or service for which no close substitutes exists and that is protected by a barrier of entry to other firms
i.e other firms can't sell that good or service
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Monopolies are constantly under attack from new products and ideas that substitute for products produced by monopolies.
e.g When email was introduced, it weakened the SA Post Office monopoly
-a new monopoly can be created from a new product
Barriers to entry
Natural barriers to entry:
•create a natural monopoly - market in which economies of scale enable one firm to supply the entire market at the lowest possible cost compared to other firms in the same market. e.g firms that deliver water and electricity are natural monopolies
Ownership barrier to entry:
•occurs if one firm owns a significant portion of a key resource
e.g De Beers controlling 90% of suppply of diamonds in 1800s
Legal barrier to entry
•create a legal monopoly - market in which competition and entry are restricted by the granting of a public franchise, government license, patent or copyright
•Firms in a monopoly are not price takers, they are price setters.
•the demand curve for a firm is the market demand curve as there is only one firm
•DEMAND IS ALWAYS ELASTIC IN A MONOPOLY
i.e a monopoly will never produce an output in the inelastic range of mkt. demand curve
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Rent seeking
•Surplus = economic rent
•Pursuit of wealth through capturing economic rent = rent seeking
•Monopoly redistributes consumer surplus to producer surplus (profit)
•So, pursuit of monopoly profit = rent seeking •Monopolists engage in rent seeking in two ways: •Buy a monopoly
•Create a monopoly
Rent-seeking Equilibrium
•No barrier to entry into rent seeking
•Rent seeking is like perfect competition •Competition among rent seekers pushes up ATC •Rent seeker makes zero economic profit •Deadweight loss is larger by amount of lost producer surplus
How to regulate a natural monopoly:
Marginal cost pricing rule:
Regulate a firm to set its price = marginal costRate of return regulation
a firm must justify its price by showing that its return on capital doesn't exceed a specified target rate
-not commonly used as it gives firms an incentive to inflate costsPrice cap regulation
a regulation that is a price ceiling. Specifies the highest price the firm is permitted to set
- gives firms an incentive to operate efficiently and keep costs under control
If marginal revenue is positive, total revenue is increasing!
if marginal revenue is negative, total revenue is decreasing!