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Chapter 7: Market Structures - Imperfect Markets (Monopoly) Notes by…
Chapter 7: Market Structures - Imperfect Markets (Monopoly)
Notes by Gritchen (26/06/21)
Definition Monopoly:
Existence of a single seller in the market who produces goods that have no substitutes.
Characteristics:
one seller and a large number of buyers.
product does not have close substitutes
Restriction on the entry of new firm.
Barriers to entry:
refers to the restriction that prevents
other sellers from entering the market
Types of barriers:
Patent and Copyright:
Patent = an exclusive right to the production of an innovative product
-Copyright = an exclusive right to the author of the book or composer of music or producers of a movie.
valid for a limited time period
Government Franchises:
the government will give exclusive rights to a firm to sell certain goods and services in a certain area
E.g. the gov has the right to install the satellite television system to ASTRO in Malaysia.
Cost of establishing an efficient plant (Natural Monopoly):
exists when one firm can meet the entire market demand at a lower price as compared to two or more firms
E.g. Utility companies such as water, electricity & local phone services.
Monopoly versus Competition
Characteristics
Monopoly
there is one one seller who sells the product which has no close substitutes.
a price maker
Perfect competition:
there are large numbers of sellers selling a homogenous product.
a price takers
Long run equilibrium
Monopoly:
will earn a supernormal profit since there are barriers to entry for newcomers.
Perfect Competition:
earns a normal profit in the long run because of free entry and exit in the industry.
Price and quantity
Monopoly:
price charged higher
equilibrium quantity is lower
Perfect competition:
Priced charged lower
Equilibrium quantity higher.
Efficiency
Monopoly:
Reduces price to increase sales
Perfect Competition:
Sells as much or as little at same price
Demand curves
Monopoly:
Faces a downward-sloping demand curve
Perfect Competition:
Faces a horizontal demand curve
Monopoly’s Revenue
Monopoly’s Marginal Revenue:
always less than the price of its good
When a monopoly increases the amount it sells,
it has two effects on total revenue (P × Q).
The output effect—more output is sold, so Q is higher.
The price effect—price falls, so P is lower.
Profit Maximization
Functions:
maximizes profit by producing the quantity at which marginal revenue equals marginal cost.
uses the demand curve to find the price that will induce consumers to buy that quantity.
Comparing Monopoly and Competition:
For a competitive firm, price equals marginal cost.
(P = MR = MC)
For a monopoly firm, price exceeds marginal cost.
(P > MR = MC)
A Monopoly’s Profit:
Profit = TR - TC
Profit = (TR/Q - TC/Q) × Q
Profit = (P - ATC) × Q
will receive economic profits as long as price is greater than average total cost.
The Deadweight Loss:
Because a monopoly sets its price above marginal cost, it places a wedge between the consumer’s willingness to pay and the producer’s cost.
This wedge causes the quantity sold to fall short of the social optimum.
The Inefficiency of Monopoly:
The monopolist produces less than the socially efficient quantity of output.
The deadweight loss caused by a monopoly is similar to the deadweight loss caused by a tax.
the government gets the revenue from a tax, whereas a private firm gets the monopoly profit.
Price discrimination:
Selling or charging different buyers
for the same types of goods.
Conditions
Existence of monopoly:
Discrimination is possible only if a monopoly exists
and if there are no competitions
Existence of different markets for the same commodity:
The market will be divided into sub-markets among which the product cannot be exchanged.
E.g. foreign-imported cars onto which the government imposes a tariff so that domestic buyers cannot import the car at a lower price.
Existence of different degrees of elasticity of demand:
monopolists can charge higher in an inelastic market and lower prices in an elastic market.
Perfect Price Discrimination:
refers to the situation when the monopolist knows exactly the willingness to pay of each customer and can charge each customer a different price.
Effects:
It can increase the monopolist’s profits.
It can reduce deadweight loss.
Examples of Price Discrimination
Movie tickets
Airline prices
Discount coupons
Financial aid
Quantity discounts
Public Policies toward
Monopolies
Government responds to the problem of monopoly:
Making monopolized industries more competitive.
Regulating the behavior of monopolies.
Turning some private monopolies into public enterprises.
Doing nothing at all.
Prevalence of Monopolies:
Monopolies are common
Most firms have some control over their prices because of differentiated products.
Firms with substantial monopoly power are rare.
Few goods are truly unique.