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Monopoly power for Managerial Economics Mcom Delhi University


Monopoly power for Managerial Economics Mcom Delhi University

Monopoly power for Managerial Economics Mcom Delhi University

Monopoly Market Mono means single, poly means seller and hence monopoly is a market structure where only one sells the goods and many buyers buy the same. Monopoly lies at the opposite extreme from perfect competition on the market structure continuum. A firm produces the entire supply of a particular good or service that has no close substitute.

Characteristic Features:

1. A single seller in the market

2. There are no close substitutes

3. There is a restriction for the entry and exit for the firms in the market

4. Imperfect dissemination of information

This does not mean that the monopoly firms are large in size. For example a doctor who has a clinic in a village has no other competitor in the village but in the town there may be more doctors. Therefore the barrier to the entry is due to economies of scale, economies of scope, cost complementarities, patents and other legal barriers.

Monopolistic competition: When there are many firms and consumers, just as in perfect competition; however, each firm produces a product that is slightly different from the products produced by the other firms.

◮ There are no barriers to entry.

Monopoly: Markets with a single seller

◮ Barriers to entry prevent competitors from entering the market.

Oligopoly: Markets with a few sellers ◮

There are significant barriers to entry

PRICING AND OUTPUT DECISIONS IN MONOPOLY

Marginal revenue

◮ Unlike perfect competition, MR is less than price and depends on Q.

◮ MR = P[1 + (1/η)] = P[1 − (1/|η|)] = P − P/|η|

PRICING AND OUTPUT DECISIONS IN MONOPOLY

MR = P[1 + (1/η)] = P[1 − (1/|η|)] = P − P/|η| (Continued)

◮ A profit-maximizing monopolist will not produce where demand is inelastic; that is, where |η| < 1, because MR < 0.

◮ MC = MR = P[1 − (1/|η|)]; so the profit-maximizing price is

MC = P[1 − ( 1 /|η| )]or P = MC [1−( 1/|η| )]

Monopolists produce less, price higher than firms in competitive equilibrium

MR = P(1 + 1/η) = MC

-Situation is inefficient, insofar as the sum of consumer and producer surplus is concerned

  • Producer surplus = difference b/w marginal cost and price
  • Consumer surplus = difference b/w willingness to pay and price
  • Total welfare = producer surplus + consumer surplus

-Monopolist has to take demand conditions explicitly into account

Monopoly and market power

Market Power: monopolist’s ability to profitably raise price above a certain competitive level (=marginal cost).

Impact of market power on social welfare:

◮ Allocative efficiency:

⋆ effect on welfare if market power is exerted

◮ Productive efficiency:

⋆ effect on welfare if market power is exerted by a technologically inefficient firm

◮ Dynamic efficiency

⋆ the incentive to generate new technologies (innovation)

⋆ incentive to invest in R&D

Monopoly power for Managerial Economics Mcom Delhi University

Sources of monopoly power

  • Natural monopoly (public utilities best example, railway tracks), economies of scale,
  • Capital requirements on production or big sunk costs on entry
  • Patents (17 years), trade secrets (Coke) Exclusive or unique assets (minerals, talent)
  • Locational advantage (popcorn shop in cinema – but in general you pay rent for these advantages)
  • Bad regulation (TV, taxi, telephone in the past) Collusion by competitors

Monopoly power for Managerial Economics Mcom Delhi University

Regulation of (Natural) Monopolies

1.Natural monopoly, market is not large enough for two firms

  • high fixed costs and low marginal costs, eg. railway tracks
  • firm wants to set monopoly price to maximize profits
  • regulator wants to set marginal cost price plus subsidy for fixed costs (monopolist would not produce otherwise

2.previous regulation: rate-of-return (RoR) regulation or price cap

  • cost structure not known to regulator, cost-reducing technology not known
  • RoR: costs and capital intensity will be too high, because return is guaranteed
  • price cap: cost will be reduced or quality falls

3.JEAN TIROLE, Swedish Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2014 for Studies on Market Power and Regulation

4.Suggests to offer mononopolists a menu of potential contracts – such that the firm reveals its cost information

Monopoly power for Managerial Economics Mcom Delhi University

Other aspects of monopoly

“Natural monopoly” if minimum of average cost occurs only at very high output level (minimum efficient scale) ⇒ there is only place for one firm in the market!

Measure of monopoly power (markup of price over cost):

markup = P−MC /MC

Monopoly power for Managerial Economics Mcom Delhi University

Difference Between Perfect And Monopoly Market:

1. Perfect market is unrealistic in practical life. But slowly certain commodities are moving towards it. Monopoly market exists in real time. 99

2. Under perfect market only homogenous products are sold but on the other hand monopoly market deals with different products.

3. Under perfect competition, price is determined by demand and supply of the market. But in monopoly the seller determines the price of the good.

4. Monopolist can control the market price but in perfect competition the sellers have no control over the market price.

5. There is no advertisement cost in perfect market. In other markets it is essential and it is included in the cost of production and is reflected in the price.

6. Monopolist sell their products higher than the perfect competitors except when there is government regulation or adverse public opinion.

Monopoly power for Managerial Economics Mcom Delhi University

Recommended Mcom Notes

M. Com. (Part-I)

M. Com. (Part-II)

Monopoly power for Managerial Economics Mcom Delhi University

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