Monopoly

A monopoly

A market where one firm dominates the market for a good that has no substitutes and where significant barriers to entry exist.

There is only one seller (price maker)

The product is unique, there are no substitutes

There are very high barriers to entry into and exit (high setting up cost) from the market

Firms outside the market will lack perfect information

Barriers to entry

A range of obstacles that deter or prevent new firms from entering a market to compete with existing firms. (so, there is no difference between short-run and long-run)

High fixed cost or setup cost

Advertising and brand names with a high degree of consumer loyalty

Economic of scale

Patent

The pace of product innovation

Collaboration between existing producers to develop new products may act as a barrier

Profit-maximising monopolist would choose the output where MC = MR.

If the total revenue is higher than the production costs, it will make abnormal profit. This will be a permanent feature.

In monopoly, there is no distinction between the short run and the long run because of the barriers that prevent the entry of competitors.

There is no economic incentive for the monopolist to move away from the profit-maximizing output Q

Natural monopoly

A firm that has economies of scale so large that it is possible for the single firm alone to supply the entire market at a lower average cost than two or more firms. It occurs in a market where the lowest costs can be achieved when only one firm sells to the market. It is typically associated with large fixed start-up costs.

If the market demand for a product is within the range of falling LRATC, this means that a single large firm can produce for the entire market at a lower average total cost than two or more smaller firms. When this occurs, the firm is called a natural monopoly.

If new firm B enter the market, the market demand will be divided by firm A and B. Thus, the demand curve for firm A will be shifted leftward.

Outcomes of monopoly

Higher price and lower output

Allocative inefficiency (MC is not equal to AR, loss of consumer and producer surplus)

Productive inefficiency (production at higher than minimum ATC) a. Lack of competition in monopoly may lead to higher cost (X-inefficiency: producing at higher than necessary ATC) due to poor management, a poorly motivated workforce, lack of innovation and use of new technologies.

Policies:

Legislation (government can force the firm to charge a price equal to its average total cost)

Regulation

To promote competition by preventing collusion between oligopolistic firms.

To manage and control mergers

To ensure more socially desirable price and quantity outcomes

DIS

The laws themselves may be vague, allowing much room for different interpretations

Laws in particular country may be enforced to varying degrees.

It is difficult to discover evidence of the collusion and to prove it

Nationalization (State ownership)

Trade liberalization (introduce foreign competitors)

Privatization (Encourage competition)

Situations which government should NOT control the monopoly power

Natural monopolies (some are state-owned & do not aim to maximize profit)

Ability to achieve economies of scale may lead to lower unit cost and price than a competitive industry

Monopoly profits as a source of funds for investment / research & development

They need to keep innovating to maintain economic profit

Protect intellectual property right

Protection of strategic industries against foreign competition

Provision of otherwise profitable goods through price discrimination

Situations which government should control the monopoly power

Abuse of monopoly power: higher price and lower output

Less choice for consumers

Abnormal profits are not justified

Lack of competition: leads to lower incentive to improve & to innovate

Allocative & productive inefficiency & misallocation of resources

Evaluation of monopoly compare to perfect competition market

Advantages:

Ability to finance R&D

Possibility of substantial Eos

Disadvantages:

Higher price & lower output

Lack of allocative & productive efficiency

Lack of competition