7/28/2019 Economics Exam Notes - Monopoly

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Why we consider PCMkt is better than Monopoly?

Monopolistic market Perfectly competitive market

Single seller Many many seller

Price maker Price taker, price set by the mkt

High barrier to entry No barrier to entry/exit

Unique products inelastic demand (no close

substitute)

Homogenous products

Large size firm Small size firm, no firm has a significant mkt

share

Aim: Maximise profit Aim: Maximise profit

Monopolistic market Perfectly competitive market

(It is seen as better mkt structure we

should aim towards)

Short run Long run

Supernormal

profit

Yes

(due to high barrier new firms

cannot enter, so no competition, a

firm makes supernormal profit in

the long run: consumers continue

to pay high price)

Yes No

(new firms enter in th

industry: consumers

are getting the

cheapest possible

goods)

Productively

efficient

(output= min

ATC)

No No Yes

Allocatively

efficient? (P=MC)

No Yes

(produce whatconsumers most

want)

Yes

(produce whatconsumers most wa

7/28/2019 Economics Exam Notes - Monopoly

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(1)Economists are opposed to monopoly because it is harmful to consumer welfare and s wel

as optimum allocation of scarce resources in an economy.

In monopolistic market structure,

The firm is very large single sellerofa product without close substitutes, so they havetremendous market power. They own/control key resources required for production and charge

higher prices.

The firm is a price maker, they can manipulate price by restricting output and thereby reduceeconomic welfare. Pricing power is greatest when demand is price inelastic.

Barriers to entry protecting monopoly power in the long run, block potential entrants from enteringa market profitably. They seek to protect the power of existing firms and maintain supernormal profits/ increase producer surplus. These barriers have the effect of making a market less contestable

(2) Price discrimination: charging different prices to different group of people for the same good orservice. Price discrimination can be beneficial for both sellers and buyers as demand conditions are

different. To practice price discrimination:

- You have to have monopoly power or some degree of control in the market

- Seller must be able to identify the customer

- Prevent arbitration or resale

e.g. Peak travel (train for London before 9am): Inelastic high price

Off peak travel (train for London after 9am): elastic lower price

Market for drug (during patent life: high after patent expires: low)

Price discrimination can be a rational strategy for a profit-maximizing monopolist.

Figure 1 shows that the firm is making supernormal profits by charging a higher price and restrict totaloutput. The high price reduce consumer surplus and create deadweight loss.

Figure 2 shows consumers pay exact value for the product, so consumer surplus is 0. Pricediscrimination can generate profits for the firm because total surplus equals to the firms profit. It alsocan raise economic welfare because deadweight loss is eliminated.

7/28/2019 Economics Exam Notes - Monopoly

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Favour of monopoly.

Natural monopoly is exists when:

Duplication of service/product would be wasteful eg two firms running the same railway route isunprofitable. one supplier can be more efficient use of recourses.

If firms fixed costs are a high proportion of total costs infrastructure e.g. railway, airport

If firm gets economies of scale from producing a large scale: that average long run cost are alwaysfalling

Results: higher output, lower price but at a loss making output: i.e. to gain the benefit of naturalmonopoly may need a subsidy.

Dynamic efficiency in monopoly: Monopoly power can be good for innovation. Supernormal profitsused to innovate and invest in production. Despite the fact that the market leadership of firms likeMicrosoft is often criticized, their investments in R&D can be beneficial to society. Technologicadevelopment will reduce costs and produce better quality cheaper products for consumers.

Oligopoly

Few large firms dominate industry and they offer similar or identical products, e.g. airlines, OPEC.

There is a high barrier to entry. Firms are price makers. Oligopoly firms collaborate to charge the

monopoly price and get monopoly profits, e.g. OPECs oil price rigidity.

Another important characteristic of an oligopoly is interdependence between firms. This can lead to

implicit and explicit collusion between the major firms in the market. In the mature oligopolistic market

firms cooperate under the tacit collusion based on price leadership and gentlemans agreement for

mutual benefit, e.g.: BP as a price leader sets the general industry price, with other firms such as

Mobile and Caltex following suit.

They engage a lot in non-price competition to increase market share e.g. mass media advertisingand marketing, gift schemes, loyalty cards/points

Immature oligopolistic market situation can lead to price war and cut-throat competition between firms

7/28/2019 Economics Exam Notes - Monopoly

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Advertising:Advertising is the paid communication of firms and organizations directed towards consumers andthe broad society.

Debate over advertising:

Advertising provides information to customers, so that customers can make better choicesAdvertising fosters competition and customers take advantage of price differences. Advertisingallows new firms to enter the market more easily.

Advertising is on the rise because of mass market and globalization dynamic. Howevereconomists generally opposed to promotional advertising. It causes the misallocation of resourcesand to drive up the price. Market is too fragmented because of advertising.

Advertising manipulates peoples tastes and foster brand loyalty that makes buyers less priceconcerned as consumers are willing to pay more for brand names.

Advertising costs passed on to buyers while promotional advertising is often not informativeproviding knowledge/information buyers already have.

7/28/2019 Economics Exam Notes - Monopoly

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Economist are opposed to monopoly on the grounds that such a market structure is harmful to

consumer welfare as well as optimum allocation of scarce resources in an economy. Explain this

statement in the light of the Commerce Commission of NZ and Australian competition and consumer

council (ACCC) of Australia rejecting the Proposal by Air NZ to sell 25 of its shares to Qantas. You

are expected to explain in detail the economic reasons for this rejection by the competition authorities

by comparing the market outcomes in a competitive market and a monopolistic market. Use an

appropriate diagram to illustrate your arguments.

Increase Market power, Merger enable them to make unnecessary high price.Monopoly can be

harmful for consumers. Prevent airlines charge monopoly price and anti competitive practice