Monopoly and High Barriers to Entry
- Defining Monopoly
- Monopoly is a market structure characterized by:
- High Barriers to Entry
- A Single seller of a well-defined product for which there are no close substitutes.
- Three Factors are particularly important in creating high barriers to entry:
- Legal Barriers
- Patents--Government grants an exclusive right to use a specific process or produce a specific product for a period of time.
- License--Process by which one obtains permission from the government to enter a specific occupation or business.
- Legal Prohibition
- Economies of Scale--if per unit costs decline as the scale of the firm increases, then small scale firms will effectively be prevented from entering the industry.
- Control over Essential Resource--If a single firm has control over an essential resource it can eliminate competition by denying competitors access to the resource. This effectively limits entry into an industry.
- The Monopoly Model
- Marginal Revenue is Less than Selling Price
For the monopolist, market demand and firm demand are the same. This occurs because the monopolist is the only seller of the product; he or she must lower the sales price if additional sales are wanted (provided market demand is downward sloping).
Example: Take the following demand curve for Beers/Day
- The marginal revenue curve of the monopolist will lie inside the firms demand curve.
- Like the pure competitor, the monopolist will expand output until marginal revenue equals marginal cost. The price it charges will be determined by the market demand curve.
- A monopolist is not assured of making economic profits.
- Price Discrimination
Price discrimination is a practice whereby a seller charges different prices to different consumers of the same product or service. The difference in price is unrelated to differences in cost.
- For price discrimination of exist, three conditions must be met:
- The firm must confront a downward sloping demand curve for its product. (Seller need not be a pure monopolist to price discriminate.)
- There must be at least 2 identifiable groups of consumers whose price elasticities of demand for the firm's product differ.
- The seller must be able to prevent the consumer from reselling the product to other consumers.
- Winners and Losers
- Output will be higher with price discrimination than it would be without it.
- It tends to reduce allocative inefficiency.
- Because it increases the profits of the monopolist, it may enable a monopolist to remain in business.
- Problems of Monopoly
- Since Adam Smith's time (1776) monopoly has been considered a necessary evil. There are several reasons for this.
- Monopoly tends to limit options available to consumers.
- Monopoly results in allocative inefficiency--in other words, the monopoly price is higher than the marginal cost of production.
- Profits do not encourage entry into the industry. Hence, monopoly firms are not subject to the usual discipline inherent in competitive industries.
- When the government grants monopoly, rent seeking is encouraged.
- When can monopoly be made competitive?
- When economies of scale are unimportant a monopolized industry can be broken up and economic efficiency increased.
- In the absence of natural monopoly, competitive firms produce more and charge lower prices.
- If Economies of Scale ARE Important, larger firms will have lower unit costs than smaller firms.
- Policy Alternatives to Natural Monopoly
- It may be possible to regulate the monopolist in order to increase economic efficiency.
- Average Cost Pricing--Force monopolist to charge a price equal to ATC (productive efficiency)
- Marginal Cost Pricing--Force monopolist to charge a price equal to MC (Allocative efficiency). Requires a subsidy since monopolist incurs losses under this strategy.
- Why regulation goes astray.
- Lack of information--regulators have difficulty in determining what prices to impose. They don't know what the firm's costs are or what the demand for the product is.
- Cost shifting--little incentive for managers to contain costs under so-called "fair rate of return" regulation. Firms have an incentive to conceal costs from the regulators and to take profits in disguised forms.
- During inflations or periods of price instability, price information is inaccurate.
- Quality may suffer (or be too high).
- Special interest effect
- Government managed firm
- Decision-makers have little incentive to control costs.
- Mangers and employees of the bureaucracy often comprise a special interest group.
- Dynamic Change, Monopoly Power, and Resource Allocation
- Even the monopolist is not completely free from competitive forces. Charging exorbitant prices will encourage the development of substitutes.
- Monopolists may actually charge prices that are below those consistent with short-run profit maximization in order to discourage entry into the industry.
- The expectation of being able to form a monopoly may encourage product development.
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This page was last modified Tuesday, February 25, 1997.