Monopoly

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9. MONOPOLY

The focus today’s lecture is the examination of how price and output is determined in a monopoly market. Pure monopoly is a single firm producing a product for which there are no close substitutes. It is important for us to understand pure monopoly since this form of economic activity accounts for a large share of output and it provides us with an insight into the more realistic market structure of monopolistic competition and oligopoly. It is characterised by: • a single seller producing a product with no close substitutes. The firm and the industry are the same. The product is unique - there is no close substitute for it. You either buy the product or go without. • effective barriers to entry into the market (legal, technological, economic). These barriers block new firms from entering the industry, blocking potential competition. • the firm is a price maker; faces a downward sloping demand curve for its product (this demand curve is the market demand curve). The firm has considerable control over price since it controls the quantity supplied and can cause price to change by varying the amount supplied. • effective barriers to entry

One special type of monopoly is a natural monopoly, a monopoly that arises because of the existence of economies of scale over the entire relevant range of output and competition is impractical, e.g., water, electricity. These industries are usually given exclusive rights by the government, with the proviso that government regulates the operations to prevent abuses of monopoly power. A larger firm will always be able to produce output at a lower cost than could a smaller firm. The pressure of competition in such an industry would result in a long-run equilibrium in which only a single firm can survive (since the largest firm can produce at a lower cost and can charge a price that is less than the ATC of smaller firms). Natural monopolies have low MC and it is to their advantage to expand output.

Barriers to entry

The absence of competition in an industry is due largely to barriers to entry. Barriers to entry may take different forms: 1. economies of scale: costs – efficient, low cost producers are usually large firms operating under conditions of economies of scale, where AC falls over a range of output. 2. Legal barriers: Patents and Licences - government creates legal barriers in giving patents and licences. Patents: this is the exclusive right to control a product for a number of years, protecting the inventor from rival competitors who did not spend any money and time in its development. Licences: the issuing of licences by the government limits entry into an industry. 3. ownership of critical raw materials: a firm that owns a critical raw material can block the creation of rival firms. 4. unfair competition – rivals may be eliminated and the entry blocked by aggressive, cut-throat tactics such as pressure on resource suppliers and banks to withhold materials and credit, aggressive price cutting designed to bankrupt competitors. Unfair competition is illegal or borders on illegality. Under conditions of economies of scale, large firms can produce output at a lower cost than can smaller firms. Assume that the ATC curve of all firms in the industry is ATCo; however, one firm has become larger than the others, thereby producing at a lower ATC. This larger firm can sell its output at a lower price (at P') at which point smaller firms will experience economic losses. At Po, smaller firms would receive zero economic profit. At P' the larger firm will receive zero economic profit, but smaller firms would receive economic losses and so leave the industry or merge with others. This situation will continue until only one large firm remains. This gives us a “natural monopoly”.

A large firm can operate as a regulated monopoly in which the government regulated the prices that could be charged for product/services. [pic]
A firm may acquire...
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