Transcript Evaluating Monopoly - uwcmaastricht-econ

Evaluating Monopoly
Comparison with Perfect
Competition
Market outcomes and efficiency
1.
2.
Higher price and lower output compared to the PC
industry. Fig. 7.14
Impacts on surpluses (Fig. 7.15):



Consumer surplus smaller than in PC due to the higher
price charged by the monopoly and the lower quantity
produced.
Larger producer surplus, taking away a portion of CS.
Deadweight loss, i.e., the loss of total surplus due to a
higher price and lower quantity.
3.
Allocative inefficiency

4.
Productive inefficiency

5.
At the profit maximizing level of output: P>MC, which
means that some consumers place a greater value on the
production of the good than what it costs the monopolist
to produce it → allocative inefficiency and misallocation of
resources.
At the profit maximizing level of output, the average cost
is larger thanm in ATC → productive inefficiency.
Lack of competition may give rise to higher costs.


Entry barriers make monopolist less concerned about
keeping costs as low as possible.
X-inefficiency takes place when producing at a higher than
necessary ATC. Different from productive inefficiency.

Lack of productive efficienty means that the firm
does not produce at the minATC, but it does
produce at some point on the ATC curve. Xinefficiency indicates that the costs are higher than
ATC.
Costs > ATC
(X-inefficiency)
ATC > minimum ATC
c
o
s
t
s
ATC
(prod. inefficiency)
minimum ATC
(prod. efficiency)
Q
Why a Monopoly may be desirable
1.
Economies of scale.
If the monopolist succeeds in achieving significant
economies of scale, so that its costs fall, shifting
the MC curve downwards, then its price and
output levels may approach those of PC.
 Consumers can gain from ES: lower costs → lower
prices and larger quantity of output.
 Society also benefits: lower costs → resources used
more efficiently.

2.
Product development and technological
innovation. Some factors suggest that
monopolies have good reasons to pursue
innovation:
Economic profits allow financing large R&D
projects.
 Protection from competition allows the
monopolist to enjoy the profits arising from their
innovative activities (this is the rationale behind
patent protection).
 Firms may use product development and
technological innovation as a means of creating
barriers to entry for new potential rivals.

3.
Possibility of greater efficiency and lower
prices due to technological innovations.

If monopolies successfully engage in R&D that
leads to technological innovations, they may adopt
production processes and new technologies that
can make them more efficient. Lower costs may be
passed to consumers in the form of lower prices.
Monopoly power and government
regulation


Economists agree in that the disadvantages of
monopolies (absence of competition, higher prices,
lower quantity of output, productive and allocative
inefficiencies, higher than necessary costs, negative
impacts on income distribution) outweigh its
advantages.
Most countries do not encourage private monopolies.
In the event of natural monopolies, these are owned or
regulated by the governments, so that the interests of
society are protected.
‘Monopoly power’ (the ability of a firm to set
prices) applies not only to monopoly, but also to
oligopoly. Oligopolistic firms sometimes act
together (collude) in order to acquire greater
monopoly power. If they succeed, they end up
acting as a monopoly.
 Legislation to reduce monopoly power applies
also to firms that try to behave like monopolies.

Legislation to reduce monopoly power.
Forms
1.

Legislation to protect competition
Most countries have laws that try to promote
competition by preventing collusion between
oligopolistic firms for the purpose of
restricting competition between them, as well
as preventing anti-competitive behaviour by a
single firm that dominates a market.
The objective is to achieve a greater degree of
allocative efficiency, by preventing monopolistic
behaviour by a firm or group of firms. Example:
Microsoft.
 Firms that are found guilty are usually asked to
pay fines or may be broken up into smaller
firms.


Difficulties with competition policies:
Interpretation of the legislation in connection with
the behaviour of the firms. a) determine which
actions constitute competitive behaviour (different
views are possible); b) laws might be vague.
2. Some gov may be stricter than others when
enforcing laws, depending on their priorities or
their political and ideological views.
3. Difficulty in finding evidence of the collusion and
proving it, as collusion occurs secretly, as it is
illegal.
1.
Legislation in the case of mergers.
A merger is an agreement between two or more
firms to join together and become a single
firm. Reasons may be: capturing economies of
scale, growing, acquiring monopoly power.
2.

The single firm created from the merging may be
very large and have too much monopoly power.
Legislation involves limits on the size of the
combined firms.

Difficulties:
a.
b.
c.
What firms should be allowed and what firms should
not
Interpretation of the legislation
Ideological differences among gov on the desirability or
not of a high degree of monopoly power.
Regulation of natural monopoly


Not in the interest of society to break up a
natural monopoly into smaller firms, as this
would result in higher average costs.
Gov usually regulate natural monopolies to
ensure more socially desirable price and
quantity outcomes.
1.
Marginal cost pricing.
That is, forcing the monopoly to charge a price
equal to marginal cost and thus achieving allocative
efficiency.
 It always leads to losses for the natural monopolist,
making it impractical. As long as the D curve cuts
the ATC curve to the left of the min ATC, it is not
possible for the MC curve to cut the D curve at a
point above ATC.

P
MC
ATC
Pm
Pac
Pmc
D=AR
Qm
Qac
MR
Qmc
Q
1.
Average cost pricing (P=ATC).
The price is determined by the intersection of the
D curve with the ATC curve.
 Also known as fair return pricing because the
monopolist is forced to earn normal profit.
 Productive efficiency is not achieved.
 Advantages:

1.
2.
monopolist earns normal profit and is not in danger of
shutting down.
more efficient than the market solution.

Disadvantages:
1.
2.
monopolist loses incentive to keeps its costs down as he
is guaranteed a price equal to its average costs.
The regulated monopoly may stop being a natural
monopoly (if technological improvements change cost
conditons) and still survive as a monopoly. Continued
regulation provides protection to the firm from new
(more efficient) competitors.
Monopoly compared with perfect
competition
1.
2.
3.
4.
Price and output
Efficiency
R&D
Economies of scale
1.
2.
Price and Output: higher price and smaller
quantity than perfect competition.
Efficiency.
Monopolies fail to achieve both productive and
allocative efficiency. Also: it may lead to Xinefficiency. Firms in PC achieve efficiency and are
less likely to display X-inefficiency due to
continuous pressure to lower their costs.
b) However, innovations in new technology may lower
costs of production, leading to increased
efficiencies.
a)
3.
R&D.
Firms in PC unlikely to engage in R&D due to lack
of funds, lack of incentive to develop new
products/differentiation and unable to create
barriers to entry.
b) Monopolies have the needed resources to engage in
R&D as well as the incentives. But high barriers to
entry could make them less likely to innovate than
smaller firms (in monopolistic competition) due to
lack of competition.
a)
4.
Economies of scale
No possibility for PC firms.
b) Monopolies more likely to take advantage of
economies of scale and may use these to create a
barrier to entry. However, they also offer the
advantage of lower average costs and lower prices
as well as greater quantities for consumers, and
could approach those achieved in PC.
a)