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Evaluating Monopoly. Comparison with Perfect Competition. Market outcomes and efficiency. Higher price and lower output compared to the PC industry. Fig. 7.14 Impacts on surpluses (Fig. 7.15):

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Evaluating monopoly

Evaluating Monopoly

Comparison with Perfect Competition


Market outcomes and efficiency
Market outcomes and efficiency

  • Higher price and lower output compared to the PC industry. Fig. 7.14

  • Impacts on surpluses (Fig. 7.15):

    • Consumer surplussmaller 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.


  • Allocative inefficiency

    • 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.

  • Productive inefficiency

    • 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.


costs

Costs > ATC

(X-inefficiency)

ATC

ATC > minimum ATC

(prod. inefficiency)

minimum ATC

(prod. efficiency)

Q


Why a monopoly may be desirable
Why a Monopoly may be desirable produce at the minATC, but it does produce at some point on the ATC curve. X-inefficiency indicates that the costs are higher than ATC.

  • 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.


  • 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.


  • 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
Monopoly power and government regulation technological innovations.

  • 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
Legislation to reduce monopoly power. Forms 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 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.



  • Difficulties with competition policies: efficiency, by preventing monopolistic behaviour by a firm or group of firms. Example: Microsoft.

    • 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.

    • Some gov may be stricter than others when enforcing laws, depending on their priorities or their political and ideological views.

    • Difficulty in finding evidence of the collusion and proving it, as collusion occurs secretly, as it is illegal.


  • Legislation in the case of mergers. efficiency, by preventing monopolistic behaviour by a firm or group of firms. Example: Microsoft.

    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.

    • 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: efficiency, by preventing monopolistic behaviour by a firm or group of firms. Example: Microsoft.

    • 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
Regulation of natural monopoly efficiency, by preventing monopolistic behaviour by a firm or group of firms. Example: Microsoft.

  • 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.


  • Marginal cost pricing. efficiency, by preventing monopolistic behaviour by a firm or group of firms. Example: Microsoft.

    • 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 efficiency, by preventing monopolistic behaviour by a firm or group of firms. Example: Microsoft.

MC

ATC

Pm

Pac

Pmc

D=AR

Qm

Qac

Qmc

Q

MR


  • Average cost pricing (P=ATC). efficiency, by preventing monopolistic behaviour by a firm or group of firms. Example: Microsoft.

    • 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:

      • monopolist earns normal profit and is not in danger of shutting down.

      • more efficient than the market solution.


  • Disadvantages: efficiency, by preventing monopolistic behaviour by a firm or group of firms. Example: Microsoft.

    • 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
Monopoly compared with perfect competition efficiency, by preventing monopolistic behaviour by a firm or group of firms. Example: Microsoft.

  • Price and output

  • Efficiency

  • R&D

  • Economies of scale


  • 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 X-inefficiency. Firms in PC achieve efficiency and are less likely to display X-inefficiency due to continuous pressure to lower their costs.

    • However, innovations in new technology may lower costs of production, leading to increased efficiencies.


  • R&D. perfect competition.

    • 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.

    • 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.


  • Economies of scale perfect competition.

    • No possibility for PC firms.

    • 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.


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