Transcript
Market Structures: Monopoly
Week 8
Barriers to Entry The Long run
Barriers to entry: imply that a monopolist can still earn supernormal profits in the long run
Define: Barriers to entry: Anything that
prevents or impedes the entry of firms into an industry thereby limiting the amount of competition faced by the existing firm
Forms of barriers to entry Economies of Scale
Large scale of production leads to lower costs of production
Natural Monopoly The case of a natural
monopoly Arises when the level of the
quantity demanded only allows a single firm to benefit from economies of scale.
LRAC
D2D1
Natural Monopoly
R
O Q
Two firms sharing the market will both make less than normal profit.
a
b
A monopoly can make supernormal profits between a and b.
Barriers to entry Economies of Scope
A firm producing a variety of products is likely to experience lower production costs
Product differentiation and brand loyalty
Ownership of, and control over wholesale or retail outlets
Legal protection Patents Licences
Aggressive tactics Price wars Massive advertising campaigns Attractive after sales service
Limit Pricing
Limit pricing – monopolist charges a price below the short run profit-maximising level in order to deter new entrants. Barriers to entry of new firms are not
total
Very large supernormal profits attracts new potential entrants
The monopolist deliberately keeps its price down thereby restricting profits
This is done in order to discourage new entrants
Limit pricing
AC new entrant
AC monopolist
R
O Q
P
L
Limit pricing
Provided price is kept below the limit price (PL), new firms
cannot make a profit.
Monopoly and public interest Disadvantages of a
monopolist Higher price and lower
output than under perfect competition
Allocatively inefficient : P>MC
X-inefficiency There is no pressure on profit
margins hence cost control becomes lax
Overstaffing Spending on prestigious
buildings and equipment that do not enhance productivity
Advantages of a monopoly
Economies of scale due to larger plant
R
Q O
MC ( = supply)perfect competition
Q1
MR
P1
P2
Q2
MCmonopoly
AR = D
x
Equilibrium of industry under perfect competition and monopoly: with different MC curves
Higher price (P2) under perfect competition
Advantages Supernormal Profits allow
research and development Increases efficiency and lower
costs of production Competition for corporate
control Inefficient monopolies face the
risk of a take over bid from another company.
Fear of being taken over by another firm may forces monopolies to be efficient
The Theory of Contestable markets Arises when barriers to entry
are not total The mere threat of entry will
have the same effect as actual competition.
O
D = AR
aLRAC
R
Q
P1
AC1b
Q1 Q2
P2 =AC2
c
A contestable monopoly
The threat of entry drives price down to P2.
Monopoly and the dead weight loss
O
R
Q
Ppc
Qpc
AR = D
Consumersurplus
Producersurplus
Deadweight loss under monopolyMC
(= S under perfect competition)
(a) Industry equilibrium under perfect competition
a
MR
O
R
Q
Ppc
Qpc
AR = D
a
Qpc
Pm
bConsumer
surplus
Producersurplus
Deadweightwelfare loss
Deadweight loss under monopolyMC
(= S under perfect competition)
(b) Industry equilibrium under monopoly
Efficiency losses under monopoly Allocative inefficiency under
monopoly Under perfect competition P=MC but under
monopoly P>MC Productive inefficiency under
monopoly In the long run perfect competition
produces at the bottom of the ATC so P=min (ATC). Under the monopoly there is no pressure to minimise costs so that P = min (ATC)
Deadweight loss