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4.4 Monopoly
1.
Conditions
Monopoly satisfies the following conditions:
-
no distinction between the firm and the industry, i.e.
there is only one producer;
-
one producer faces many buyers, i.e. the producer has
market power; and,
-
there is a negatively sloped demand curve.
The demand curve faced by
the only seller is the same as the market demand curve.
Unfettered by competition the monopolist knows the impact of any
pricing decision has a negligible effect on competitors because there are
none. The monopolist can
pursue pure profit maximizing strategy.
Monopoly is mitigated only by
competition from substitutes.
The firm is able to choose the price-quantity combination to maximize its
profits. The monopolist
producer tends equates marginal revenue and marginal cost rather than
price equal to marginal cost.
In theory the monopolist is considered inefficient because the quantity
supplied is less and the price higher than under perfect competition.
The inverse of a monopoly or monopsony can also exist, i.e. market
power exercised by a single buyer facing many producers.
Monopoly exist for one or more of four reasons.
First, one firm may control the entire supply of a basic input.
Second, a firm may become a monopolist because the average cost of
producing the product reaches a minimum at an output sufficient to supply
the entire market - a natural monopoly.
Is Microsoft a “natural monopoly’?
Third, a firm may acquire control over product through a patent on
a basic process of production or the product itself, e.g. IPRs like a drug
patent. Fourth, a firm may
become a monopolist because government awards an exclusive market
franchise, e.g. electric power, water supply, etc.
While a monopoly may exist in a given market, a monopolist is
seldom entire insulated from the economy as a whole.
All commodities are rivals for the consumer’s limited income.
The more ‘near substitutes’ the greater the moderating influence on
a monopolist. The threat of
entry by outsiders interested in gaining some of the monopolist’s excess
profits can serve to moderate the pricing behavior of a monopolist, e.g.
the threat that cable companies could offer telephone service will limit
the actions of a telephone monopolist.
2. Monopoly Demand Curve
The monopolist faces the same demand curve as the industry.
As in perfect competition, the market demand curve is constructed
from the horizontal summation of individual consumer demand curves and is
usually negatively sloped, i.e. if price goes up, demand goes down.
In perfect competition, however, if the market price (over which
the perfect competitor has no control facing a horizontal demand curve)
goes up the quantity supplied by firms will increase.
In monopoly, however, an increase in price will cause a decrease in
the quantity supplied by the monopolist.
Thus unlike the perfect competitor, a monopolist can choose which
price to charge and thereby what quantity will be demanded.
The monopolist can thereby charge a price that supplies a quantity
that maximizes profits but cannot adjust both independently.
This can be seen by reference to marginal revenue in perfect
competition and monopoly: if
-
R = pq
-
MR = dR/dq
-
in perfect
competition, the firm is a price taker at a given market price facing a
horizontal demand curve and therefore MR = p
-
in monopoly
facing a negatively sloping demand curve, the firm is a price setter and
MR does not = p because an additional unit of q can only be sold at a
lower price (M&Y 10th
Fig. 11.3, M&Y 11th Fig. 10.3; B&B Fig. 11.2, B&Z Fig. 11.3)
3. Short-Run Equilibrium
If let free from outside interference a monopolist will choose the
price and output at which the difference between total revenue and total
cost is at a maximum, i.e. will maximize profits.
In perfect competition, the maximizing firm will equate price to
marginal cost to maximize profit and the supply curve is derived from
these points. Under monopoly,
maximum profits are obtained when output is at the point where marginal
revenue equals marginal cost .
Thus at any output where marginal revenue exceeds marginal cost,
profit can be increased by increasing output.
At any rate where marginal cost exceeds marginal revenue, profits
can be increased by decreasing output (M&Y 10th
Fig. 11.2; M&Y 11th Fig. 10.3; B&B Fig. 11.2; B&Z not displayed).
In perfect competition a unique relationship exists between the
price and the output supplied.
In monopoly there is not a unique relationship.
This is because variation in marginal revenue of the monopolist
accompanied by a shift in demand can result in a different output level
but at the same price.
4. Long-Run Equilibrium
In perfect competition there can be no long run economic profits or
losses because firms will enter or leave the market.
In monopoly, there are no long-run competitors unless the industry
ceases to be a monopoly - by definition.
Thus long-run equilibrium in a monopoly will be characterized by
economic profits. If, on the
other hand, a monopoly experiences short-run losses it will adjust the
scale and characteristic of its plant to eliminate such losses in the
long-run. If this is not
possible the monopolist will leave the industry.
Assuming short-run profits, in the long-run the monopolist will
adjust its plant to achieve even larger profits.
Output will be provided at the level at which long-run marginal
cost equals long-run marginal revenue (M&Y 10th
Fig. 11.5; M&Y 11th Fig. 10.6; B&B & B&Z not displayed).
5. Perfect Competition vs.
Monopoly
First, under perfect competition, each firm operates at the point
where long-run and short-run average cost are at a minimum.
Under monopoly, however, the firm will operate at minimum average
cost but not at its long-run minimum.
Second, under perfect competition output tends to larger and price
lower (p=MC) than under monopoly (MR=MC).
This results in a ‘dead weight loss’ of monopoly which reflects the
fact that the consumer surplus is reduced but the gain to the monopolist
is less than the loss to consumers (M&Y10th
Fig. 11.8;
M&Y 11th Fig. 10.9; B&B Fig. 11.16; B&Z Fig. 11.9).
6. Monopoly & ‘Big”
in Economic Thought
Dangers of
monopoly were a concern to Marx whose solution was public ownership of the
means of production. The
extremity of this solution fuelled Alfred Lord Marshall efforts to set out
a model of perfect competition and demonstrate the comparative costs of
monopoly, oligopoly & monopolistic competition.
According to Marshall, the monopolist was like a tree in the
forest; it would grow but eventually it would fall.
Reasons included the idea that inheritors to the monopolist’s power
would be less able than the founder until eventually the firm died –
Eatons?
Following a series of Harvard
Law Review articles written by Adolf A. Berle, Jr. and E. Merrick
Dodd, Jr., in 1932 Berle and Gardiner Means’ published their influential
book, The Modern Corporation and
Private Property.
This text established the concept of separation of ownership and
control of the ‘modern’ corporation and laid the foundation for
John Kenneth Galbraith’s concept of the ‘technostructure’, i.e large
firms can become self-perpetuating or ‘immortal’ through the self-genesis
of management. For a brief history see:
"The Making of the Modern Corporation", Wilson Quarterly,
Autumn 1997.
4.5 Monopolistic Competition
Monopolistic
competition satisfies the following conditions:
-
like perfect competition in that there is a large number
of sellers so that the actions of one producer have no significant
effect on rivals;
-
like monopoly and oligopoly in that each seller faces a
negatively sloped demand curve for a 'distinctive' product; and,
-
each seller possesses some market power depending on the
elasticity of demand.
Under monopolistic competition, independence of producers
results from the 'attachment' of certain consumers to specific producers.
This affects price but to a lesser extent than under monopoly (M&Y
10th
Fig. 12.1;
M&Y 11th Fig. 11.1; B&B Fig. 13.13; B&Z Fig. 13.1a). In the long-run, price equals
average costs but marginal revenue equals marginal cost (M&Y 10th
Fig. 12.2a; M&Y 11th Fig. 11.2; B&B Fig. 13.14; B&Z Fig. 13.1b). In theory monopolistic competition
is considered inefficient because price is higher and quantity supplied
lower than under perfect competition
(M&Y 10th
Fig. 12.2b, not displayed M&Y 11th, B&B,
B&Z).
Monopolistic competition occurs in a market in which
product differentiation exists and which exhibits elements of both perfect
competition and monopoly. There are a large number of sellers of close
substitutes that are not exactly the same. Under these conditions it is
difficult to determine exactly what is the industry. Using the Chamberlain
Solution, it is assumed:
-
firms producing such differentiated goods can be
clustered into product groups;
-
the number of firms in the group is sufficiently large so
that each firm operates as if its actions had no effect on its rivals;
and,
-
demand and cost curves are the same for all firms in the
group.
Given that each firm's product is slightly different it
faces a negatively sloped demand curve. The position of the demand
curve depends, however, on the price of other firm's output. Thus an
increase in the prices of rivals will shift the firm's demand curve up to
the right; a decrease would cause a shift to the left. In the short-run
equilibrium will be reached where marginal cost equals marginal revenue,
i.e. profit maximizing. In the long-run, however, firms are able to change
the scale of product and enter or leave the industry. Therefore
long-run equilibrium is reached where long-run average cost is tangent to
the demand curve and where marginal cost is equal to marginal revenue,
i.e. firms are maximizing profits. But because price is equal to
average cost, economic profits are zero. At this point there is no
incentive to entry and equilibrium is established
(M&Y 10th
Fig. 12.2a; M&Y 11th Fig. 11.2; B&B Fig. 13.14; B&Z Fig. 13.1b).
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