What is a monopoly?
One firm In a market, they set equilibrium price and quantity
what is oligopoly?
Few firms in market, decisions of each firm affect payoff of all other firms.
What is a dominant firm?
One large firm , many small firms. Decisions of large firm affect payoffs of all other firms, but decisions of small firms do not affect any other firm.
What is Monopolistic completion?
Many firms with slightly differing products, no decision of any firm affects the payoffs of any other firm.
What is pure competition?
- Many firms making same product
- No firm has any influence in the market, they are price takers
- Free to vary price but will only be in equilibrium where price= marginal cost.
- If a firm sets price above equilibrium price then its demand will be 0
- If a firm sets its price below equilibrium price the its demand will equal total market demand
Monopoly characteristics
- opposite of pure competition
- Influence over market price ad quantity produced
- These are set so that profit is maximised
- Decision of market price and output is not completely independent (For a given price the monopolist can only sell what the market is able to buy, if price is to high the monopolist will only sell a fraction of its output)
- Therefore they can either set the price and let market choose output OR set output and market chooses price. (consumer constrains price and output)
Why do monopolies exist?
- Patented (new drug)
- Legal fiat (US postal system)
- Sale of ownership of a resource of production (e.g. toll highway)
- Creation of cartel (e.g. OPEC)
When is profit maximised?
Marginal revenue= Marginal cost
Why is optimal condition MR=MC?
Because when MC>MR there is incentive to cut output to make up for the loss in revenue and when MC
What is marginal revenue?
The rate of change of revenue when output is increase (Derivative of revenue function with respect to y) dP(y)y/dy
What is marginal cost?
The rate of change of cost when output is increased (derivative of cost with respect to output) dC(y)/dy
Why is monopoly inefficient?
MC is smaller than Price which means there are customers willing to but more product at a lower price than market price but higher than marginal cost which means customers will be satisfied and so too will producers as they have earned more profit. However this cannot be done without lowering the price of all the output which would lower profits.
When is pareto’s efficiency reached?
When the condition (utility or profit) of the supplier or consumer cannot be improved without harming the condition of the consumer/ supplier.
What is DWL?
Dead weight loss. Gains to trade not achieved due to inefficiency of the market. In monopoly the monopolist produces less than the efficient output so sells this at a price higher than market price under perfect competition.
What is mark up pricing?
As the monopolist sets price at a level where mR=mC,, P>mC so price is just a mark up of marginal cost.
What does the magnitude of the mark up depend on?
Price elasticity of demand. If demand is highly elastic (sensitive to price changes/ gentle slope e.g 1) then mark up will be small. If demand is highly inelastic (insensitive to price/ steep slope e.g 0) the mark up will be large.
What formula links price, marginal cost and elasticity of demand?
P= MC(y)/1-1/ε
This shows that mark up price depends on elasticity
What happens when profit tax is levied on a monopolist?
- Monopolists aim to maximise profits
- profit tax reduces monopolists profits from π(Y) where Y= profit maximising output, to (1-t)π(y*)
- The only way to maximise post tax profits is to maximise pre tax profits.
- Therefore this does not change the suppliers choice of output, price or customer demand.
- Profit tax is a neutral tax
What happens when quantity tax is levied on a monopolist?
- A tax of £T increases MC by £T
- This reduces profit maximising output
- This increase profit maximising price
- This reduces demand
- Quantity tax is distortionary
In what scenario is pareto’s efficiency achieved in monopoly? At what cost?
- Under natural monopoly
2. Such a firm makes a negative profit
Describe a situation that results in natural monopoly
- They arise when there are extremely high fixed costs such as the case of distribution of infrastructure to ensure supply.
- This is normally the case for public utilities
- E.G. cables ad grids for electricity, pipelines for gas and water, network for rail services.
What is the effect of a new entrant in a natural monopoly?
- May cause potential inefficiency as infrastructure is duplicated (more is produced than demanded by market)
- Waste of resources
- May be efficient to allow one firm
What is the ‘entry defence’ in natural monopoly?
- Incumbent firm uses the threat of predatory price
- Predatory price is when the dominant firm cuts price to such a level the new entrant makes a negative profit, thereby inducing their exit.
