MARKETS WITH MARKET POWER - Tufts University

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different things), and oligopoly (so few sellers that each needs to watch what the others are doing). • The cases of monopoly and monopolistic competition can be analyzed using the traditional economic model. That model is not applicable to oligopoly because oligopoly markets are evolving social institutions. Teaching strategy: See the Extension “Competition and Concentration” (below) for more discussion of how these two forces interact, and why competition does not always win out. 2. Pure Monopoly: One Seller 2.1 The Conditions of Monopoly • The three conditions of monopoly are: only one seller, the good being sold has no close substitutes, and barriers exist to prevent new firms from entering the market. • One reason new firms may be prevented from entering monopoly markets is economic. The fixed costs to enter the market may be very high. A natural monopoly means that the minimum efficient scale of production is large relative to the market demand. • Barriers to entry may also be legal, such as through copyrights, patents, and trademarks. • Barriers to entry may also be deliberate. Through exclusionary practices a firm may get its suppliers to agree to not sell to competitors. Through predatory pricing a firm may temporarily sell at a price below its costs to drive competitors out of business. 2.2 Examples of Monopoly • Examples of local monopolies (limited to a specific geographical region) are relatively common, such as the only theatre in a small town. • A regulated monopoly is a private company that is run under government supervision, such as AT&T in the past. 2.3 Profit Maximization for a Monopolist • A monopolist will choose to produce where marginal cost equals marginal revenue. • Unlike a firm in a perfectly competitive market, a monopolist faces the entire demand curve and can adjust its selling price. • As a price-maker, a monopolist faces a downward-sloping marginal revenue curve. • Rather than setting price equal to marginal cost, a monopolist will set price at the maximum willingness to pay (the point on the demand curve). • A monopolist can make a sustained economic profit because new firms cannot enter the market to drive down prices. Teaching strategy: See the Extensions section (below) for additional numerical examples. 2.4 Monopoly and Inefficiency • A deadweight loss exists in a monopoly market. Because the monopolist produces at an output level at which price exceeds marginal cost, society could gain from increased output of the product. • Graphical analysis illustrates that a monopoly market, as compared to the case of perfect competition, results in a transfer of benefits from consumers to the monopolist, as well as a deadweight loss. Chapter 12 − Markets with Power 2
• Monopolists may also use their market power to create other inefficiencies, such as engaging in rent-seeking behavior to obtain transfers or favors. 2.5 Can Monopoly be Efficient? • In the case of a natural monopoly, multiple firms would have higher per-unit production costs than a monopolist. A firm operating under conditions of natural monopoly is normally regulated to produce at higher levels and sell at a lower price than the firm would on its own. • The granting of a monopoly through copyrights and patents can be a way to encourage research and innovation. • Monopolists may behave more like a competitive firm if they fear potential competitors or government regulation. • In the case of price discrimination, a firm can sell its product to different buyers at different prices. Buyers that are less responsive to price are charged a higher price. This allows the firm to capture more of potential consumer surplus as profits. 3. Monopolist Competition 3.1 The Conditions of Monopolist Competition • The four conditions of monopolistic competition are: numerous small buyers and sellers, the sellers produce goods that are similar but differentiated, producers can freely enter or exit the market, and buyers and sellers have perfect information. 3.2 Examples of Monopolistic Competition • Examples of monopolistic competition are very common, such as fast-food restaurants and different types of bookstores. 3.3 Profit Maximization with Monopolistic Competition • Monopolistically competitive firms face a downward-sloping demand curve. Their marginal revenue curve will lie below their demand curve. • Profit maximization occurs at the point where marginal revenue equals marginal cost. • If monopolistically competitive firms are making positive economic profits, then new firms will enter the market. This will increase supply, drive down prices, and eventually result in all firms earning zero economic profits. 3.4 Monopolistic Competition and Long-Run Efficiency • Monopolistically competitive firms produce below the level where the social benefits of production are equal to the social costs. Thus, they operate inefficiently. • Monopolistically competitive firms may engage in non-price competition, such as through advertising or being open for long hours. 4. Oligopoly 4.1 The Conditions of Oligopoly • Oligopoly markets are characterized by containing only a few sellers (at least some of which are large enough to influence the market price); and conditions exist which make entry into such market difficult. • In making decisions, an oligopolist must anticipate the likely reaction of its rivals. Chapter 12 − Markets with Power 3
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MARKETS WITH MARKET POWER - Tufts University

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