Comparing Equilibrium situations for Monopoly and perfect Competition

Characteristics of a MonopolistA monopolist firm is the only supplier of a good or service in

a market.

•The revenue curves for a monopoly are different from those of a perfect competitor.

•The monopolist is able to restrict output so that a high price can be charged, this means in order to sell more product the monopolist must drop its price.

• Sound similar to the LAW OF DEMAND?

•As price decreases quantity demanded increases

•This must mean the monopolist must have a downwards sloping demand curve!

•AR=D

Revenues for a monopolist

Price Quantity Total Revenue

Average Revenue

Marginal Revenue

30 1 30 30 30

25 2 50 25 20

20 3 60 20 10

15 4 60 15 0

10 5 50 10 -10

5 6 30 5 -20

Revenue Curves for the Monopolist

The AR curve is the firms demand curveBoth the AR and MR are downwards sloping, but AR < MRWhen TR is increasing, MR is positiveWhen TR is decreasing, MR is negativeWhen TR is at its maximum MR=O

Comparing Demand Curves

Perfect Competitor Monopolist

Demand Curve

Degree of influence over price

Relationship between AR and MR

Horizontal Downwards sloping

Price Taker Only producer, Price setter

AR=MR MR<AR

Profit Maximising Equilibrium for the Monopolist

To identify the profit maximising equilibrium position for the monopolist firm.

1. Find where MR=MC, from this position draw a dashed line directly down to horizontal axis, (Qe)

2. Continue this dashed line vertically till you reach the AR curve, then take this line to the vertical axis (Pe)

To identify AC at profit max level.

Find where the line goes vertically up from Qe and reaches the AC curve take this then to the vertical (price axis) point c

Total supernormal profit Pe, a, b, c

Differing profit situations for the monopolist

Profit SituationsThese are assessed in the same way as perfect competitors- at the profit maximising level of outputIf

AR < AC Subnormal Profits

AR=AC Normal Profits

AR > AC Supernormal Profits

What happens in the SR and LR?

In the short run, a monopoly must stay in the industry no matter what the profits position , as at least on factor is fixed.

In the Long Run Earning a supernormal profit – this situation will

continue as strong barriers to entry prevent any other firms entering the market

Earning a normal profit – a firm will continue to operate, as it is earning just enough profit to be worthwhile

Earning a subnormal profit – a firm will leave the market as better returns can be gained else where

Barriers to entryBarriers to entry- strategies available that will stop new firms from entering a market

This means, existing firms will be able to keep earning supernormal profits in the long run.

Examples of barriers to entry

Patents – give the firm intellectual property rights over a new invention

Predatory pricing – policies to cut prices to a level that would force any new entrants to operate at a loss

Cost Advantages- resulting from economies of scale (allowing them to undercut price)

Spending on R&D (research and development)

Producing a good with no close substitutes

Advertising and marketing – competitors find it expensive to break into the market

Monopoly VS Perfect Competition

Compared to a perfectly competitive firm a monopoly will

Deliberately restrict output Set a price higher than MCBe able to earn supernormal profits in the LR. Not achieve the efficient level of output where AR=MR

Monopoly VS Perfect Competition

However there are some situations where the monopolist can provide some advantages to society

Supernormal profits can be used to pay for R&D which could lead to further efficiencies

If the monopolist is earning sufficient economies of scale a firm could charge a price below that of a competitive firm.

Loss of Allocative EfficiencyWork book page 73

In a perfectly competitive market, price is set by demand and supply at market equilibrium, so the market is allocatively efficient

Curves of a monopolistDemand curve is downwards sloping MR< ARThe monopoly restricts output to the profit maximising level where MR=MC

Where MR=MC, the monopolist charges a higher price and lower output than the market equilibrium where MC (S) = AR (D)

The allocative efficient level of output is where AR=MC

Deadweight loss will exist. . Deadweight loss (DWL) = Represents a loss of allocative efficiency

that is lost to the market

Loss of Allocative Efficiency

Government Policies and Monopolies

Because monopolists operate at a non allocative efficient point governments may choose to intervene in the following ways

Price Controls-Force the monopoly to operate at a price where

AR=MR (called marginal cost pricing )If costs are too high the firm may be forced into

a subnormal profit. As a result the government may need to subsidise the firm

- Force the monopoly to operate where AR=AC (called average cost pricing)

The firm will then be making a normal profit and it will be operating at a close to the allocatively efficient point.

Remove all artificial barriers to entry for a firm – e.g legal barriers

Encourage/legislate competition – forcing monopolies to share facilities

Force any parts of a monopoly that can be broken up to be sold