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