4. Competition (cont'd)

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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