Comparing Equilibrium situations for Monopoly and perfect Competition

Characteristics of a Monopolist A 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 PriceQuantityTotal Revenue Average Revenue Marginal Revenue

Revenue Curves for the Monopolist The AR curve is the firms demand curve Both the AR and MR are downwards sloping, but AR is> When TR is increasing, MR is positive When TR is decreasing, MR is negative When TR is at its maximum MR=O

Comparing Demand Curves Perfect CompetitorMonopolist Demand Curve Degree of influence over price Relationship between AR and MR HorizontalDownwards sloping Price TakerOnly 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

Normal Profits AR =AC

Supernormal Profit AR > AC Supernormal Profits

Subnormal Profits AC> AR

Differing profit situations for the monopolist Profit Situations These are assessed in the same way as perfect competitors- at the profit maximising level of output If AR < ACSubnormal Profits AR=ACNormal 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

Monopoly VS Perfect Competition Due to high barriers to entry, compared to a perfectly competitive firm a monopoly can and will Deliberately restrict output Set a price higher than MC Be able to earn supernormal profits in the LR. Not achieve the efficient level of output where AR=MR

Barriers to entry Barriers 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 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 Efficiency Work 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 monopolist Demand curve is downwards sloping MR< AR The 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