As individual’s income rises, they can afford more of the goods they want, such as computer and clothing. These are normal goods. For other goods, called I nferior goods, an increase in income reduces demand. In this case, as individual’s income rises, they can afford more of the higher technology goods such as VCD players and DVD players which have better quality and at the same time perform the same functions of video recorders. On the other hand, they will buy less of video recorders because they have lower quality and become an inferior nowadays. So, even if the price of video recorders dropped, the demand for them will not increase.
A decrease in demand for inferior goods when consumers’ income goes up.
It is how the income of the consumer affects the demand of video recorders.
Secondly, since VCD players and DVD players are becoming more popular nowadays, the price of them has come down as well. In order to attract consumers, the price of VCD and DVD players are much lower than before. Because people make their buying decisions based on the price of related goods, demand will be affected by the prices of other goods. Here, VCD and DVD players are substitutes of video recorders. Substitute goods are goods which can replace one another in satisfying the wants of consumers. When the price of a substitute declines, demand for the good will fall. In this case, as the price of substitute goods (VCD and DVD players) declines, demand for video recorders will fall. (from D1 to D2)
A drop in the price of the substitute good
Furthermore, a change in taste can affect the demand for a good without a change in price. People may think that video recorders are old fashion, so they refuse to buy them. As consumers have less interest in video recorders, the demand for them will decrease.
Finally, expectations will also affect demand. Consumers may expect that the price of video recorders will drop in the near future, they may put off buying one until later.
These are the factors that affecting the demand of video recorders. Since there is a change in these factors, the purchase plan of the consumers, the relationship between the price and the quantity demanded will change, triggering a change in demand. Referring to the quotation, since the other factors have been changed, there is nothing to deal with the Law of Demand, which states that all other factors should remain constant.
2a. It has often been argued that production by monopolies is inefficient. Do you think the local electricity supply market should be opened up to competition? Explain your answer.
Before we go into the details, let’s look at the major characteristics of monopoly. By definition, a monopoly means there is one and only one seller in this market. Entry to the market is restricted because of the government franchises which grant production to a single producer only. Also, the producer has sole possession of the skill or resources required for producing the product. Furthermore, the producer can benefit from economies of scale that lowers the unit cost of production will exist when the output volume is high, which is called a natural monopoly. Normally, the set-up cost is high which means not so many producers can afford it. On the other hand, the monopoly is the only producer of that particular product. But most of the goods have substitutes in one way or another. Lastly, market information in monopoly market is definitely imperfect and highly restricted, which means that it is difficult to get information such as price.
Monopolists have always been criticized as being inefficient. In the following, we are going to show why there is inefficiency for a monopoly. Before we can do so, we need to know what marginal revenue and marginal cost are.
Marginal revenue (MR) is the change in the total revenue of a producer when one more unit of the good is sold. For example, when the amount of output produced is m, the total revenue will be TRm. If one more unit is sold, the total revenue will become TRm+1. The extra total revenue received from selling that additional unit of good will be TRm+1 – TRm. For a firm operating in a perfectly competitive market, the extra revenue it gets from selling one more unit of the good will be just the same as the market price (MR=D).
The marginal revenue curve of a perfectly competitive firm is the same as its demand curve
If the firm is a monopolist (which does not practice any price discrimination), to sell one more unit of its product, the monopolist needs to lower its price not just for this extra unit but all previous units sold as well. So, the marginal revenue will be much lower than the price. The marginal revenue will always lie below the demand curve. Usually, it should be twice as steep as the demand curve or halfway between the demand curve and the vertical axis.
The marginal revenue and demand curve of a monopoly
Marginal cost is the change in the total cost incurred by the producer when one extra unit of good is produced. No matter whether a firm is a price taker or a price searcher, to maximize profit, it must produce at the point where MC=MR.
If MR > MC, the monopolist gains profit by increasing output.
If MR < MC, the monopolist gains profit by decreasing output.
If MC = MR, the monopolist is maximizing profit.
Thus, MC=MR is the profit-maximizing rule for a monopolist.
Let’s examine why there is inefficiency for monopoly. The graph below illustrates the comparison of a perfectly competitive market and a monopoly in terms of price and output.
As monopoly, a marginal revenue curve lies halfway between the demand curve and the vertical axis. Equilibrium occurs where the marginal cost curve intersects the marginal revenue cost curve at Em. At Em, the equilibrium quantity is Qm, and the price that this monopolist can charge is Pm. In comparison with a perfectly competitive market, a monopolist will charge a higher price but produce less output.
On the other hand, consumers in fact are willing to pay a higher price for an extra unit of the good than the cost which the monopolist needs to incur in order to produce that extra unit. However, the monopolist will not produce the extra unit because if he produces, the MC will be greater than the MR and the profit will drop. This is called allocative inefficiency of monopoly. This is why monopoly will lead to inefficiency in resource allocation.
To a certain extend, since production by monopolies is inefficient, why still keeping monopoly rather than opening up to competition? In the case of the local electricity supply market; there are some reasons in support of keeping it under monopoly.
One of the reasons is that a firm is better at producing a good than anyone else. It is truth that the China Light & Power Co. Ltd (for the provision of electricity in Kowloon, the New Territories and the outlying islands) and the Hong Kong Electric Co. Ltd (for the provision of electricity on Hong Kong Island) have unique abilities that make them more efficient than all other firms in supplying power. To conclude, they have natural ability.
Secondly, they are natural monopolies in the sense that the output volume has to great in order to enjoy economies of scale. A natural monopoly is an industry in which a single firm can produce at a lower cost than two or more firms. So, what is economies of scale?
To explain the concept of economies of scale, we have to look at the average cost curve. An average cost curve shows the relationship between average cost and output. Average cost (AC) is the total cost (TC) divided by the amount of output (Q).
The following is an average cost curve:
The average cost curve indicates that at first the average cost decreases as output increases. This shows a negative relationship between the average cost and output. This is what we meant by economies of scale. This downward trend goes on until the curve reaches its lowest point, which is called the optimum scale of production, and it will start climbing again which shows diseconomies of scale. If there are a huge number of suppliers in the market, the output of each of them will be small. In contrast, a single supplier can have a large output to take it to the lowest point of the average cost curve. As the local electricity suppliers can enjoy strong economies of scale, it may benefit the consumers as well. If the local electricity suppliers can run the firm in lower cost, the price will be lower as well.
Because the initial set-up cost is high in running an electricity supply firm, to ensure that they can recoup the huge set-up cost through future profit, the local electricity suppliers have a government franchise to guarantee that they have the exclusive right to produce the good and thus be able to get enough profit to pay for its initial investment.
Since keeping the local electricity supply industry under monopoly can lower the average cost and thus may benefit the consumers, it is preferable that it should keep under monopoly.
2b. In terms of circulation, Oriental Daily News, Apple Daily and The Sun are the three largest newspapers in Hong Kong. In addition, there is a dozen or so more local newspaper in Hong Kong. Analyze whether the newspaper market in Hong Kong is an oligopoly or under monopolistic competition.
Before we proceed, let’s look at the differences between an oligopoly and a market under monopolistic competition.
First of all, there are many buyers and sellers in the market under monopolistic competition. In contrast, the market is dominated by a few large suppliers and there may still be a large number of smaller suppliers in an oligopoly.
Furthermore, entry to the oligopoly market is restricted because of the high set-up cost and government requirement for operating licenses. The market under monopolistic competition, in contrast, has no restrictions that prevent new firms from entering the market or existing firms from leaving the markets.
In terms of dependency, each firm acts independently under monopolistic competition market. The demand curves faced by firms operating in such a market are just like any other ordinary downward-sloping demand curve. This means that these firms can have some degree of control over their prices. For example, they may boost their sales by lowering their prices, attracting some customers to switch from other sellers and buy from them. Depending on their cost structure, they can search for the right price for their products, to maximize their profits.
The demand curve of a firm under monopolistic competition
In contrast, an oligopolist has to take into consideration the possible reaction of the competitors when deciding whether to raise or lower the price. If an oligopolist tries to raise the price, competitors, who always hope to increase their market shares by attracting more customers to come to buy from them, will keep their price unchanged or just increase by a smaller extent. Some of the customers will then switch to other producers whose price is lower since these goods are close substitutes of one another. As a result, this oligopolist will lose a lot of business. The demand curve it is facing is rather price elastic. But if the oligopolist tries to lower the price, the competitors will follow by lowering their prices as well. So, the percentage rise in the quantity demanded will be small when he tries to lower the price. As a result, the oligopolist is facing an inelastic demand curve when attempting to lower the price. Therefore, oligopolists are interdependent when dealing the setting of price and output. To conclude, it is not easy for oligopolists to change the price. Any attempt to raise the price of its product will result in a loss in business and an attempt to lower its price will trigger a price war without much gain in sales. Here is the demand curve of an oligopolist. The upper portion of this demand curve is price elastic. The lower portion is price inelastic.
As the firms under the market of monopolistic competition can lower their price to attract customers, firms under oligopoly market in contrast, has to engage in non-price competition, such as better quality, better packaging, better advertisements in order to attract customers to come to buy from them. If there is any change in the market demand which in turn necessitates a change in the price, it is always the large producers to take the initiative to institute the price change in an oligopoly market. These dominant suppliers are called the price leaders. It is different from the market of monopolistic competition that every firm can control their own prices
The above are the major difference between an oligopoly and a market under monopolistic competition. Let’s examine whether the newspaper market in Hong Kong is an oligopoly or under monopolistic competition.
First of all, let’s look at the number of sellers in the newspaper market. As we know, the newspaper market in Hong Kong is dominated by a few large publishers which are Oriental Daily News, Apple Daily and The Sun. But there are still a lot of small publishers such as Hong Kong Daily News, Ming Pao, SingTao. It is one of the characteristics of an oligopoly. Although there is no government restriction such as franchises that prevents free entry, the initial set-up cost is prohibitively high, and the three large ones have lower per unit cost brought about by economies of scale. The goods they produce (newspapers) are close substitutes, but there are some differences between them such as the style. For example, some newspaper put more emphasis on reporting the truth and some are more entertaining. It seems that the newspaper market in Hong Kong is an oligopoly.
In response to the dependency of price setting, the newspaper market in Hong Kong is interdependent. Most of the newspapers in Hong Kong now are priced at $6. Publishers’ attempt to lower or increase the price may lead to price war or a loss in business. Most of the publishers will not take this risk. They are engaging in non-price competition either. In order to attract readers, they try their best to improve the quality of their newspaper. They try to do more research in order to find out what readers really want. This is also one of the characteristics of an oligopoly.
According to the above characteristics, we can say that the newspaper market in Hong Kong is an oligopoly.
Reference
SS101 Social Sciences: A foundation Course Unit 7 and 8, Open University of Hong Kong, 2001
David C. Colander, Economics, fifth edition, , Middlebury College
Samuelson, Paul A (2001) Economics, 17th edn, McGraw-Hill Education.
