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Introduction

MONOPOLY Table of contents: Introduction................................................................3 The basic model.............................................................4 Dead-weight losses.........................................................5 X-inefficiency................................................................6 Price discrimination.........................................................7 Regulation of monopolies....................................................8 -Price regulation........................................................8 -Public ownership......................................................9 -Regulation via taxation...............................................10 Monopolistic competition..................................................10 -Excess capacity.......................................................11 Others problems............................................................12 Bibliography...............................................................13 Monopoly Introduction A monopoly exists in theory where a firm is the only supplier of a good or service for which there are no direct substitutes. Whilst potential entry may not be ruled out in principle, it does not take place in practice because a monopoly is protected by extremely effective barriers to entry. Thus a monopoly can be regarded as the other extreme case in the spectrum of market structures. A monopoly may arise as a result of natural forces, or it may be artificially created. By a natural monopoly we mean a situation in which there are such extensive economies of scale involved in the supply of a commodity that duplication of the entire supply system would be hopelessly uneconomic. The classic examples of this situation are the public utilities, all of which either are, or were, nationalized in the UK. Thus more than one electricity grid, or gas pipe network, or rail network would be expected to raise costs much more than revenue. Notice, however, that the same argument cannot be applied to every individual part of the supply system as is commonly supposed. Whilst it is only sensible to have a single gas main running down each road, there is no reason why the gas itself cannot be stored in a large number of competing plants, which obtain it from competing gas suppliers, and fed into the network at a price to be negotiated between the supplier of the gas and the owner of the network monopoly. The state may also choose to award an exclusive right to supply to one body, most commonly through franchises or patents. There are many variants of the former. The Post Office, for example, is not overall a natural monopoly, but has always been run as a state monopoly in order to ensure safe delivery of official correspondence. ...read more.

Middle

However, where ownership is divorced from control, the loss of profit is borne by shareholders, whilst the benefits of X-inefficiency are enjoyed by the managers. Price discrimination So far, we have assumed that the monopolist sells all his output for a uniform price. In practice, this may not be the case because the monopolist is able, and finds it profitable, to practice price discrimination. In general terms, price discrimination occurs when a producer sells a specific product to at least two distinct buyers at different prices that do not reflect differences in the cost of supply. Essentially it can arise whenever buyers' willingness to pay different amounts for an identical good or service can be turned to the seller's advantage. Where the seller is a profit-maximizing firm, the potential advantage is, of course, increased profits. Successful discrimination, as will become clear when we discuss the formal models, requires three things to be true. In the first place, the monopolist must be able to deal with his buyers separately. Secondly, there must be differences in the prices buyers are willing to pay, and thirdly, the seller must have the market power to exploit these differences. Alternatively, it may be said that successful discrimination rests both upon the ability of the seller to select his clientele and upon the prevention of resale by the customer who buys cheaply to the customers who pay higher prices. Since it is extremely difficult to resell most services, it is much easier to practice price discrimination for services as compared to goods. It is also considerably easier to discriminate where markets are physically separated, such as home and abroad. In the latter circumstances, the monopolist is discriminating only between a few large markets, as is also true where, for example, a firm sells part of its production to another manufacturer for incorporation in his own products, and part direct to the general public at a much higher prices. ...read more.

Conclusion

Moreover, in these circumstances the effect is likely to be significant. For example, if a fish and chip shop lowers its prices it could have a significant effect on the trade of a similar shop in the next street, event though the effect on shops farther away is negligible. This is also means that, before our fish and chip shop proprietor makes a decision to change his prices, he would need to consider precisely how his rival might react, because that would be an important factor in determining the final outcome. These problems are tackled explicitly in oligopoly models, but the fact that they can arise in situations where there are a large number of firms that are small in relation to the size of industry suggests that the assumptions of the monopolistic competition model relate to rather an extreme case in exactly the same way as those for perfect competition. The perfectly competitive model is based on extreme assumptions, but it does yield a supply curve, which is useful, in conjunction with the demand curve, in the analysis of competitive markets and how they react to changes in external factors. With monopolistic competition, firms are price makers, as in monopoly, so they have no determinate supply curve. Hence there can be no aggregate industry supply curve. Further, even at the individual firm level, it is difficult to predict how it will respond to a simply change like an increase in demand because of the conflicting ways the relevant factors operate in determining the overall effect. Indeed, considerations of this kind have led one commentator to conclude that from this point of view the theory of monopolistic competition is almost theoretically empty (Archibald, 1961). However, an important contribution of the theory as developed initially by Chamberlin was to emphasize the importance of advertising and product variation in the analysis of the firm, and in recent years these aspects of his work have been the subject of renewed interest, particularly in the light of the development of the analysis of the characteristics of products. ...read more.

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