Natural monopolist: enjoys huge economies of scale, with decreasing LAC over the entire range of outputs the market will demand.
Social costs and benefits
Monopolists charge above marginal cost, therefore above marginal utility to the consumer. Produces a Pareto inefficient amount of output, unfulfilled potential to maximise social welfare = deadweight loss.
But natural monopolies enjoy huge economies of scale, cannot operate at efficient level of output without losing money. When subsidised only way to bring services to consumers at price=marginal cost= marginal benefit.
- Compare and contrast the effects of a) profits tax, and (b) sales tax, on the price and output of a competitive industry in the short run and the long run.
Varian ch 16 sales tax p27, 291
Begg Ch 15, 495-487;
When a tax (such as sales tax) is present in a market there are two prices: the price the buyer pays, and the price the supplier receives. Difference made up of tax.
As far as the equilibrium price facing the suppliers is concerned, doesn’t really matter who is responsible for paying the tax – just matters that the tax must be paid by someone.
How much tax is passed on depends on elasticity of supply:
Perfect elasticity (horizontal curve) – all tax is passed on to consumer
Perfect inelasticity (vertical curve) – all tax is paid by producer
Usually somewhere in-between, a tax leads to some increase in price, some reduction in demand and some reduction in output:
Varian p293
In the short-run, with a fixed number of firms, industry supply curve will have an upward slope, so that part of the sales tax falls on consumers, part on the firms. Consumers pay higher price, firms receive lower price, some leave the industry. In the long-run, with a variable number of firms, the industry supply curve will be flat (firms have to receive price = minimum average cost) and so all the tax falls on the consumers:
Varian p 400
Profits tax is a tax directly on the pure profits of the firm. In short-term would decrease incentives for entry into the industry, keeping supply lower and price higher. In long-term the free entry enjoyed by other firms would eliminate any pure profits from a competitive industry.
3. Why is price discrimination often a feature of monopoly behaviour?
Begg 151-154, Varian p434
Firms with some degree of monopoly power can enhance and exploit their position. If price discrimination is possible, it is profitable to employ it. Allows firms to produce extra output without forcing down price of all units. Reduces Pareto inefficiency.
First Degree – monopolist sells different units of output for different prices, and these prices may differ from person to person – perfect price discrimination. All the market surplus is accrued by the firm (none with the consumer) and Pareto Efficiency is achieved. Idealised concept, few examples.
Second Degree – monopolist sells different units of output for different prices, but doesn’t discriminate between individuals – non-linear pricing. Everyone who buys same amount pays same price. Eg Bulk Discounts Must give consumers incentive for self-selection according to willingness to pay (otherwise they just consume less pay less and, but still have consumer surplus on what they do consume – better than none at all). Incentivise by giving a surplus at the top end of consumption also and offering an inferior quality product at the low end.
Third Degree – occurs when monopolist sells output to different people for different prices, but every unit of output sold to a given person sells for same price. Groups with more elastic demand curves face lower prices. Most common form of pric discrim, eg OAP, Student discounts.
See lecture notes and diagrams for price discrimination.
Discriminating monopolist charges different prices to different customers. To equate MR from different groups, groups with inelastic demand must pay higher prices (eg business class).
Successful pr discrimination requires that customers cannot trade the good amongst themselves.
Early 1980s Microsoft employed price discrimination on their licensing fee for MS-DOS (rather than charge manufacturers a uniform price for each copy installed on a computer they built). Fee was based on number of computers built by the manufacturer (leaving zero marginal cost of installation once fee paid), higher fee for bigger producers, but set low enough to make MS-DOS highly attractive. Achieved 90% market penetration.
- What problems arise for production and pricing when an industry has large fixed costs, such as railways or electricity? Can such industries operate efficiently in the private sector?
Large fixed costs (esp when combined with small marginal costs) mean that the minimum efficient scale is large relative to the size of demand, and the market often gives way to a natural monopoly. Other firms cannot enter due to prohibitively large fixed costs. Also most efficient to have monopolists because returns to scale at all levels of expected output. But problem with pricing:
Varian p426.
If the natural monopolist operates at the Pareto efficient level (P=MC) it will make losses. In order to break even or make profit it must charge at or above average cost (MR), but will then produce an inefficient amount of output. Should the government nationalise the industry and use public money to subsidise the cost of average production, in order to achieve maximum efficiency and consumer utility? Or allow the firm to operate inefficient level of production in order to avoid losses?
The problem with subsidising a private firm is gov regulators have difficulty determining the exact costs of the firm, and therefore AC of production, at which price should be set. May be able to run more efficiently with price discrimination.
Problem with nationalisation and subsidisation is that subsidy may just represent inefficiency: costs also difficult to measure and internal gov-bureacracies can escape close scrutiny, less accountable.
