Chapter 4 - Theory of monopoly

Chapter 4 - Theory of monopoly

1. Source of monopoly power

   • Patent laws
   • nationalised industry
   • Incumbent has exploited economies of scale
   • High sunk costs
   • Multiplicity of brands cover all 'gaps in the market'
   • Essential raw material controlled
   • Brand loyalty
   • consumer inertia (do nothing e.g. gas switch)
   • imperfect knowledge
   • high barriers to entry

2. Monopoly pricing

   • Marginal cost pricing - MC=AR - allocatively efficient
   • Average cost pricing - AC=AR - normal pi

3. Monopoly

   • 1:100 concentration ratio
   • high barriers to entry
   • Natural
     • High fixed costs force LRAC to fall continuously
     • Better in the hands of one firm
     • high MES
   • Pure
   • The higher the MES, the more likely a Monopoly is

4. Consumer and producer surplus

   • Monopoly converts some consumer surplus to producer surplus
   • Dead weight loss

5. Price Discrimination - Different prices for different consumers for reasons other than costs

   • Firms cannot be undercut by other rivals(monopoly)
   • Resale is prevented
   • At least two different elasticities of demand
   • Types
     • First degree
       • All consumer surplus turned to pi (need to know every consumers preferences perfectly)
     • Second degree
       • Different blocks of consumption receive different prices - bulk buying discount
     • Third degree
       • Two markets, elastic D lower price, inelastic D higher price, combined in between
   • LRAC and MC constant in these markets(is ignored)
   • Dimensions of P.D.
     • Geographical - car prices higher in UK than Europe mainland
     • Time - peak prices
     • Age - Child bus tickets cheaper
   • Consequences
     • price discriminator
       • Higher output than operating at single price = economies of scale, which leads to lower prices
       • Previous good/service not able to be provided due to loss can now be provided, show with AC and AR curves
     • consumer
       • Some consumers pay less than others. but some pay more
       • first degree = total loss of consumer surplus/welfare

6. MARKET FAILURE & EVALUATION

   • market failure as there is a dead weight loss, also called allocative inefficiency
     • BUT dynamically efficient even though not statically
       • Dynamic efficiency in monopoly compared with perfect competition - MC falls so price also falls
     • By restricting output gains from economies of scale are lost
   • consumer faces lack of choice and can be exploited because the firm is a price maker BUT pi can be reinvested to improve quality + lower cost=price

7. how do small firms survive

   • niche market
   • quality of service
   • innovation
   • internet