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MARKET STRUCTURES (CONTINUED………..):MONOPOLY

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Introduction to Economics ­ECO401
VU
Lesson 6.2
MARKET STRUCTURES (CONTINUED...........)
MONOPOLY
Monopoly defines the other pole or extreme of the market structure spectrum. Usually refers to
a situation where there is a single producer in the market. However it actually depends upon
how narrowly you define the industry.
Economists are often interested in how much monopoly power any firm (not necessarily a
monopoly) has. Here monopoly stands for the extent to which the firm can raise prices without
driving away all it customers. In other words, monopoly power and price elasticity of demand
are inversely related.
Profit maximization under monopoly:
i.  The profit maximizing or best level of output is given where MR=MC. Price is then
read off the demand curve which is downward sloping. Note however the
difference with perfect competition, where the firm's demand curve was horizontal
and not downward sloping like the industry. IN a monopoly, however, the firm "is"
the industry and therefore faces the same demand curve as the industry (a
downward sloping one).
ii. Depending upon the level of AC at the point where MR=MC, the monopolist might
be earn supernormal profits, breaking even or minimizing short run losses.
iii. Price is greater than MR in equilibrium. Therefore price is not equal to MC. As
such, therefore, the supply curve for the firm is not the rising part of the MC
curve.
A monopolist can make supernormal profits even in long run because there is no easy entry
for other firms as in the case of perfect competition. So a monopolist can maintain her high
price even in the long run.
How can a monopolist retain its monopoly?
i.  These can be due to "natural" reasons or "active policies" pursued by the
monopolist.
ii. Large initial fixed costs may be involved which makes it prohibitive for others to
enter.
iii. Natural monopoly experiences economies of scale as its operation becomes
bigger and bigger and therefore it is cost-effective for only one single firm
producing for the entire economy, rather than two or more firms.
iv. Product differentiation or brand loyalty.
v. Active pricing strategies (limit pricing: charging a price below a potential entrant's
AC to drive him out or discourage him from entering).
vi. The "threat of takeover" by the monopolist sometimes prevents other firms from
entering.
vii. The monopolist controls the supply of key factors of production.
viii. The monopolist produces a product which no one else can imitate, i.e. is
protected by patents or copyrights.
Monopolies and the public interest:
a. Disadvantages of monopolies:
i.  Monopolists produce lower quantities at higher prices compared to perfectly
competitive firms. This is because monopolists do not produce where P=MC (the
point of allocative efficiency) nor at P= ACminimum (the point of cost efficiency).
ii. Monopolists earn supernormal profits compared to perfectly competitive firms
iii. Most of the "surplus" (producer + consumer surplus) accrues to monopolists.
iv. Monopolists do not pay sufficient attention to increasing efficiency in their
production processes.
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Introduction to Economics ­ECO401
VU
b. Advantages of monopolies:
i.  Natural Monopolies are beneficial and efficient for society.
ii. Supernormal or monopoly profits can be invested in R&D, development of new
innovative products and to sustain a price war when breaking into new foreign
markets.
c. Government regulation:
The government can regulate monopolies so as to ensure that they set a price where the AR
curve intersects the MC curve. This will ensure allocative efficiency. It might not be possible to
ensure that productive efficiency is attained as well because it is not necessary for the AR
curve to intersect MC at the ACminimum. Also, in setting AR (or P) = MC, the economist might
make a loss in which case the government would have to provide a subsidy. If the monopolist
makes a profit then a tax is warranted. Due to difficulties with implementing subsidies,
governments sometimes regulate monopolies at the point where the AR curve intersects the
AC curve. This often takes the monopolist reasonably close to the allocative and productive
efficiency points without necessitating a tax or a subsidy.
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Table of Contents:
  1. INTRODUCTION TO ECONOMICS:Economic Systems
  2. INTRODUCTION TO ECONOMICS (CONTINUED………):Opportunity Cost
  3. DEMAND, SUPPLY AND EQUILIBRIUM:Goods Market and Factors Market
  4. DEMAND, SUPPLY AND EQUILIBRIUM (CONTINUED……..)
  5. DEMAND, SUPPLY AND EQUILIBRIUM (CONTINUED……..):Equilibrium
  6. ELASTICITIES:Price Elasticity of Demand, Point Elasticity, Arc Elasticity
  7. ELASTICITIES (CONTINUED………….):Total revenue and Elasticity
  8. ELASTICITIES (CONTINUED………….):Short Run and Long Run, Incidence of Taxation
  9. BACKGROUND TO DEMAND/CONSUMPTION:CONSUMER BEHAVIOR
  10. BACKGROUND TO DEMAND/CONSUMPTION (CONTINUED…………….)
  11. BACKGROUND TO DEMAND/CONSUMPTION (CONTINUED…………….)The Indifference Curve Approach
  12. BACKGROUND TO DEMAND/CONSUMPTION (CONTINUED…………….):Normal Goods and Giffen Good
  13. BACKGROUND TO SUPPLY/COSTS:PRODUCTIVE THEORY
  14. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):The Scale of Production
  15. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):Isoquant
  16. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):COSTS
  17. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):REVENUES
  18. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):PROFIT MAXIMISATION
  19. MARKET STRUCTURES:PERFECT COMPETITION, Allocative efficiency
  20. MARKET STRUCTURES (CONTINUED………..):MONOPOLY
  21. MARKET STRUCTURES (CONTINUED………..):PRICE DISCRIMINATION
  22. MARKET STRUCTURES (CONTINUED………..):OLIGOPOLY
  23. SELECTED ISSUES IN MICROECONOMICS:WELFARE ECONOMICS
  24. SELECTED ISSUES IN MICROECONOMICS (CONTINUED……………)
  25. INTRODUCTION TO MACROECONOMICS:Price Level and its Effects:
  26. INTRODUCTION TO MACROECONOMICS (CONTINUED………..)
  27. INTRODUCTION TO MACROECONOMICS (CONTINUED………..):The Monetarist School
  28. THE USE OF MACROECONOMIC DATA, AND THE DEFINITION AND ACCOUNTING OF NATIONAL INCOME
  29. THE USE OF MACROECONOMIC DATA, AND THE DEFINITION AND ACCOUNTING OF NATIONAL INCOME (CONTINUED……………..)
  30. MACROECONOMIC EQUILIBRIUM & VARIABLES; THE DETERMINATION OF EQUILIBRIUM INCOME
  31. MACROECONOMIC EQUILIBRIUM & VARIABLES; THE DETERMINATION OF EQUILIBRIUM INCOME (CONTINUED………..)
  32. MACROECONOMIC EQUILIBRIUM & VARIABLES; THE DETERMINATION OF EQUILIBRIUM INCOME (CONTINUED………..):The Accelerator
  33. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS
  34. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….)
  35. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):Causes of Inflation
  36. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):BALANCE OF PAYMENTS
  37. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):GROWTH
  38. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):Land
  39. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):Growth-inflation
  40. FISCAL POLICY AND TAXATION:Budget Deficit, Budget Surplus and Balanced Budget
  41. MONEY, CENTRAL BANKING AND MONETARY POLICY
  42. MONEY, CENTRAL BANKING AND MONETARY POLICY (CONTINUED…….)
  43. JOINT EQUILIBRIUM IN THE MONEY AND GOODS MARKETS: THE IS-LM FRAMEWORK
  44. AN INTRODUCTION TO INTERNATIONAL TRADE AND FINANCE
  45. PROBLEMS OF LOWER INCOME COUNTRIES:Poverty trap theories: