Part nine Imperfect competition

1. Part nineImperfect competition Dr Mohamed I. Migdad Associate Professor in Economics

2. Imperfect competition And monopoly

3. Monopoly • In economics, a monopoly (from the Greekmonos, one + polein, to sell) is defined as a persistent market situation where there is only one provider of a kind of product or service.

4. Characteristics of Monopoly • Monopolies are characterized by a lack of economic competition for the good or service that they provide and a lack of viable substitute goods. • The following are primary characteristics of a monopoly

5. 1. Single Seller • A pure monopoly is an industry in which a single firm is the sole producer of a good or the sole provider of a service. This is usually caused by a blocked entry

6. 2. No Close Substitutes • The product or service is unique in ways which go beyond brand identity, and cannot be easily replaced (a monopoly on water from a certain spring, sold under a certain brand name, is not a true monopoly; neither is Coca-Cola, even though it is differentiated from its competition in flavor)

7. 3. Price Maker • In a pure monopoly a single firm controls the total supply of the whole industry and is able to exhert a significant degree of control over the price, by changing the quantity supplied.

8. continue • In subtotal monopolies (for example diamonds or petroleum at present) a single organization controls enough of the supply that even if it limits the quantity, or raises prices, the other suppliers will be unable to make up the difference and take significant amounts of market share.

9. 4. Blocked Entry • The reason a pure monopolist has no competitors is that certain barriers keep would be competitors from entering the market. Depending upon the form of the monopoly these barriers can be economic, technological, legal (basic patents on certain drugs), or of some other type of barrier that completely prevents other firms from entering the market

10. Monopsony • Monopoly should be distinguished from monopsony, in which there is only one buyer of the product or service; it should also, strictly, be distinguished from the (similar) phenomenon of a cartel.

11. Oligopoly • In a monopoly a single firm is the sole provider of a product or service; in a cartel a centralized institution is set up to partially coordinate the actions of several independent providers (which is a form of oligopoly).

12. An oligopoly • An oligopoly is a market form in which a market is dominated by a small number of sellers (oligopolists). • The word is derived from the Greek for few sellers. Because there are few participants in this type of market, each oligopolist is aware of the actions of the others.

13. continue • Oligopolistic markets are characterised by interactivity. The decisions of one firm influence, and are influenced by, the decisions of other firms. Strategic planning by oligopolists always involves taking into account the likely responses of the other market participants.

14. Oligopsony • Oligopsony is a market form in which the number of buyers are small while the number of sellers in theory could be large. • This typically happens in market for inputs where a small number of firms are competing to obtain factors of production. • This also involves strategic interactions but of a different nature than when competing in the output market to sell a final output.

15. continue • Oligopoly refers to the market for output while oligopsony refers to the market where these firms are the buyers and not sellers (eg. a factor market). A market with a few sellers (oligopoly) and a few buyers (oligopsony) is referred to as a bilateral oligopoly. • The terms monopoly (one seller), monopsony (one buyer), and bilateral monopoly have a similar relationship.

16. Forms of monopoly Legal monopoly • A monopoly based on laws explicitly preventing competition is a legal monopoly or de jure monopoly. When such a monopoly is granted to a private party, it is a government-granted monopoly; (eg. Jawal) • When it is operated by government itself, it is a government monopoly or state monopoly.

17. A government monopoly • A government monopoly may exist at different levels of government (eg. just for one region or locality); • a state monopoly is specifically operated by a national government.

18. Natural monopoly • A natural monopoly is a monopoly that arises in industries where economies of scale are so large that a single firm can supply the entire market without exhausting them. • In these industries competition will tend to be eliminated as the largest (often the first) firm develops a monopoly through its cost advantage.

19. Natural monopoly • In these industries monopoly may be more economically efficient than competition, although because of potential dynamic efficiencies this is not necessarily clear-cut.

20. Natural monopoly • Natural monopoly arises when there are large capital costs relative to variable costs, which arises typically in network industries such as electricity and water.

21. Natural monopoly • The idea of "natural monopoly" is mere theoretical abstraction to justify expanding the scope of government, and that it in the case of nationalization or deprivatization it is the government intervention itself that creates a monopoly where one did not actually exist.

22. Local monopoly • A local monopoly is a monopoly of a market in a particular area, usually a town or even a smaller locality: the term is used to differentiate a monopoly that is geographically limited within a country, • as the default assumption is that a monopoly covers the entire industry in a given country.

23. Local monopoly • This may include the ability to charge (to some extent) monopoly pricing, for example in the case of the only gas station on an expressway rest stop, which will serve a certain number of motorists who lack fuel to reach the next station and must pay whatever is charged.

24. Monopolistic competition • Industries which are dominated by a single firm may allow the firm to act as a near-monopoly or "de facto monopoly", a practice known in economics as monopolistic competition.

25. Monopolistic competition • Common historical examples arguably include corporations such as Microsoft and Standard Oil (Standard's market share of refining was 64% in competition with over 100 other refiners at the time of the trial that resulted in the government-forced breakup).

26. Monopolistic competition Monopolistic competition occurs when: • There are many producers and many consumers in a given market. • Consumers have clearly defined preferences; the goods and services are heterogeneous. • There are barriers to entry.

27. continue • A monopolistically competitive firm acts similar to monopolists in the short run, but in the long run has no profits and excess capacity.

28. a horizontal monopoly. • Large corporations often attempt to monopolize markets through horizontal integration, in which a parent company consolidates control over several small, seemingly diverse companies (sometimes even using different branding to create the illusion of marketplace competition). Such a monopoly is known as a horizontal monopoly.

29. a vertical monopoly • A monopoly arrived at through vertical integration is called a vertical monopoly. A common example is vertical integration of electricity distribution with electricity generation, which is common because it reduces or eliminates certain costly risks.

30. Coercive monopoly • A coercive monopoly is one that arises and whose existence is maintained as the result of any sort of activity that violates the principle of a free market and is therefore insulated from competitive forces that would otherwise be a potential threat to its superior status. The term is typically used by those who favor laissez-faire capitalism

31. Monopolistic pricing • Equilibrium in monopoly • If a monopoly can only set one price it will set it where marginal cost (MC) equals marginal revenue (MR) as seen on the diagram on the right.

32. Monopoly and efficiency • In standard economic theory, a monopoly will sell a lower quantity of goods at a higher price than firms would in a purely competitive market. • In this way the monopoly will secure monopoly profits by appropriating some or all of the consumer surplus, as although the higher price deters some consumers from purchasing, most are willing to pay the higher price.

33. Monopoly and efficiency • Assuming that costs stay the same, this does not lead to an outcome which is inefficient in the sense of Pareto efficiency; no-one could be made better off by shifting resources without making someone else worse off. • However, total social welfare declines compared with perfect competition, because some consumers must choose second-best products.

34. Monopoly and efficiency • It is also often argued that monopolies tend to become less efficient and innovative over time, becoming "complacent giants", because they don't have to be efficient or innovative to compete in the marketplace.

35. Monopoly and efficiency • Some argue that it can be good to allow a firm to attempt to monopolize a market, since practices such as dumping can benefit consumers in the short term; and once the firm grows too big, it can then be dealt with via regulation

36. Concentration ratio • In economics, the concentration ratio of an industry is used as an indicator of the relative size of firms in relation to the industry as a whole. This may also assist in determining the market form of the industry.

37. Concentration ratio • One commonly used concentration ratio is the four-firm concentration ratio, which consists of the market share, as a percentage, of the four largest firms in the industry. • In general, the N-firm concentration ratio is the percentage of market output generated by the N largest firms in the industry.

38. Concentration ratio • The concentration ratio has a fair amount of correlation to the Herfindahl index, another indicator of firm size. • Some examples of the four-firm concentration ratio include:

39. Concentration ratio • Traditional agriculture: Less than 5 percent • Sheet metal: 9 percent • Asphalt paving: 15 percent • Typesetting: 16 percent • Publishing: 23 percent • Soap and detergents: 63 percent • Men's slacks: 75 percent • Aircraft: 79 percent • Greeting cards: 84 percent • Cigarettes: 93 percent

40. Concentration ratio • Market forms can often be classified by their concentration ratio. Listed, in ascending firm size, they are: • Perfect competition, with a very low concentration ratio, • Monopolistic competition, below 40 percent for the four-firm measurement, • Oligopoly, above 40 percent for the four-firm measurement, (Example- Boeing and Airbus in jetliners) • Monopoly, with a near-100 percent four-firm measurement. (Example- Microsoft in PC operating systems)

41. Herfindahl index • In economics, the Herfindahl index is a measure of the size of firms in relationship to the industry and an indicator of the amount of competition among them. • It is defined as the sum of the squares of the market shares of each individual firm. As such, it can range from 0 to 10,000, moving from a very large amount of very small firms to a single monopolistic producer.

42. Herfindahl index • Decreases in the Herfindahl index generally indicate a loss of pricing power and an increase in competition, whereas increases imply the opposite.