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The economics of market power

The economics of market power. 1. Monopoly definition price, output & profit 2. The welfare effects of monopoly comparison with perfect competition 3. Competition policy. 1. Monopoly. Competitive world high profits - new entrants losses - exitsclosure prices determined by the market

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The economics of market power

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  1. The economics of market power • 1. Monopoly • definition • price, output & profit • 2. The welfare effects of monopoly • comparison with perfect competition • 3. Competition policy

  2. 1. Monopoly • Competitive world • high profits - new entrants • losses - exits\closure • prices determined by the market • small firms - no market power • Monopoly • theory: single firm = industry (100% of the market) • practice: 25% or more of the market

  3. 1. Monopoly • A) The consequences of monopoly • price, output & profit • Figure 1 • Profit maximisation: MC=MR • Level of profit: AR - AC (supernormal profit)

  4. Profit maximising under monopoly £ MC a AR AR MR Qm O Q

  5. Barriers to entry • B) Sustaining a competitive advantage • No, or few, substitutes. Little competition • Barriers to entry • (i) Economies of scale (cost advantage) • (ii) Government policy e.g. patents • (iii) Ownership of know-how • technological, organisational, etc.

  6. Barriers to entry • (iv) Ownership of natural resources • oil, diamonds, etc. • (v) Distinctive capability e.g. being innovative • (vi) Aggressive tactics • e.g. limit pricing • …. supernormal profit in the long run

  7. 2. The welfare effects of monopoly • Competitive market versus monopoly • static effects • see figure • Pm > Pc : consumer surplus, producer surplus • Qm < Qp : consumers have less choice • deadweight loss • costs & ‘X-inefficiency’ e.g.nationalised industries

  8. Equilibrium of industry under perfect competition and monopoly: with the same MC curve £ MC P1 AR = D MR Q1 O Q

  9. Dynamic effects • profits - investment in R&D (large sunk costs) • large size - scale economies - lower costs - lower price • Different MC curves

  10. Equilibrium of industry under perfect competition and monopoly:with different MC curves £ MCmonopoly P1 AR = D MR O Q1 Q

  11. 3. Competition policy • Monopoly is not always bad! • Government policy • rules regarding the conduct of business • assumes: competition maximises consumer welfare • balance: competition versus MES • EU policy (McAleese) & UK policy

  12. UK Policy • Competition Act (1998) • Competition Commission • investigate mergers & acquisitions • ‘Chapter I prohibitions’ • investigate agreements (written or not) which restrict or distort competition (e.g. tacit collusion) • ‘Chapter II prohibitions’ • conduct of firms i.e. abuse of market power • Appeals Tribunal - legal • DGFT - ‘dawn raids’

  13. Conclusion • Firms strive for larger profits & market domination • mergers & acquisitions • growth • barriers to entry • Market failure • justifies government intervention • competition policy

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