Sources of Monopoly Power and PC vs. M

The following are sources of monopoly power -

- Economies of scale (see earlier post) : When monopolist firms get big, their average costs can get very low for the industry, making competition by other difficult if not impossible.
- Patents / copyrights : The protect firms' intellectual property, and give them the incentive to innovate and to create g/s that make our lives better (i.e. medications, the new Glee song).
- Natural monopoly : In some industries, costs are so high that the market can only be profitable for one firm. If another firm entered, demand would be split and, because average costs are high, both would make losses. Thus, the government allows such "natural" monopolies to exist. Examples : gas and electricity companies.
- Control over supply : Firms that control what's effectively the whole supply of a good have a monopoly in that goods (i.e. De Beers and diamonds).
- Brand loyalty : Did you know a Kleenex is a facial tissue? Or a Hoover is a vacuum cleaner? Sometimes brand names become the product, leading to monopolies.
- Use of force / anti-competitive behavior : When a firm tries to prevent competition, it is acting in an anti-competitive manner. This is illegal, but difficult to prove legally. Example : Microsoft and it's software.

Pros and Cons of PC vs. M-
In PC, prices are low (derived from industry supply curve) and, in the long-run, only normal profit can be made. Furthermore, this type of market structure is both productively and allocatively efficient. In a monopoly, output is restricted, prices are "too" high, and the structure is inefficient. Both produce where MC=MR to maximize profits. Monopolies can achieve economies of scale which can drive prices down. Furthermore, monopoly profits could be directed to R&D which leads to technological advancement which is good for economic/potential growth. However, because prices are high, some consumers will not be able to afford the good.

Perfect Competition (PC)

1. Perfect Competition (PC)
Assumptions of the model -
- There are many buyers and sellers, none of whom are able to influence the market (= ”price-taker”)
- Each firm is very small relative to the industry.
- Products are identical (homogenous).
- There are no barriers to entry or exit.
- There is perfect knowledge of prices, costs of production, a product quality

Example – Wheat farms in Canada, milk producers in China


The demand curve facing the industry and the firm in perfect competition:
The graph shows that price, demand, average revenue, (p x q / q leaving p), and marginal revenue (the revenue of selling one more unit of the good) are all equal. The y-axis is price (and costs too if you want) and the x-axis is quantity in whatever units used.

Profit-maximizing level of output:

The profit maximizing level of output is where MC = MR.

Below, we see possible SR profit situations (abnormal profits, normal profits and losses, all moving towards long-run normal profits).

There are three SR possibilities: abnormal profits, losses and normal profits. If firms are making abnormal profits, the profit maximizing level of output dashed line hits the average cost curve (AC1) below where p* equals MC, AR, MR and D. The box that is constructed using the line by which the average cost curve hits the profit maximizing line represents abnormal profits (blue box above).
On the flip side, if average costs are higher than where p* equals MC, AR, MR and D, we have losses which can be shown by the corresponding red box in the graph (AC2).
It is theoretically possible to be at normal profits in the short run. This has no box and is simply shown by having the AC curve hit MC, p*, AD, MR and D.
It's important to use the vertical line which passes through the point by which MC=MR to construct these diagrammatical representations.

It is possible to achieve abnormal profits or losses in the short-run. However, normal profits prevail in the long-run.  This is due to adjustments in the industry supply and demand curve.  If firms are making SR abnormal profits, soon enough producers will enter the market to shift out the industry supply curve.  This lowers the price (and thus the D, AR, MR curve) to the point at which normal profits are made.  Alternatively, if firms are making SR losses, soon enough producers will leave that the industry supply curve will shift inwards and find equilibrium at a higher price.  This shifts the firm's D, AR, MR curve up and will continue until normal profits are made.  Note I have not included an industry supply and demand curve in this post, but it looks like the one in the supply and demand post earlier. 

productive efficiency : occurs when a firm produces at the lowest possible cost per unit, AC = MC
allocative efficiency (=socially efficient level of output) : occurs when output is at society's optimum level, AR = MC

Perfect competition (PC) is both productively and allocatively efficient. However, all products are consider to be identical so there is no chance to choose between slightly differentiated products.