Oligopoly

Explain why prices tend to be quite stable in a non-collusive oligopoly.

Oligopoly is where a few firms dominate an industry. Some oligopolistic firms produce almost the same product, for example petrol. Some firms produce highly differentiated products such as motor cars. Others produce less differentiated products, such as Shampoo. A non-collusive oligopoly is when firms in an oligopoly industry don't cooperate with other firms in the industry and therefore have to be very aware of the reactions of other firms when making pricing decisions. So when a firm lowers the price of their product, they have to increase their output which means higher costs for the production of their product. Consequently, their total revenue will fall because the demand for the product is more inelastic than before. Hence their total cost will increase. When their total costs increase their profits will decrease. As a result non-collusive oligopolistic firms tend to have relatively stable prices since raising prices by decreasing output and decreasing prices while increasing output can both harm an oligopolistic firm. Therefore non-collusive oligopolistic firms incline to produce between the point a and b on the diagram below. Nomatter where the marginal cost curve intercects the marginal revenue curve inbetween a and b the price will stay the same and therefore it remains stable.

Monopolistic Competition

Explain whether or not a firm in monopolistic competition earning abnormal profits is productively and allocatively efficient.

A monopolistic competitive industry is made up of a fairly large number of firms. In relation to the size of the Industry, monopolistic competitive firms are small. They produce slightly differentiated products, for example by brand name, color, design and quality of service. A firm in monopolistic competition has a downward sloping demand curve, since they are (extended) price-makers, which means that they are influential enough to affect the price of their product. The demand curve is relatively elastic because of the many substitutes (which are slightly different). A monopolistic competitive firm is able to gain abnormal profits in the short run. In this case the firm is maximizing profits by producing at the level of output where MC=MR. On the diagram below, q1 represents the productively efficient level. Productive efficiency is achieved when the marginal cost is at the lowest average total Cost. This means a productively efficient firm utilizes all its resourses and produces at the lowest cost possible. A monopolistic competitive firm is allocatively efficient when the marginal cost curve intersect the average revenue curve. This is because the price consumers are willing to pay equals the to the marginal utility they recieve. So a firm is allocatively efficient when there is an optimal distribution of the product. It's also called the socially optimum level of output. In this case, when a firm in monopolistic competition is earning abnormal profits, it is neither productively efficient, nor allocatively efficient. This is because the firm produces where marginal costs is equal to the marginal revenue, as opposed to the points of productive and allocative efficiency which are located differently.

Short response question > Monopoly

1. Explain the level of output at which a monopoly firm will produce

There are main theories of Monopoly: A firm is a monopolist when it's the only firm producing the product and is therefore the industry. For a monopolist, there exist barriers to entry, which stop new firms from entering the industry and maintain the monopoly. As a consequence of barriers to entry the monopolist may be able to make abnormal profits in the long run. However, it is important to know how much monopoly power a firm has. The strength will really depend upon how many competing substitutes are available.

The demand curve of a monopolistic firm is downward sloping, since it is the industry demand curve. Even though a monopoly firm can control their output and their price of the product, it can't control both at the same time. This means that for a monopoly firm the law of demand still is important. The law of demand says that as the price of a product falls, the quantity demanded of the product will increase; ceteris paribus. So in order to sell more of their product they have to lower their price. This affects the output. When a firm sets a high price for their product, the demand is less and therefore the output is less. However when the monopoly firm lowers their price to p1, the quantity demanded for their product increases to q1. Therefore the output increases as well. Hence a monopolist can't charge whatever price they like and still sell their product. Nevertheless a monopoly firm's goal is to maximize their profits and they maximize their profit by producing at the level of output where the marginal cost is equal to marginal revenue.

2. Using a diagram, explain the concept of a natural monopoly

A firm is a natural monopoly when there are only enough economies of scale available in the market to support one firm's abnormal profits. Economies of scale are any decreases in long-run average cost when a firm alters all of its factors of production in order to increase its scale of output.

The monopoly firm has the demand curve of D1. Because of the economies of scale the LRAC is shaped and positioned as it is. Therefore the monopolist can make abnormal profits between q1 and q2. This is because the average revenue is greater than the average cost for the range of output. However, when another firm enters the industry the demand from the monopolist would decrease and the curve D1 would shift to the left, D2. When the firms produce at the demand curve D2, they will have huge losses and won't be able to make normal profits because the LRAC would be above the AR and every level of output. However a monopolist will only gain abnormal profit when it is able to assure all of the demand of its product. So an industry is monopoly because the market will only support one firm.

3. Using appropriate diagrams, explain whether a monopoly is likely to be more efficient or less efficient than a firm in perfect competition.

Monopoly is more likely to be less efficient than a firm in perfect competition. The power of the monopoly plays a big role, since monopolists can use an anti-competitive behavior to keep their monopoly power. Competitive behavior is when they use their image, sales, advertisement or special offers to keep the customers attracted.

A monopoly firm produces productively and allocatively inefficient, as shown in the diagram on the left. A monopolist would probably produce at q1. However the most efficient point to produce as a monopolist is at q where MR=MC. Therefore the monopoly may restrict output and charge a higher price than in perfect competition. So the high profits of monopolists are considered unfair. However, the dimension of the profits depends on the power of the monopoly. So overall, a monopolist can charge a higher price for a lower level of output. Since some monopolists can act against public interest. Hence, the government has laws and policies to limit monopoly power.
Compared to the monopoly, the perfect competitive market produces most allocative and proactively efficient where MC=AR. Therefore all the profit-maximizing firms in the perfect competition produce efficient at the point q on the right diagram.

Monopoly

I live in Gockhausen, which is a very small village surrounded by forest. In this village there is only one hair dresser. For people who don't have a car, who are not able to go to town or who don't want to go to town only for getting a haircut, this is the only opportunity to go to a hair dresser. Especially for older people; this is an advantage. This firm has characteristics of a monopoly firm, such as producing a unique product in Gockhausen, since it is the only hairdresser in vicinity. This means that they are single sellers of the product in Gockhausen. Furthermore they are price makers. The danger, the hairdresser in Gockhausen faces is that more people might go to town to a hairdresser than go in Gockhausen, so that there is not enough demand for their product. However, monopolies are non-price competitors, meaning they don't attract customers by lowering the price; they attract them by having sales or packages or flat rates, as well as advertisement. Therefore the hairdresser in Gockhausen makes a lot of announcements and advertisement in the newspaper as well as flat rates and special offers. I think it is also important whether the hairdresser is older and normal or modern, young and lively. What would need to be true for the firm to be a pure monopoly is that there is no other hairdresser in Zurich and vicinity.