The economics of market power

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The economics of market power

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

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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

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1. Monopoly

• A) The consequences of monopoly
• price, output profit
• Figure 1
• Profit maximisation MCMR
• Level of profit AR - AC (supernormal profit)

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Profit maximising under monopoly

MC
a
AR
AR
MR
Qm
O
Q
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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.

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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

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2. The welfare effects of monopoly

• Competitive market versus monopoly
• static effects
• see figure
• Pm gt Pc consumer surplus?, producer surplus?
• Qm lt Qp consumers have less choice
• deadweight loss
• costs X-inefficiency e.g.nationalised
  industries

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Equilibrium of industry under perfect
competition and monopoly with the same MC curve

MC
P1
AR D
MR
Q1
O
Q
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Dynamic effects

• profits - investment in RD (large sunk costs)
• large size - scale economies - lower costs -
  lower price
• Different MC curves

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Equilibrium of industry under perfect competition
and monopolywith different MC curves

MCmonopoly
P1
AR D
MR
O
Q
Q1
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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

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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

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Conclusion

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