Business Economics: Monopoly - Assignment Example

Business Economics and Section # of 20th December 2009 MONOPOLY Monopoly is a term given to any individual or firm who has no competition in the market. The individual or firm has a monopoly when it has enough power and control over a particular product or service to determine terms of access to it. Where monopolies exist, there is a lack of competition and there are no substitute goods present. (Case & Fair, 2007) To understand why firms prefer to be in a monopoly, rather than be involved in a perfectly competitive market, let us define some concepts that would be used in the explanation. Single Seller In a monopoly, there is a concept of one seller of a good who is responsible for the production of all the output of that good. This means that the firm and the industry are identical as the industry is made up of just one firm. In a perfectly competitive market, however, there is an infinite number of sellers selling the identical goods. Market Power Market Power is defined as a firm’s ability to have an effect on the terms of exchange of the good it deals in. Basically, it is the degree of freedom with which the firm can set its price. Monopolies are considered to practice great market power. However, that does not mean that their market power is absolute. (Case & Fair, 2007) A monopoly has a downward sloping demand curve which shows that demand has some degree of elasticity in it. Price changes by a monopoly, therefore, do affect the demand and monopolies also aim to maximize profits by setting the right price. Barriers to Entry Becoming a monopoly is the ideal stage for any firm. It gives the firm authority and flexibility in setting prices and maximizing profits. There are several ways through which monopolies retain their dominant position in the market. These are known as Barriers to Entry. Barriers to entry are those factors in the industry that act as hindrance for competition to enter the market and helps monopolies retain their position. There are three main kinds of barriers to entry namely, economic, legal and deliberate. (Case & Fair, 2007) BARRIERS TO ENTRY AND THEIR ADANTAGE FOR MONOPOLIES Economic Barriers These barriers consist of economies of scale, cost advantages, capital requirements, and technological superiority. Economies of scale mean declining costs in the production of additional units of goods. This happens because as the production increases, the fixed costs get divided over more units and, keeping the variable cost same, the per unit cost of production decreases. When this and the high cost of setting up a business are put together, they hold back many prospective competitors from entering the industry. Monopolies usually are large firms that are practicing economies of scale. Their production processes have large investments of capital and they have a huge Research and Development department. That coupled with the access to technologically advanced equipment and facilities, monopolies can produce innovative and far more technologically advanced products than any would be competitor entering the market could. Legal Barriers A firm may use legal rights to sustain its competitive advantage in the market. When capturing a new market with an innovative product, the firm can get intellectual property rights like patents and copyrights for its idea, product, service etc. This prevents competitors from copying the good and entering the market for the period of time specified by the patents or copy rights. Deliberate Actions When a firm is a monopoly in a market, it is equal to that industry. This gives the firm authority and power in negotiating terms with external forces. The firm can use this power to keep competition out from the market. The firm can take actions such as collusion, lobbying governmental authorities, and force. MONOPOLY VERSUS COMPETITVE MARKETS As discussed previously, monopolies have the position to practice market power. For perfectly competitive markets, however, this is not the case. Perfect competition means that there are infinitely many competitors selling the same good (Salsman, 2000). This means that a perfectly competitive firm has no power over setting the price for its products. For perfectly competitive firms, the price of the product is set by the prevailing demand and supply in the market. If the firm tries to increase the price of its product above that of the market level, it would not earn him more profits. Instead, its customers are going to shift to another firm to buy the same product. Being a monopoly is a stress free state for a firm. Unlike a perfectly competitive market, where the firms have to constantly keep a check on competition and act accordingly, monopolies need not worry about competition. They can focus on their products and production processes. They just need to cut down their costs as much as possible to maximize their profits (Ward & Begg, 2002) . INTEL FINED BY EU FOR PREDATORY PRICING It is very difficult to conclude that Intel undertook predatory pricing. In fact, it is very complicated to reach a decision that a firm is guilty of predation. Instead of predatory pricing, the reason for Intel’s success and AMD’s stumbling and failing could be AMD’s own inefficiency or poor performance products as compared to Intel’s. Moreover, it is very hard to deduce if Intel is pricing its chips below the cost. Even if there is a price-cost or profit-sacrifice test available and feasible and Intel fails it, it would not prove that Intel’s intentions were evil. There could be other reasons for Intel offering high discounts and rebates to its customers. For instance, if Intel came up with a new microprocessor and wanted to launch it, it might prefer to sell of the existing microprocessors that are present in the market at the lowest possible price in order to save on the losses. It, very clearly, depends on the demand of the product also. Perhaps, the reason why the big retailers and wholesalers are signing deals and contracts with Intel is because they, being an essential part of the distribution channel, know exactly what the customer demands and what sells. Perhaps, the deals and contracts are a mere reflection of the fact that the customers demand Intel more and AMD less, and not a strategy by Intel to eliminate the existence of AMD from the competition There is no doubt about the fact that Intel proposes huge discounts and deals, along with rebates for its special customers. But again, it is not evident that these actions are intended to wash away competition or not. AMD is the only prominent competitor that Intel has. If Intel gives discounts to its customers with as proportional to the amount of business that those customers give the company, it is hard to justify how it is wrong. Is it even right to call it predatory pricing or is it simply competition? This is a debatable question that puzzles many entities. (Nocera, 2008) In Intel’s case, it is like saying that discounts are bad. However, price competition is one of the main elements of capitalism and is the consequence of competition and low prices and discounts act as a benefit for the consumers. Much of the discounts are probably a result of Intel’s long existence in the industry and its large dominant position in the industry. Due to this, the company has achieved great levels of economies of scale. Perhaps, Intel just passes down the savings in cost to lower prices for consumers, and that too is a benefit for the consumer. (Nocera, 2008) Nonetheless, looking at things from another angle gives a different picture of the company altogether. AMD’s allegations on Intel have been reflective in different articles by different authors. Suppose a computer manufacturer is experiencing a decrease in sales. When it goes to Intel for a contract, Intel tells it that due to the decrease in sales of the computer manufacturer, Intel would not be able to give many discounts to it unless it shifts more of its business towards Intel. This manipulation puts a pressure on the computer manufacturers and is unethical. Such was the case with in Japan, when AMD lost its share in the market when companies like Toshiba and Sony switched to Intel because they were both losing share in the market and Intel presented them with a similar deal that they could not forgo. (Nocera, 2008) So we can see that it depends on how you look at the situation to decide as to if Intel should be considered guilty or not. From one perspective, Intel seems right playing its role in the market by adopting strategies to gain a competitive edge over its competitors. It offers discounts and signs contracts with the computer manufacturers that are mutually beneficial. Moreover, the low prices it offers are a result of the economies of scale it experiences and its production process. These discounts and low prices are forwarded to the consumers. On the other hand, forcing customers into signing deals with the company seems to be unethical. It will limit the growth of the industry in terms of the number of competitors entering or growing. If competition is eliminated, there will be no innovation and consumers could be charged very high prices. BIBLIOGRAPHY Book Ward, D. & Begg, D.(2002) Economics for Business. Second Edition. Mcgraw-hill Professional Case, K & Fair, R.(2007) Principles of Economics. Eighth Edition. Pearson Education Kotler, P & Armstrong, G(2008).Principles of Marketing. Twelfth Edition. Pearson Education Articles Arnold, R.(2005).“Competition versus monopoly: Combines Policy in Perspective”. The Review of Austrian Economics. Volume 1, No.1, pp. 231-232 Council for Economic Education (n.d.). The Choice is Us: Monopolies. EconEdLink [Internet]. Available from http://www.econedlink.org/lessons/index.php?lesson=686&page=student [Accessed 19th December 2009] Nocera, J.(2008). A.M.D. and Its War with Intel. New York Times [Internet]. Available from http://www.nytimes.com/2008/06/21/business/21nocera.html?pagewanted=2&_r=1 [Accessed 19 December 2009] Oxford Analytica.(2009) Intel Fined By European Commission. Forbes.com. Available from http://www.forbes.com/2009/05/14/intel-european-commission-business-oxford.html [Accessed 19 December 2009] Salsman, R.(2000). "Pure and Perfect" Competition? By What Standard?. Capitalism Magazine. Available from http://www.capmag.com/article.asp?ID=271 [ Accessed 19 December 2009] Skeath, S. Velenchik, A. & Nichols,L.(1992). “Consistent Comparisons Between Monopoly and Perfect Competition”. Journal of Economic Education. Vol.23, No.3, pp. 255-261. Younkins, E.(n.d.). Pure and Perfect Competition: An Unrealistic and Mistaken Ideal. Rebirth of Reason. Available from http://rebirthofreason.com/Articles/Younkins/Pure_and_Perfect_Competition_An_Unrealistic_and_Mistaken_Ideal.shtml [Accessed 19 December 2009] Read More