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Micro Economics - Essay Example

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Monopoly is a market where there is one firm catering to a large number of buyers. The firm sells a product which is unique and has no close substitutes. Monopoly markets have prohibitively high entry costs. The firm sets its price and quantities to maximize profits…
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Micro Economics
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Download file to see previous pages The maximization of profits by a monopolist is shown in the diagram below. The necessary condition is that the marginal cost equals the marginal revenue and the sufficient condition is that the marginal cost curve has a greater slope than the marginal revenue curve at the intersection (Koutsoyiannis, 1975). Observe since the equilibrium price is higher than the average cost of production the equilibrium output, the monopolist makes a profit. This profit is shown as the shaded region in the diagram. Figure 1:Monopolist's equilibrium A typical reason for monopoly to occur is increasing returns to scale. If a particular firm has increasing returns to scale in any particular commodity, it has a natural advantage over any other firms in that market. This situation is known as natural monopoly. Monopoly can also occur through government regulation. There can be particular sectors in the economy that government run institutions run. Private entrepreneurship is not allowed. It may also be these industries require so high overhead costs private producers can’t afford it. The biggest disadvantage of monopoly is that it leads to exploitation of consumers. Particularly, this is true if the monopolist uses price discrimination to extract the entire consumers’ surplus. However, as first argued by Schumpeter (1950), the monopolist’s extraction of surplus is essential for economic growth. In competitive markets, the producers have to be content with zero profits. Investment returns are normal. Consequentially, the firm cannot invest in research and development which drives technological growth and innovation. However, since the monopolist is able to derive a surplus, it can invest this in research and development funds to attain technological competence. This is crucial for the monopolist or other big firms in order to retain their status as market leaders. And typically, technological innovation is what drives economic growth since it enables the resources of the economy to become more productive thereby breaking free of capacity constraints (Varian, 2006). Therefore, an economy can have benefits as well as damages if a monopolist is in charge of a particular market. Monopolistic competition however is a market which combines features of Monopoly as well as perfect competition. Monopolistic competition is a market comprising of numerous buyers and sellers. However, unlike perfect competition, here products are differentiated. Every seller thus is a monopolist for his own product (Ison & Stuart, 2006). The producers now are not mere price takers. They simultaneously set price and quantity to maximize prices. However, entry is costless and therefore as long as there are positive profits, new firms enter the industry. As a result, monopolistically competitive firms can only earn zero profits in the long run equilibrium (Varian, 2006). Typically, monopolistically competitive markets are what we observe the most in the real world (Koutsoyiannis, 1975). Markets start off with very few producers, but attracted by profits new firms enter. As competition intensifies, firms try to differentiate their products through advertising or introducing new varieties. The biggest advantage of monopolistic competition is that firms offer horizontally as well as vertically differentiated products and this results in better matches with consumer preferences. In the long run, there are no barriers to entering or exiting the market. As long as firms make supernormal profits, new firms ...Download file to see next pagesRead More
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