Microeconomic Analysis of Potato Chip Industry - Essay Example

? Microeconomics 08/26 Microeconomics In 2007, the potato chip industry in the Northwest was competitively structured and in long-run competitive equilibrium; firms were earning a normal rate of return and were competing in a monopolistically competitive market structure. In 2008, two smart lawyers quietly bought up all the firms and began operations as a monopoly called “Wonks.” To operate efficiently, Wonks hired a management consulting firm, which estimated a different long-run competitive equilibrium. The new company is now a “monopoly” which is only the sole provider of potato chip in the entire country. Now, there is only a single supplier of potato chip all across the region (Brigham, 1976). As all firms decided to merge together to create a single monopoly, now there will be barriers to entry in the industry as no further firms can enter the market easily and threaten the existence of existing firms. The firm is now protected against any other foreign threat as no other firm can enter the market to compete with it. This monopoly is owned by a single firm and so the business enjoys the benefit of having the entire market share to itself without any pressure or constraints. However, this monopoly is not a natural monopoly and so it can charge its customers with whatever price suits it and gain higher profits. A monopoly also produces goods and services by producing required quantity at a price where marginal cost equals marginal revenue just like any other market structure. But, it can also choose to set a price at which quantity is demanded where price might exceed the marginal cost (Case, 1996). Monopoly is highly beneficial to society and consumers as well. Large firms usually attain the benefit of gaining from economies of scale. Economies of scale is increase in efficiency as the number of goods produced by a firm increases. Due to economies of scale, the Average cost curve goes downwards. If the fall in Average cost curve is very large so a monopolist can charge its consumers a lower price and generate a higher output than the monopolistic competition of the market. This way, monopolist maximizes the profits. Marginal cost becomes equal to marginal revenue at this point. This means that now the consumers can enjoy potato chips at a lower price than it was when the market was monopolistic due to huge producer surplus. The society gains as well (Allen, 2005). As this monopoly is privately owned, and not a government regulated natural monopoly, government does not have any say here. But it can produce revenues for the entire economy in form of more and more exports. This single firm can take advantage of economies of scale from its home economy and maintain a cost advantage through which it can exploit the international market and can sell at a relatively cheap rate abroad. Governments do gain when the economies prosper as now government receives more money in form of taxes which it can utilize in infrastructure and other welfare activities (Allen, 2005). However, the change from monopolistic market structure to monopoly does come with a lot of changes in profits and revenues. In a monopolistic competition, the industry comprise of a huge number of firms, each one of those have relatively small size as compared to total market. That is why; no firm can affect the overall market price because of its small size. But, in a monopolistic structure, firms can differentiate their output by having some control over price (Allen, 2005). The short-run equilibrium of monopolistic market is achieved by setting the price where marginal cost is equal to marginal revenue. The profits of a firm arise by entrance of similar products by different firms in the market; where every firm competes for only a percentage of the total demand. Whenever a new firm enters the market, the demand curve shifts downwards due to which profits remain no more (Allen, 2005). Now due to large entrants of firms in the market, the individual demand curve shifts to the left. Here, the zero profit condition arises where costs are equal to revenue. This is the condition for maximization of profits where marginal costs will be equal to marginal revenues. Here, the problem that arises is that production becomes cost-inefficient. The long-run average costs are not at minimum at this point. The output is same but firms have to decrease their price to compete in market at this point. So they go for differentiation (Allen, 2005). When the firm moves from being a monopolistic competitive firm to being a monopoly, it exploits consumer by producing less output at higher price than the competitive equilibrium. This situation is not efficient and producer surplus increases as consumer surplus decreases. When Average cost is equal to Average revenue, so there is no producer surplus (Allen, 2005). Monopolies charge a higher price than monopolists and less output and they exploit consumers. When market moves from monopolistic structure to monopoly, there is a dead weight loss to society. Consumer surplus was much more in a monopolistic structure than in a monopoly as profits increase due to high prices (Sloman, 2002). The market structure that will benefit Wonks to operate in will be Monopoly as they will have control over their prices. But it might not be beneficial for consumers as they can be exploited (Allen, 2005). As firms grow they can exploit their economies of scale as well too. This means that firms can manufacture potato chips at a lower cost and then carry their savings to their consumers. But, mostly these savings are not used for the benefit for the consumers but use to increase profits. These profits are however advantageous for firms as they create barriers to entry for new firms. Also, the firms are dynamically efficient in a monopoly market structure. These firms are safeguarded from competition monopolies. The potato chip firm can also use this profit for its further growth into the international market by investing in research and development. It can invest in process or product innovation for better and enhanced quality of chips. Here, consumers can benefit too as they gain from process innovation by getting more variety of chips (Allen, 2005). It is sometimes seen as a huge gain enjoyed by monopolies as because of their barriers to entry to industry, they can easily invest in innovations and inventions without fear of copying or theft. But according to Adam Smith, which I believe is the case in this scenario as well; monopolies usually go against the interests of public and produce more costs than benefits for them (Allen, 2005). There will be less choice of potato chips for the consumers. Whatever flavors are produced by the monopoly will be supplied all across the region, and consumers have no choice than to consume them. There is no competition so there are no new flavors produced by competitors; and as monopoly functions in its own interests, it will only produce the flavors which are cost efficient for it. Also, consumers have to pay high prices for chips which they wouldn’t have if there was a monopolistic market structure. This is because there is no alternative for consumers. Also, the monopolists can easily limit or confine the output or supply to a particular quantity to exploit its leading position for a period of time to boost up the price (Allen, 2005). This rise in price and decrease in output would eventually lead to a decrease in the consumer surplus. Consumer surplus is the extra net benefit that is achieved by consumers when they pay a lesser price than they are willing to pay. However, in a monopolist market structure, consumers usually pay the price that they are prepared to pay or even more than that. Consumer sovereignty is eroded as monopolist can gain control over consumers over time (Samuelson, 1976). Monopoly is also bad to society and consumers as when the firm will move from monopolistic structure to monopoly, it will make people redundant. The employment is judged by the level of output. As monopoly will create less output so it will need less people to produce it and so a lower output means lower employment in the economy and less money for people (Samuelson, 1976). As the potato chip company is the only one in the region, they will invest hugely in research and development. As a result, the monopolist might know more than consumer and can use the knowledge to exploit consumers for its own benefits. Monopolies only care for themselves and not for the overall benefit of society. Even when monopoly is distributing profits to shareholders, there is a net welfare loss to the community and the society. A net welfare loss is any loss that results from an economic transaction or from intervention by the government. This allows the economist to judge the impact a monopoly creates in society (O'Sullivan, 2001). The extra profits that can be used to put back in the economy are captured by monopoly for its own purposes. Welfare loss is loss of community and consumer benefit, with regards to producer and consumer surplus. This occurs when market is supplied by a monopoly rather than several competing firms. Thus, I stand by the notion that this monopoly will be advantageous to producers but hazardous to consumers (O'Sullivan, 2001). Bibliography Allen, W. B. (2005). Managerial economics: Theory, applications, and cases. New York: W.W. Norton Samuelson, P. A., & Temin, P. (1976). Economics. New York: McGraw-Hill. Sloman, J., & Sutcliffe, M. (2002). Economics. Harlow, England: Prentice Hall/Financial Times. O'Sullivan, A., Sheffrin, S. M., & Prentice-Hall, Inc. (2001). Prentice Hall economics: Principles in action. Needham, Mass: Prentice Hall. Case, K. E., & Fair, R. C. (1996). Principles of economics. Upper Saddle River, N.J: Prentice Hall. Brigham, E. F., & Pappas, J. L. (1976). Managerial economics. Hinsdale, Ill: Dryden Press. Read More