Price Regulation, Perfect Monopoly - Essay Example

Perfect competition exists when one firm is the only producer of a particular product in the market for whichthere are no substitutes. The existence of a perfect monopoly can be explained by the presence of entry barriers such as economies of scale and ownership or control of essential resources. There are two price-setting options that create different tradeoffs; they are single price and price discrimination. The demand curve for a monopolist is the market demand curve. Price regulation can be introduced to reduce partially or wholly the bias of monopolists to under allocate resources and to secure substantial profits. Perfect Monopoly Perfect competition exists when one firm is the only producer of a particular product in the market for which there are no substitutes. Some of the best examples are professional sports leagues and public utilities. Monopoly is characterized by an exclusive seller whereby the firm and industry are identical. It is also characterized by unique products. In the business, there are no similar replacements for the firm’s products. The firm has monopoly on price determination; it has significant control over prices because it can regulate the quantity of supplied product. Entry or exit from the market is also blocked (Goldberg 152). Barriers to Entry One of the major barriers is economies of scale. It occurs in a market where the lowest unit cost and, hence, low-unit prices for consumers depend on the existence of only one firm. In such a market, having a large firm with significant market share is more efficient than having many firms competing (Baumol & Blinder 228). Therefore, new firms cannot manage to start up in industries with economies of scale. The second major barrier is ownership or control of particular essential resources. If an essential resource is solely owned by a single firm, other firms will find it difficult to enter the industry and compete favorably (Baumol & Blinder 221). The third major barrier is government policy. The government can give a particular firm the rights to provide certain products or services in the market. In such a case, there will be no other firms that will produce similar substitute products (Baumol & Blinder 220). The fourth major barrier is a network effect. It is the effect that several users have on the value of the product to other users. If the number of people using a particular product is high, the benefits to individuals will be high. If a powerful network exists in the market, it limits the entrance of competitors because they will fail to gain adequate number of users capable of creating rival positive network effects. The fifth major barrier is limit pricing of products. It means the already-established firm sets a low price that is often accompanied by high output. Thus, new firms in the industry will not make any profit at that price. The incumbent firm achieves limit pricing by selling its commodities at a lower price than the average total costs of potential entrants. As a result, there will be no new firms entering the market (Baumol & Blinder 221). Determining Output and Price A monopolist confronts a swapping between cost and the quantity sold. In order to sell a larger quantity, the monopolist must set a lower price. There are two price-setting options that create different tradeoffs. They are single price and price discrimination. For a single price strategy, the monopolistic enterprise sells each unit of its product for the same price to all its consumers. In the price discrimination approach, the monopolistic firm sells different units of its products at different prices to its consumers (Jain & Ohri 239). For price discrimination to be efficient, the firm must have the ability to control output and price. The market must also be segregated. At comparatively low cost to itself, the enterprise must be able to segregate customers into separate groups, each of which has a varied willingness or capability to pay for the commodity. Such separation of buyers is usually based on different elasticities of demand. The original purchaser should not be in a position to resell the product. If customers in the low-price section of the market could readily resell in high-price segment, the firm’s price discrimination approach would create competition in the high-price segment. Such competition would reduce the price in the high-price segment and undermine the firm’s price discrimination strategy (Jain & Ohri 239). Monopoly Demand The demand curve for a monopolist is the market demand curve; the quantity demanded increases as price decreases. The downward-sloping demand curve implies that the monopolist can only increase sales by imposing a lower price. Cheaper cost applies not only to the additional output sold but also to all preceding units of output (Hall & Lieberman 298). The monopolist is a price maker. All imperfect competitors face downward-sloping demand curves. Thus, firms enjoying monopoly can influence the total supply through their own output decisions. For example, they can influence product price by changing the market supply. In deciding on what volume of output to produce, the monopolist is also indirectly determining the price it will charge (Sexton 356). The monopolist also sets prices in the elastic region of demand. If demand is elastic, any reduction in price will raise total returns. Consequently, when demand is inelastic, a reduction in price will lower total returns. Therefore, the monopolist will never choose a price-quantity combination where price reduction makes total returns to decrease. A profit-maximizing monopolist will continually want to avoid the inelastic section of its demand curve in preference to some price-quantity combination in the elastic range. In order to get to the elastic region, the monopolist must lower price and increase output (Sexton 362). Economic Effects of Monopoly One of the effects of monopoly is on price, output and efficiency in production. A monopolist finds it beneficial to sell a less-significant output at a higher price than what competitive producers can do. Monopoly does not generate productive or allocative efficiency. Monopolistic price is higher than competitive price and also surpasses the least average total cost of production. A monopolist finds it profitable to restrict output and, thus, use fewer resources than is warranted from the consumer’s standpoint (Hirschey 464). The second economic effect of monopoly is the income transfer. Monopoly shifts income from consumers to the stockholders of monopolistic firms. The monopolists impose a higher price than would a purely competitive firm with the same production costs. The monopolistic profits are not equally distributed because higher income groups largely own corporate stock. Thus, the owners of monopolistic enterprises benefit at the expense of consumers who overpay for the product. The third economic effect of monopoly is costs complications. Given identical costs, a purely monopolistic enterprise will charge a higher price, produce smaller output, and designate economic resources less effectively than an essentially competitive enterprise. However, costs may not be equal for essentially competitive and monopolistic yielders. The costs incurred by a monopolist may be either larger or smaller than that incurred by solely competitive firm. There are four main reasons why costs may differ. They include economies of scale, X-inefficiency, monopoly-preserving expenditures, and long run prospective that enables technological advancement. X-inefficiency occurs when an enterprise’s real cost of creating any product is higher than the cheapest possible price of producing it. Regulated Monopoly Price regulation can be introduced to reduce partially or wholly the bias of monopolists to under allocate resources and to secure substantial profits. The socially optimal price is fixed where the marginal cost and demand curves intersect. Also, the fair-return price is fixed where the average-total-cost and demand curves intersect. The socially optimal price ensures allocative efficiency but may result in losses. The fair-return price generates a reasonable profit, but fails to achieve allocative efficiency (Sexton 375). Profit –Maximizing Output The marginal ratio and marginal cost helps the monopolist in determining the profit-maximizing output. The monopolist does not impose the highest price possible; instead it maximizes profit where the difference between TR and TC is the greatest (Baumol & Blinder 224). Thus, profit depends on the price as well as the quantity sold. The monopolist can charge a price that buyers will pay for that output level. Hence, the price is on the demand curve. Though losses may occur in monopoly, the monopolist will not persistently run at loss in the long run. A monopolist would sell at a lesser output and impose a greater price than would pure competitive enterprises operating in the same market. Income distribution is more uneven than it would be under a more competitive scenario, unless in a situation where the government regulates the monopoly and precludes monopoly profits. When a monopolist creates significant economic inefficiency and appears to be long-lasting, regulators could use antitrust laws to disintegrate the monopoly. Conclusion In a perfect monopoly, there is a single supplier of one commodity for which there are no close substitutes. The existence of a perfect monopoly can be explained by the presence of entry barriers such as economies of scale, ownership or control of essential resources, and pricing or other strategic actions. Given the same costs, a pure monopolist will find it beneficial to limit output and charge a higher price than would other sellers in a competitive market. Monopoly transfers income from consumers to owners of monopolistic firms. A monopolist can increase its profit through price discrimination provided it can segregate consumers on the basis of elasticity of demand or if its product cannot be transferred between segregated markets. Works Cited Baumol, William J., and Alan S. Blinder. Study guide [to] Microeconomics, principles and policy, 11th edition. Mason, Ohio: South-Western/Cengage Learning, 2009. Print. Goldberg, Kalman. An introduction to the market system. Armonk, N.Y.: M.E. Sharpe, 2000. Print. Hall, Robert Ernest, and Marc Lieberman. Microeconomics: principles & applications. 5th ed. Mason, Ohio: South-Western, Cengage Learning, 2010. Print. Hirschey, Mark. Managerial economics:. 11th ed. Mason, OH: Thomson/South Western, 2006. Print. Jain, T.R., and V.K. Ohri. Principles of Economics. Delhi: FK Publications, 2010. Print. Sexton, Robert L.. Exploring microeconomics: pathways to problem solving. Fort Worth, TX: Dryden Press, 2012. Print. Read More