Monopoly: Question 3

3. Using appropriate diagrams, explain whether a monopoly is likely to be more efficient or less efficient than a firm in perfect competition.

A firms that is using resources to their maximum efficiency by producing their output at the lowest possible average total cost is productively efficient (AC=MC)
Allocatively efficient firms produce the right amount of output. There is neither under nor over-allocation of resources towards a odd. If the price was higher than the marginal cost, this is a signal that more output is desired, if price was lower than marginal cost, the signal from buyers to sellers is that less output is desired. Only when P=MC is the right amount of output is being produced. You could also write this as AR=MC.
In this diagram, the quantity at which should be produced to be productively efficient is Q1. Q2 would be the quantity which a firm should produce at to be allocatively efficient. But since a monopolistic firm produces at the quantity Q where their marginal revenue is equal to their marginal cost in order to maximize profit, it is neither allocatively efficient nor productively efficient. And they don't have to be because there is no one they have to compete with. This is the total opposite to perfect competition where firms are forced to be using their resources as efficient as possible.

In perfect competition, firms are allocatively and productively efficient when they're breaking even which all firms do in the long run. At this point, for the quantity Q MC=AC and MC=AR, and at the same time it still maximizes profits. This is only possible for firms in perfect competition due to their perfectly elastic demand curve. Since a monopoly has a normal downward sloping demand curve and another curve that represents the marginal revenue, it won't ever be able to be both allocatively and productively efficient.
In conclusion, a monopoly is less efficient than a monopoly than a firm in perfect competition since a firm in perfect competition will eventually always become allocatively and productively efficient in the long run. While a monopolistic firm will only be able to be allocatively or productively efficient if the government regulates it.

Monopoly: Question 2

2. Using a diagram, explain the concept of a natural monopoly.

An industry is a natural monopoly if there are only enough economies of scale available in the market to support one firm. In other words, this means that only a very big company who already has all economies of scale can produce the product.

This is due to the extremely high costs that only very big companies can face. Furthermore, it is more efficient when only one single firm produces the product that is being demanded. This can be shown in an example. If there are 8 firms in the market for nuclear power plants and each of those firms produces one nuclear power plant, each firm faces costs of 150 million $ while when there are 2 firms each producing four nuclear power plants, the costs faced by the each firm would only be 40 million $. But when there is only one single firm producing eight nuclear power plants, the costs for this firm are only 40 million. The difference between 1200 million $ (8x 150 million $) and 320 million $ (8x 40 million $) shows the inefficiency of more than one firm operating in such a market. This is the main feature of a natural monopoly. Furthermore, if more than one company would be in such a market, the new firm would take parts of the demand of the firm that was already in the market and thereby shift the demand curve down which would cause a decrease in price for both firms or losses for both.
The control over such natural monopolies by the government is to put a price ceiling. It is put to the point where AC= AR (in this case D) since that's when the firm breaks even. This control is necessary because without it the output the firm would make would be way to low and the price would be too high. This would mean that a lot of people would not be able to afford the product which is most of the time a necessity or to get it because there is not enough produced. But at the set price which is called the fair return price the population can afford the product and the firm is breaking even.

Monopoly: Question 1

1. Explain the level of output at which a monopoly firm will produce.

The assumption that are being made for the theory of monopoly are the following:
○ There is only one firm producing the product so the firm is the industry .
○ Barriers to entry exist, which stop new firms from entering the industry and maintains the monopoly.
○ As a consequence of barriers to entry the monopolist may be able to make abnormal profits in the long run.

Furthermore, in a monopoly the law of demand still exists which says that in order to increase the demand, the firm has to lower its price which is shown by the downward slope of the demand curve. Therefore, a monopolistic firm can't just charge any price, but has to adjust the price to the demand for the product it is selling which also effects the output the firm can make. But what - just like every other firm - a monopolistic firm really wants to do is to maximize its profits. The profit-maximizing point is where the firm's marginal cost is equal to the firm's marginal revenue. Then the firm will produce at the quantity/ output Q1.
But since a monopolistic firm often produces a necessity - most of the time a natural monopoly - , the government intervenes and regulates the price. The government does that because without the regulation the output the firm would make would be way to low and the price would be too high. This would mean that a lot of people would not be able to afford the necessity or to get it because there is not enough produced. The price the government sets is where the average revenue is equal to the average cost. At this price the firm is breaking even and the price is low enough so the population is able to afford it while the output is high enough so everybody is able to get it. This price is called fair return price.

Oligopoly

1. Explain why prices tend to be quite stable in non-collusive oligopolies.

Oligopoly is where a few firms dominate an industry. The industry may have quite a few firms or not very many, but the key thing is that a large proportion of the industry's output is shared by just a small number of firms. The product differentiation in oligopolies differ largely depending on the industry. Also the barriers to entry or exit could are differently high or low depending on the industry. The key feature that is common in all oligopolies however is that there is interdependence. As there are just a few firms in an oligopoly, each needs to take careful notice of each other's actions.
Non-collusive oligopoly exists when the firms in an oligopoly do not collude and so have to be very aware of the reactions of other firms when making pricing decisions. In such a non-collusive oligopoly price tends to be quite stable since firms neither like to raise their price nor to lower it. If a firm raises its price, it will lose consumers that will now buy the product from the rivals since their price is lower. If a firm will lower its price, the other firms in this industry will respond to that and will also lower their price in order not to lose consumers. But then another firm will lower its price further, so all the others will also lower their price. This will continue like this until the price is so low that it is beneath the average cost and the firm will experience losses. This is called price war. Due to that the price in non-collusive oligopolies will be quite stable.

But there is also another reason for the rigidity of the price in non-collusive oligopoly: the shape of the MR curve for an oligopoly. The MC curve has a vertical section. This means that if marginal costs were to rise then it is possible that MC would still equal MR and so the firms, being profit maximisers, would not change their prices or outputs. Due to the shape of this MR curve, the MC could rise from MC2 to MC1 and the firm would still be maximizing profits by producing at Q and charging P.

Monopolistic Competition

Explain whether or not a firm in monopolistic competition earning abnormal profits is productively and allocatively efficient.

The assumptions made in monopolistic competition are as follows:
○ The industry is made up of a fairly large number of forms.
○ The firms are small, relative to the size of industry. Therefore firms can act independently of each other.
○ The firms all produce slightly differentiated products.
○ Firms are completely free to enter of leave the industry since there are no barriers to entry or exit.

A monopolistically competitive firm can early earn profits in the short-run. This is because there are no barriers to entry. Such a firm will produce at the profit maximizing point, MC=MR, while its average cost is less than the price it is selling its product for.

Productively efficient is achieved at the level of output where a firm produces at the lowest possible cost per unit, at the point where AC is at a minimum. This is the point where the MC curve cuts the AC curve (AC=MC). If the firm in the diagram above would be productively efficient, it would be producing at the quantity q1 where MC is equal to AC. But it doesn't: it produces at the profit maximizing point MC=MR.

Allocatively efficient is achieved at the level of output where the MC curve cuts the AR curve: the socially optimum level of output. (AR=MC) If the firm in the diagram above would be allocatively efficient, it would be producing at the quantity q2 where MC is equal to AR. But it doesn't: it produces at the quantity q, the profit maximizing point.

A firm in monopolistic competition is neither productively nor allocatively efficient.