and Policies regarding Monopolies P116-119 1. 2. 3. 4. Explain, using diagrams, why the profit maximizing choices of a monopoly firm lead to allocative inefficiency (welfare loss) and productive inefficiency. Explain why, despite inefficiencies, a monopoly may be considered desirable for a variety of reasons, including the ability to finance research and development (R&D) from economic profits, the need to innovate to maintain economic profit, and the possibility of economies of scale. Evaluate the role of legislation and regulation in reducing monopoly power. Draw diagrams and use them to compare and contrast a monopoly market with a perfectly competitive market, with reference to factors including efficiency, price and output, research and development (R&D) and economies Where S = D in the market, (i.e MC = For a competitive firm, price equals marginal cost. For a monopoly firm, price exceeds marginal cost. AR) Price Allocative inefficient price and quantity Marginal cost Monopoly price Allocative efficient price and quantity PC price Marginal revenue 0 Monopoly PC quantity quantity Demand Quantity What do the following areas or points represent : 1. A 2. B 3. C 4. D 5. G 6. CFAO 7. DGBO 1. A = monopoly output 2. B = perfect comp output 3. C = monopoly price 4. D = perfect comp price 5. G= perfect comp equilibrium point 6. CFAO = monopoly total revenue 7. DGBO= perfect comp total revenue 8.But what is the triangle about? While a market with perfect competition will always move to the output where demand =supply (AR=MC), a monopoly will operate where MC=MR which restricts output and increases the price causing a deadweight loss 1. Pass Antitrust laws 2. 3. 4. 5. To prevent formation of mergers. To break up large companies. To prevent companies from performing activities which make markets less competitive. Establish a government department to promote competition in markets. [In NZ the Commerce Commission] Turning some private monopolies into public enterprises (usually natural monopolies). Regulate pricing – (see next 4 slides) Doing nothing at all – why not? (see end of PPT but this is where more research is needed). 1. 2. Regulating the price to Allocative Efficiency (e.g. in NZ the government runs the Rail Service) – but may have to subsidise a loss. Regulate the price to a low or normal profit situation. (no subsidy required but neither is it allocatively efficient.) Price Marginal cost Average total cost Average total cost Regulated price Subnormal profit Demand 0 Quantity Price Marginal cost Regulated price Average total cost Demand 0 Quantity Markup pricing mc AC pricing ac MC pricing mr ar Explain and illustrate why, despite inefficiencies, a monopoly may be considered desirable for a variety of reasons, including: ◦ the ability to finance research and development (R&D) from economic profits ◦ the need to innovate to maintain economic profit, and ◦ economies of scale that results in lower prices than a competitive market (even at mark-up pricing). 1. Why do governments regulate the prices in industries such as natural gas and electricity? Governments regulate the prices in industries such as natural gas and electricity as they are essential resources for society. Firms produce at the profit-maximizing level of output where MR=MC. In a natural monopoly the marginal revenue experienced by a monopolist is less than the price it charges. By default marginal cost will also be less than the price, which leads to allocative inefficiency. This will cause a shortage of electricity and prices becoming relatively less affordable. The government is concerned of the welfare of society, which is why they regulate prices in order to minimize or eliminate this allocative inefficiency. See http://blogs.pamojaeducation.com/economics/2013/08/11/monopolyto-regulate-or-not/ 2. Why would a state government think that de-regulation of the electricity industry might eventually result in lower prices in the longrun? The deregulation of the electricity industry will cause new firms to enter the industry. This will cause a more competitive market, which will help lower prices in the long run. As more firms enter the market the quantity supplied will increase, causing a decrease in the price of electricity and eliminating any abnormal economic profits made in the industry.