Monopoly and Monopolistic Competition

Notes on Monopoly and Monopolistic Competition

Monopoly is a market with a single supplier of a good or service. It emerges when there are:

• No close substitutes
• Example of something that has no close substitutes:

• Water, when it is not used for drinking, has no close substitutes for activities such as showering, washing dishes or doing the laundry.

• Close substitutes can cause competition

• Changes, such as in technology, can create substitutes
• Emergence of email has become a close substitute for mail-carrying services
• However, new products can lead to monopoly

• A Barrier to Entry
• Barrier of entry refers to anything that can protect a firm by not allowing other firms to enter the market and compete with it.
• Barriers to entry can occur from three main sources:

• Monopoly resources (Ownership Barrier): an important resource that is required for production is owned by a single firm
• Government regulation (Legal Barrier): the government can give a single firm the exclusive right to produce some type of good or service.
• Example: government license, patent and copyright laws
• The production process (Natural Barrier): a single firm can produce output at a lower cost than can a larger number of producers.
• Natural monopoly: a monopoly that emerges because a single firm can supply a good/service to an entire market at a smaller cost than could two or more firms.

A monopoly firm maximizes profit by producing the quantity at which marginal revenue equal marginal cost (just like a competitive firm). It can, however, choose the price at which that quantity is demanded. Unlike a competitive firm, a monopoly firm’s price exceeds its marginal revenue, so its price exceeds marginal cost.

For a competitive firm: P = MR = MC
For a monopoly firm: P > MR = MC                   

A monopolist often can raise its profits by charging different prices for the same good based on a buyer’s willingness to pay. This is known as price discrimination
Monopoly is inefficient because it creates deadweight loss.
Monopoly can be beneficial:

• It can lower the cost of production
• It provides some kind of an incentive to innovate.

Monopolistic Competition

In monopolistic competition: most firms posses some power to set their prices (like in monopoly), yet they also face competition from the entry of new firms (like in perfect competition)
Monopolistic competition is a market in which:

• A large number of firms compete
• Each firm has a differentiated product
• These are products that are slightly different from the competing firms’ products.
• Firms compete on marketing, price and product quality
• Firms are free to enter and exit the market
• There are no barriers to entry, yet a firm can’t make an economic profit in the long run.

Markets can be identified by:

• The four-firm concentration ration
• This is the percentage of the total revenue of the industry accounted for by the four largest firms in the industry
• The lower the concentration ratio, the higher the degree of competition
• The Herfindahl-Hirschman Index
• This is the square of the percentage market share of each firm summed over the largest 50 firms in a market. If there are fewer than 50 firms in a market, then it is summed over all the firms.
• A HHI close to 0 indicates a perfect competition, while a HHI of 10,000 indicates a monopoly.

Monopoly - Back to Economics
Monopolistic Competition - Back to SG Learn Online