The monopoly market structure - Essay Example

? Economics For Business of the INTRODUCTION: Monopoly is the type of market structure where there is only one company offeringthe products or services. As there is only one provider, the consumers do not have any other option than to avail the products or service from that particular provider (Brickley& Zimmerman, 2009). This report analyses the monopoly market structure and the reasons why it is considered an inefficient market. Also, the report discusses why it is preferable to have a monopoly market structure in some sectors than perfect competition. Monopoly Monopoly is a market structure where there is a single producer or seller of the product in the market with no substitutes available. This means that the ultimate power lies with the producer or seller and not with the consumer. In other market structures, the authority to choose a product is in the hands of the consumer, but in a monopolistic market there are no substitutes available, and the consumer has to accept what is being offered to them (Arnold, 2008). Monopoly is considered inefficient due to the fact that the market doesnot have any substitute of the product giving the producer or seller an authority to set prices according to their need (Froyen, 2009). They usually discriminate regarding the prices and charge higher than the marginal cost of production in the market. Such market does not focus on the consumers as they are aware that no matter what happens, the consumers will choose their product even if the quality of the product is below the standards. In such a market structure, the barriers to entry are high giving no or little entry positions to other businesses. As a result of the barriers, there is no competition or rivalry in such market (Leamer, 2009). This market is considered inefficient than the other market structures because this market produces less output as compared to others. With no competition, reduction in the output level leads to high prices. It also creates inequality because it converts the consumer surplus into producer surplus. This inequality between the price charged and the marginal cost makes this market inefficient. This means that there is price discrimination in such market and some consumers have to pay higher prices (Gartner, 2009). In monopoly the output level is less and creates unemployment of the resources. The resources are not properly and efficiently utilized as compared to other market structures. In such market the price is greater than the marginal cost which becomes a burden on the consumers. The consumers are not satisfied with the production as the price is higher and the availability of the product is lower to create artificial scarcity - by this way the market can earn high profits(Gartner, 2009). Such a market structure is considered inefficient as it provides an advantage that the market is independent. It lets an authority manipulate price to increase profit whereas in perfect competition the actions of each firm is dependent and the firm cannot charge high prices because of competition. (Economics Help) The monopoly is inefficient in allocation because the price is greater than the marginal cost. By increasing the price of the product the market can earn higher profits as compared to other market structures (Green region in the above graph), but by reducing the price of the product (PM to P1) the market will have to sell more quantity of the product (QM to Q1) which will be the combined loss of both the consumer and the producer surplus (Pink region in the above graph). The Average Cost (AC) curve is higher than normal which shows that monopoly is productively inefficient because monopolist does not have to face competition to reduce cost to the lowest possible level. It means that the monopoly is ineffective in the production of goods (Williamson, 2008). Monopoly markets rarely innovate as they are aware that there are no competitors in the market, and they are the sole producer of the product whereas in perfect competition the products are timely and effectively innovated to keep attracting the customers because of stiff competition in the market. They also have to assure greater quality products than the rivals to maintain their superiority, but on the other hand, the monopoly markets ignore such concerns and provide their customers with low quality products at higher prices (Mankiw, 2009). There are not much of choices available in the monopoly market as there is a sole producer and supplier in the market. The consumers have limited choice in such market whereas in perfect competition there are many substitutes and alternatives available in other market structures. The focus of monopoly market is on earning higher revenue rather than satisfying the customers with their products; whereas in perfect competition, organisations strive hard to make sure that their customers are satisfied. The reason behind such an objective is no competition which reduces the consumer’s sovereignty, but in perfect competition and in other market structures the aim is to satisfy the consumers which would ultimately help the firm to earn profit (Mankiw, 2009). Why Monopoly Is Preferred InSome Sectors Monopoly might be preferred in some sectors to control the price of the goods or services for their unique and differentiated products in the market. This prevents such market structure to be influenced and to set their prices according to the situation. This means that the sector wants to be price maker rather than price taker. By keeping the producers or the sellers limited can give the sector a competitive advantage (Mankiw, 2009). Such market structures are rarely observed as it gives total authority to block competition from entering the industry. Some common examples for such market structure are gas and electric companies, water companies, local telephone companies, etc. This market structure provides the sector with an opportunity to increase its profit by charging different prices to different buyers. For example, in some regions an electricity providing company charges commercial and residential areas differently based on the fact that each of the sectors is different. Another example for price discrimination can be seen in airlines where business travellers are charged higher than other passengers while other passengers are charged lower based on their demands. The reason that business travellers are charged higher is because their demand for travel is inelastic. The main reason for such price discrimination is to increase the profit or revenue and givethe opportunity to convert the consumer surplus into producer surplus(Mankiw, 2009). Another reason why the monopoly might be preferred in some sectors is survival. This could be only possible when the sector restricts the entry of competitors in the market. This could help the sector to acquire profit even in the long run and could help to transfer the income from the customers to the owners (Williamson, 2008). Monopoly is preferred in some cases to achieve economies of scale. This means that the increase in efficiency of production would lower the average cost per unit through high production. This could also act as an entry barrier that could protect the particular sector from competition because when new firms would try to enter the industry they would have to be large-scale producers otherwise the newly established firm might not be able to obtain profits for survival or growth. Because of this reason, the competitors hesitate to make any efforts to enter such sectors (O'Sullivan&Sheffrin, 2003). This market structure gives an opportunity to create supremacy over the sector and eliminates threats from competitors as the firm established itself in the industry. With no substitutes available in the market, the sector can produce quality goods efficiently and can reduce its overall average cost because of the high fixed cost that has been incurred in order to manage such a business. The sector has complete control over the output level of the commodity, and it provides the sector with an advantage to influence the price (O'Sullivan&Sheffrin, 2003). In other market structures the action of a firm in the industry is basically dependent on one another, and the firms have to consider every angle before reacting as other firms in the industry are competing against each other. But in a monopolistic market each of the actions is independent and would not affect any other sector of the industry. Some sectors prefer monopoly because in the short run they have an opportunity to maximize the profit by setting the prices higher or minimize the loss by reducing the output level to an extent that the marginal or the additional revenue becomes equal to the marginal cost. In long run the sector can also earn high profit because there will be no competition in the market for the product. But the case would not be the same in other market structures because of high competition in the market for profit and market share (Wessels, 2000). Some sectors prefer monopoly because it gives them an advantage to supply the whole market with products. Since the marginal revenue is not constant,these sectors can earn more by either selling more output at higher price to earn more revenues or they could simply reduce the price of the commodity and increase the output level in the market which would also lead to higher revenues (Wessels, 2000). Solution of the Problem The imposition of a one unit sales tax on the output of a monopolist will result in increasing the overall prices of the product as the monopolist will directly increase the price in order to overcome the increase in the cost due to the imposition of the one unit sales. This can be shown with the help of calculations as below: In order to get the equation for total revenue we will multiply p with q: As we know the monopolists firm maximize the profit when marginal cost is equal to the marginal revenue. So in order to calculate the profit maximization quantity and price, it is important to first calculate the marginal cost and marginal revenue. In order to find the marginal cost we will calculate the first derivative of total cost function: Similarly, in order calculate the marginal revenue, we will calculate the first derivate of total revenue function: The profit maximization point will be when marginal revenue will be equal to the marginal cost, hence: As it is given that: If ax2 + bx +c = 0 then x= So, Now, And We will ignore the first equation as it will result in the generation of negative value for output quantity which is not possible, hence taking second equation: So the profit maximization level of output is 1.21 in this case, the price at this level will be: This situation is depicted in the graph below: Now, if one unit sales tax is imposed then this will lead to increasing the marginal cost of the firm. Hence the new marginal cost curve will be: So the profit maximization output quantity in this case will be: As it is given that: If ax2 + bx +c = 0 then x= So, Now, And We will ignore the first equation as it will result in the generation of negative value for output quantity which is not possible, hence taking second equation: So the profit maximization level of output is 1 in this case, the price at this level will be: So this shows that the profit maximization price will increase by almost one unit. This is shown in the graph below: CONCLUSION Monopoly is considered an inefficient market structuresince there is only one seller and the seller can charge higher prices from the customers than in the case of the perfect competition. However, considering the nature of some sectors, it is preferable to have monopoly market structure. For instance, it would be preferable to have one company offering electricity throughout the city at the amount of fixed cost that has been involved in operating such a business. Therefore, it depends on the costs that has been involved in the overall business, and if the cost is very high to operate such businesses, then it is better to have one company rather than several firms because it will allow the company to lower their average costs through economies of scale; thus, the customers will get the product or service at a lower price. References Arnold, R. (2008). Economics.Mason, OH: South-Western Cengage Learning. Brickley, S., & Zimmerman, J. (2009).Managerial Economics and Organizational Architecture. Boston, MA: McGraw Hill. Economics Help. Diagram of Monopoly. Available at [Accessed 13 November 2012] Froyen, R. (2009).Macroeconomics: Theories and Policies, (ninth edition). New York, NY: Pearson. Gartner, M. (2009).Macroeconomics, 3rd edition. Harlow: FT Prentice Hall, chapter 6, pp. 150-159. Leamer, E. (2009). Macroeconomic Patterns and Stories.Heidelberg: Springer-Verlag Berlin Heidelberg. Mankiw, G. (2009). Principles of Economics.Mason, OH: South-Western Cengage Learning. O'Sullivan, A. &Sheffrin, S. (2003). Economics: Principles in Action. Upper Saddle River, NJ: Pearson Prentice Hall. Wessels, W. (2000).Economics.New York, NY: Barron’s Educational Series. Williamson, S. (2008). Macroeconomics: Third Edition. Canada:Pearson. Read More