Monopolies in Contemporary Market - Essay Example

Monopolies in Today's Market Overview A monopoly has been a controversial in the global economic dis due to its power in controlling the market it operates. A monopoly is a market structure where there is a single seller or one provider of a kind of product or service. A monopolist therefore is a single seller or supplier of a product or service which has no close substitute. The market structure is a direct opposite of perfect competition because there are barriers to entry in form of legal restrictions, patents, regulations, tariffs, technical prowess etc. Other unique characteristics of a monopoly are its huge capital outlay and the existence of economies of scale, savings brought about by increases in quantities produced. Atimes, monopolies exist as a result of government backings in which case the monopolies provide goods, products or services which the government considers essential to the well being of the people. The absence of supply curve in the monopolized market causes inefficient allocation of society's resources. Therefore there is that tendency for a monopolist to charge high prices and probably making higher profits compared with firms in perfect competition. The objective of this paper is to unravel the role of monopolies in today's market and the implications of technology and systems on the monopolies. The rest of this paper examines different types of monopoly, its revenue, monopoly and price discriminations, and implications of technology and systems. Types of monopoly There are generally four main types of monopoly, below they are briefly explained. (a) Pure Monopoly: This is a type of monopoly that exists in a particular region or city in which its products have no close substitutes. This makes it possible for the monopolist to charge extra prices because their products are necessities. (b) Natural Monopoly: A monopoly that exists because of economies of scale it enjoys in which large scale production brings lower average cost. Even though a competitor arises in the industry lower prices the monopolist would charge is capable of sending the competitor off the market. (c) Efficiency Monopoly: When government does not legalize monopoly, a monopoly may exist largely due to its ability to satisfy the customers in which case competition is inadvertently rule out. (d) Legal Monopoly: This form of monopoly has government backing such that laws are enacted to simply rule out competition. Wikipedia says "when such a monopoly is granted to a private party, it is a government granted monopoly; when it is operated by government itself, it is government monopoly or state monopoly". Monopoly Revenue Basically, a monopolist faces downward sloping demand curve which is also the firm's average revenue curve. As the monopolist sells a single price for its products, average revenue per product is the same as the price. For the monopolist to increase its sales it charges lower unit price for its products. At price P1 the monopolist only manages to sell Q1 quantity of the product; in order to increase its sales it reduces the price from P1 to P2 and as such sales is increased from Q1 to Q2 which he now gains in figure 1 below. Given the above scenario, the differential of the total revenue in relation to quantity gives marginal revenue which shows that the additional revenue large enough to offset the reduction in price. Figure 1: Showing Monopolist's gain brought about by price reduction. However, the monopolist maximizes profit where marginal revenue equals marginal cost. The reason is the since marginal cost is always greater than zero the monopolist will operate at profit because marginal revenue will be positive and where demand is elastic. If the monopolist stops production where marginal cost is less than marginal revenue, he will be leaving his profit untapped while quantity in which marginal revenue is greater than marginal cost the firm will be operating at losses. Profit maximizing price is determined by drawing a line where marginal cost and marginal revenue intersect and project to meet the demand curve, this is drawn to meet the price axis which therefore forms the price. Monopoly and Price Discrimination In order for a monopolist to succeed in price discrimination, there has to be some monopoly power, the firm can separate markets and sell at different prices, the buyers in different markets have different price elasticities of demand and the resale of the products are prevented. When a monopolist charges different groups of people or segment of the market different prices for identical or near identical products the practice is referred to as price discrimination. The main reason a firm engages in this is to increase profit since the differences are not as a result of differences in cost. For example, if a monopoly firm discovers that customers are willing to pay more than $50 and others are willing to pay less than $50; the firm will increase the price to the former and reduce the price to the latter in order to increase sales. Figure 2: showing monopoly's price discrimination. Suppose a Toronto-based Microwave firm is protected from competition and it faces a relatively inelastic demand curve DA in Toronto market shown above. In Vancouver, the firm faces some competition and as such elastic demand curve, DB. The firm maximizes profit where marginal revenue equals marginal cost. In Toronto, the firm maximizes profit at qa in which the firm charges Pa price. In Vancouver it occurs at qb and pa respectively. In the two markets, prices charged are different, higher price in Toronto and lower price in Vancouver, therefore the firm has been able to discriminate price. In order to choose the total output, the firm compares the overall marginal revenue by adding the separate quantities in each market. Furthermore, total output that maximizes profit occurs at q where marginal cost equals marginal revenue at price c in figure 2 above. Forms of price discrimination Price discriminating practices have been classified into three general forms by economists: 1. First Order Price Discrimination: This is the case where the monopolist gets the maximum amount from the consumer who is willing to pay. This is possible when the firm recognizes willingness of the customers to pay. Examples of this form of price discrimination include prices of appliances, automobiles, and houses where there are no fixed prices. 2. Second Degree Price Discrimination: This form of price discrimination uses the quantity purchased as a basis of charging different amount. The demand curves for customer who do not demand large quantities of product are tending towards inelastic demand while the demand curves for those that demand a great deal of the products are more elastic and it makes economic sense to lower their prices and garner more profit. Examples are food stuffs bought in retail or large quantities. 3. Third Order Price Discrimination: Otherwise called Systematic Price Discrimination, this is the case where buyers are classified according to age, location, industry, income or the utility to which the product will be put to and then charging different amount for the different classes of buyers. Implications of Technology and Systems: It may seem that a monopoly exists to sap all it could from its customers but atimes this is not the case. Normally, a monopolist uses its market power to encourage innovation which in turn brings about lower prices to the customers and the society. Economists argue that comparing a monopoly with a competitive industry may be misleading because a monopoly which is protected from competition uses any advantages of cost-saving it derives by investing in research. If the research, the argue, comes out successful, the monopolist's costs will be lower than those of its competitors in the long run no matter how high it may be in the short run. Also a monopoly firm can spend a huge amount of money on advertising with the hope of increasing sales. Under perfect competition, firms do not bother about such since they can always exhaust their products in the market. Furthermore, the spending made by the monopolist on advertising causes shift in the demand curve outward; with this the firm can now increase it sales. The shift in demand curve would in turn motivate the firm to increase it volume of production. As the monopolist enjoys advances in technology however, there is that tendency bureaucratic inefficiencies, coordination problems, policy irregularities etc to set in owing largely to its increasing size. The structural imbalances are brought about by hiring more personnel, building more spaces and introducing new lines of production. However, the monopolist could eliminate these anomalies especially in the long run; in small firms this may prove very difficult if not impossible. Recent developments in the world market could be employed by a monopoly firm in order to stay afloat. If a certain department of the firm proves economically inefficient such could be outsourced to further reduce the costs. With expansion strategies in place, bulk purchase of raw materials and other factor input could result in quantity discounts which reduce operational costs much more. A monopolist has incentives to introduce cost-saving innovations. Lipsey opines "a monopoly can always increase its profits if it can reduce its costs. We have seen that a cost reduction will cause the monopoly to produce more, to sell at a lower price, and to increase its profits. Furthermore, since it is able to prevent the entry of new firms into the industry, these additional profits will persist into the long-run". Therefore, because the firm is in for profit maximization, in both short-run and long-run there are always incentives reduce costs. Real World Example De Beers' Diamond of South Africa is good example of a monopoly firm which has dominated the diamond market for about 70 years now. De Beer produces about 50% of all diamonds in the world and purchases diamonds from other producers. The results being that De Beer sells over 80% of diamonds to manufacturers and dealers. This firm is that type of monopoly that is not regulated and as such sells diamond at an "appropriate" price which is unrelated to the production cost. The company makes about 60% of total revenues yearly and rates of return on equity are over 30%. When demand for diamond is low, De Beer reduces sales in order to maintain price, this is followed by rigorous advertising so as to ginger up the demand in order to reduce it inventories by increasing sales. When De Beer notices influx of "low quality" diamonds in the market, it simply buys them up which affects its profits adversely. When this is accomplished, the market returns to normalcy and the firm continues to swim in profit. Bibliography 1. Lipsey, R., Purvis, D., & Steiner, P. (1988). Economics, (6th Ed.) New York: Harper & Row Publishers. 2. McConnel, C., Brue, S., & Barbiero, T. (1996). MicroEconomics, (7th Ed.) Toronto: McGraw-hill Ryerson. 3. Miller, R. L.(1991): Economics Today. 7th Ed. New York, Harper Collins Publishers. 4. Baumol, W. J., Blinder, A. S., & Scarth, W. M. (1994): Economics: Principles and Policy. 4th Canada Ed. Toronto, Harcourt Brace & Company. 5. Monopoly: Retrieved April 11, 2006 from http://en.wikipedia.org/wiki/Monopoly Read More