Monopolistic competition and Oligopoly questions

Monopolistic competition page 118

Productively efficient is the point where the cost is minimized. This is at MC = AC (Q2). Allocative efficiency is the social optimum point, where MC = MR (Q3). All firms wish to maximize their profits so they will produce at MC = MR (Q1). As seen on the graph, the firm is producing at Q1 so there for it cannot be allocatively efficient or productively efficient if it is not producing at Q2 or Q3.

Oligopoly page 125

When firms are non-collusive they do not agree on a price to sell. This is an advantage to consumers because the price will be lower and more will be produced opposed to a collusive oligopoly. Since changing their price will have drastic changes in demand firms need to be aware of the reaction of other firms. If an oligopoly, that is non-collusive, raises the price and the other oligopoly doesn't it, will lose consumers and thus revenues and finally profits. If, on the other hand, a firm lowers its price, then the firm will receive more profits. Other firms will follow but undercut the price to make up for lost profits. This will result in a "price war" and the price of a good will keep decreasing until at one point the firm will be selling it at a loss. The price thus remains stable in a non-collusive oligopoly market because the price cannot change without erupting into a "price war" or a loss of profits.

Monopoly question

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

All firms with to receive profits, monopolies included. A monopoly will produce at the profit maximization point, where the marginal cost meets the marginal revenue. If the monopoly's average costs are below the demand curve then the firm will be making abnormal profits. Because the monopoly's demand curve is the same as the industry's demand curve, because the monopoly is the industry it will be a downward sloping demand curve. A monopoly can change its price and level of output, but not both at the same time. If a monopoly wishes to increase its profits it will reduce it output, this way the price will increase.

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

A natural monopoly states that there is only room for one firm because there are not enough economies to scale. The economies of scale set the position of the average total cost curve.

When the revenue is higher than the cost the firm is making abnormal profits. When the first is producing between q1 and q2 the monopoly is earning abnormal profits. If another firm entered the market then the demand would decrease to D2. This way the firm will not be covering its average total cost and earn losses.

So it is more productively efficient for an industry to have one firm with limited economies of scale. If there is only one firm and it produces in the demand satisfying area on the graph then that firm will earn abnormal profits. The government usually helps regulate the monopolies, blocking barriers to entry, making the firms more productively efficient.

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

A monopoly, like all firms will produce at the point where marginal cost is equal to marginal revenue. The price will be set high with low output to increase profits, but the monopoly will not be allocative or productively efficient. With large economies to scale, the marginal cost decreases making it possible for the firm to produce more and charge a higher price.

The monopoly will produce where marginal cost is equal to marginal revenue to maximize its profit. At p1, the price of the good is higher than p2, which is the monopoly's cost; thus the monopoly is earning an abnormal profit marked in green. Allocative efficiency is where marginal cost equals average revenue at q2, but the monopoly is not producing there so it is not allocatively efficient. Productive efficiency is where marginal cost is average cost at q1. However the monopoly is not producing there either so it is not productively efficient.

A perfect competition firm needs to be very efficient both allocative and productive because by raising its price, it leaves the market.

Winemaker Monopoly

In a small town next to Pfäffikon, the town where I live, there is a wine maker and seller. It is the only wine maker in the area. When you drive through the area you will see many sloped fields filled with grape plants. These fields are owned by the wine maker. Since it is the only wine sell and producer in the area it can be regarded as a monopoly for wine. Consumers do not have to buy the wine from the wine maker in the town because they could go to the neighboring village and get foreign wine but not enjoy the local wine.

The wine maker in my town is a monopoly. It is the only firm in the market that supplies local wine from the region. It can thus make its own prices because it is unique and regional, it is a price maker. It is also the only producer of the unique wine from the region. Lastly, it frequently uses non-price competition such as free wine tasting gatherings and advertisements in the local newspaper. Furthermore, the winemaker is a monopoly because it has set high barriers to entry. For the most part the winemaker owns the entire agricultural region where he grows his grape plants.

If the winemaker were to be a pure monopoly, it would have to set higher barrier of entry, buying even more agricultural land in the region, owning all the resources and making it impossible for other firms to enter the market for the regional wine.

Monopoly