Monopolistic Competition and Monopoly
Introduction
In economics there are four different kinds of market structures. These are monopoly, monopolistic competition, oligopoly and perfect competition. The potato chip company was previously operating in a monopolistic competitive market. There are certain characteristics of such a market. There are many buyers and sellers of commodities in the market therefore the firm is a price taker. It cannot control the price of a product although it has a level of influence over the price. The consumers assume that there are non-price differences in the products of the different businesses. The business tends to differentiate their products in order to attract and retain customers. There are very few barriers to businesses in their efforts to enter and exit this market.
As long as there is profit to be earned in that market, the businesses will enter the market in order to earn profits. The company through product differentiation is able to raise its products prices as the customers are loyal to its products. In the market the consumers have all the information on the products in the market and their non-price differences
A monopoly is a market structure whereby there is a single seller of a certain commodity in the market. The firm is therefore able to sell its products at a certain price that it desires. A monopoly is a company where the market demand is the same demand it faces for its products. Secondly, a price increase in its goods does not cause a decrease in the demand of its goods. Other firms are not able to enter the industry due to certain high barriers of entry such as the size of capital required or market regulation by the government.
The company is able to influence the prices of the goods. It is able to charge any price however it is limited to the demand of the market. The firm is the industry itself. The company engages in price discrimination. It charges lower prices for its products in highly elastic markets and charges high prices in the markets with less elasticity. Price discrimination occurs in a market that has fulfils certain conditions. The company could have a lot of market power, the consumer demands for goods and services differ or the company has the ability to prevent or arbitrage profit. A monopoly enjoys the three conditions necessary to effect discrimination.
There are various advantages and disadvantages of operating as a monopoly to different stakeholders. However the benefits of a monopoly are marginal compared to the weight of the disadvantages. This paper will discuss the disadvantages and advantages of a monopoly market structure and show that it is not the best system to have. It is only beneficial to the firm since it earns supernormal profits.
Benefits of a Monopoly to Different Stakeholders.
There are several advantages that will accrue by the existence of the Wonks monopoly in the market. A monopoly produces goods in large scale in order to earn high profits. They are no other competitors in the market therefore the goods will definitely be sold. Due to the mass production, a monopoly can enjoy economies of scale. It can therefore charge averagely lesser prices of goods that companies in a competitive market would not be able to charge.
This leads to an increase in the consumer welfare. Monopolies ensure there is no duplication of production of goods and services. This helps in helping to avoid wastage of resources. In a monopolistic competitive market, the business spends a lot of resources in producing differentiated products and engaging in marketing efforts such as branding and advertising. These are costs that the monopoly does not incur. There is a concern that this kind of market structure causes the consumers to spend more on a product due to advertising or a brand name and not because of the good or superior qualities of the product.
The monopolies are also able to apply price discrimination whereby the people in the society who are not so financially well are able to purchase the products at a cheaper price. However, Wonks will be forced to compete in the international markets. It will have to create a competitive advantage in the global market place through research, development and innovative technology. The supernormal profits that monopolies make in the local market are used by the company for research and development.
Price and Output Determination in Monopolistic Competition and Monopoly structures
In a monopolistic competitive market, the firm faces competition from other firms. The company has to differentiate its products in order to gain some price control in the market. The company in the short run behaves like a monopoly however in the long run it will be operating in a perfectly competitive market. In the short run, it is the only company producing its unique product. The consumer cannot find perfect substitutes for the firm’s products. In the long run however, more firms enter the market and the company’s product no longer enjoys a differentiated advantage.
The demand curve for the monopolistic curve becomes flatter and flatter as the firm’s demand decreases. The prices will also go lower in the market. In the long run, the monopolistic competitive firm will still sell their products at the point where MC=MR, however the demand curve of the firm has become flatter, causing the average revenue and average costs to dip lower (Spence, 1976). As more firms enter the market, the company will no longer be able to set their product prices higher than the average costs. The company earns no economic profit. At this point there will be no entry in this market. Shortly firms will start leaving this industry to start looking for profits. This will be the long-term equilibrium of the firm. The prices will go down benefiting the customers. The output of the firm will also be reduced.
In a monopoly however, both in the short and long-run, the company will charge higher prices for lower output. The differences in the output in the two markets will be that the products in the monopolistic market will be differentiated unlike the products in the monopoly. The monopoly will not have the need to differentiate its products to attract customers as it does not face any competition. In a monopoly, there is the tendency for the company to restrict output so that it can influence the prices of the goods. The lower output will definitely push the prices up. In the short run, both the monopolistic competitive and the monopoly firm are inefficient, producing less output while charging high prices. as shown below.
In a perfect market, the price of the product will be at the point where market demand is equal to market supply. This shows that there is allocative efficiency in the market. However for a monopoly, the profit maximizing point is where the company will produce quantity Qm at a price of Pm. This shows that the consumers will be paying a higher price for lesser goods in comparison to the market conditions in a perfectly competitive market. The firm is selling its products at a price higher than the average costs leading to inefficiency.
Wonk’s Beneficial Market Structure
The Wonk’s company should operate as a monopoly. In this market structure, the company makes supernormal profits both in the long run and in the short run as its product prices are above the average costs. The company also does not incur high costs in differentiating and marketing its products. It invests more in research and development.
The monopoly market structure is not in the long run beneficial to the consumers. The monopoly has inefficiencies where it charges higher prices for products yet it produces less output in the market (Skeath, Velenchik, Nichols & Case, 1992). These actions lead to a deadweight welfare loss for the consumers in the market. There are also costs of monopolies that impact the economy. The monopoly will use part of its supernormal profits in rent-seeking behavior. It will aim to influence the government administration to allow it to remain a monopoly by creating or maintaining the existing barriers of entry (Cowling & Mueller, 1978).. Price discrimination is not also beneficial to all the consumers. There are consumers who will end up paying higher prices for a product than if a single product was being produced in that market. Price discrimination in these markets tends to lower consumer welfare (Cowan, 2007). The government usually steps in to control monopolies by introducing price regulation. This is to limit the monopolies from exploiting the consumers leading to loss in social welfare.
The consumers will benefit more when the company operates in a monopolistic competitive environment. The firm will be forced to be innovative in differentiating its products to satisfy customer needs and wants. There will be a variety of goods for the consumers to choose from. The customer therefore gains from the constant improvements in the products. The monopoly firm has no incentive to improve in its product or production processes as there is no competition in the market place. In the short run, both the monopolistic competitive and monopoly firms are inefficient charging higher prices for their products. However in the long run, the consumer benefits in the monopolistic competitive environment since more firms will enter the market and the market inefficiencies will be eliminated.
Conclusion
The aim of any company is to make a profit. The company should therefore continue operating in the monopoly as it will get supernormal profits. However the monopoly causes loss in consumer welfare. It operates in allocative inefficiency of resources. It produces less goods and charges high prices. It does not really invest in innovation and a huge chunk of the supernormal profits it earns is spent in pressuring the government to let it continue as a monopoly.
References:
Cowan, S. (2007). The Welfare Effects of Third-Degree Price Discrimination with
Nonlinear Demand Functions. The RAND Journal of Economics, 38(2), 419-428
Cowling, K & Mueller, D. (1978). The Social Costs of Monopoly Power.
The Economic Journal, 88(352), 727-748
Skeath, S., Velenchik, A., Nichols, L. & Case, K. (1992). Consistent Comparisons
between Monopoly and Perfect Competition. The Journal of Economic Education, 23(3), 255-261
Spence, M. (1976). Product differentiation and Welfare. The American Economic Review,
66(2), 407-414.
