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MARKET STRUCTURE: MONOPOLY

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by

Todd Cota

on 2 October 2015

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Transcript of MARKET STRUCTURE: MONOPOLY

MARKET STRUCTURE:
LONG-RUN PROFIT OR LOSS
Abnormal Profits earned in the short-run continue into the long-run, when a firm's monopoly power has effective barriers to entry.
A MONOPOLY IS NEITHER PRODUCTIVELY NOR ALLOCATIVELY EFFICIENT
Monopolies produce at the profit-maximizing level of output, decreasing the supply, which causes scarcity and an increase in price.
PROFIT-MAXIMIZING LEVEL OF OUTPUT
MONOPOLY POWER EXISTS BECAUSE OF HIGH BARRIERS TO ENTRY
ECONOMIES OF SCALE (Gains from ATC advantages)
specialization, division of labor, bulk buying, financial economies, transport economies, large machines, promotional economies
NATURAL MONOPOLY
The Industry supports only enough Economies of Scale for 1 firm (e.g. gas & electric companies)
LEGAL BARRIERS
Government protected industry, via Intellectual property rights (patents, copyrights & trademarks) --- (abnormal profits = increased inventions via R&D)
BRAND LOYALTY
Customers are willing to consume the product due to long-term loyalty or early invention of product
e.g. Band Aid, Aspirin, Granola, Highlighter (Hi-Liter), Frisbee
ANTI-COMPETITIVE BEHAVIOR
Firms behave in restrictive market practices (price wars)
Able to sustain longer term losses than competitors
e.g. Microsoft
REVENUE MAXIMIZATION
A monopolist decides to maximize revenue (MR=O) rather than maximize profits (MC=MR) , in order to grow their market share via lower prices, causing increased consumption.
WHAT DETERMINES A FIRM OPERATING IN A MONOPOLISTIC MARKET?
Only 1 firm producing the product (the firm is the industry)
High barriers to entry
Able to make abnormal profits in the long-run
A firm's monopoly power is determined by how narrowly the the industry is defined!
Monopolists Demand curve is the industry Supply curve.
Can only control Price or Output (Qd) --- not both
Profit maximization: MC=MR
If demand for a product falls, a monopolist will shut down, if not covering ATC (Average Total Costs).

ADVANTAGES OF A MONOPOLY COMPARED TO PERFECT COMPETITION
Achievement of economies of scale within a 'big industry' decreases Marginal Costs, increasing output and decreasing price.
DISADVANTAGES OF A MONOPOLY COMPARED TO PERFECT COMPETITION
Monopolies without many economies of scale, may decrease output, causing scarcity and an increase in price
3 COSTS TO SOCIETY
Productively & allocatively inefficient
Can charge higher prices due to lower output
engage in anti-competitive behavior (to maintain power in the marketplace)
A firm's monopoly power is determined by how many substitutes are in the marketplace.
A firm's monopoly power is often only within a certain product they produce or sell.
Price/Cost
Output
0
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Monopoly: Ferry Ship Producing Firm
TR MR
P Q (PxQ)

ΔTR

ΔQ
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COMPARING A REGULATED WITH AN UNREGULATED NATURAL MONOPOLY: MC PRICING & AC PRICING
MC Pricing (P=MC): Achieving a forced efficient allocation of resources.
MC Pricing leads to losses for the natural monopolist because Pmc lies below the ATC curve at the point of production, so price is too low to allow the firm to cover its average costs (loss at d-c). Marginal Cost Pricing leads to an efficient solution, it is impractical, as the losses forced on the monopolist would make it go out of business in the long-run.
PmQm represents an unregulated firm

HIGHER PRICE -- LOWER OUTPUT BY A MONOPOLY
The monopolist's MC curve is not its supply curve, because there is no single relationship between price & quantity supplied in a monopoly. The reason being that the MC=MR rule for the monopolist may result in different prices for the same quantity, depending on demand conditions for the monopolist's product.
CONSUMER & PRODUCER SURPLUS & WELFARE (DEADWEIGHT) LOSS IN MONOPOLY COMPARED WITH PERFECT COMPETITION
A+B= maximum community surplus
A=consumer surplus
B=producer surplus
C= remaining consumer surplus in a monopoly
D= increase in producer surplus
E= loss of consumer surplus (deadweight loss of consumer welfare)
F=loss of producer surplus (deadweight loss of producer welfare)


So, what’s the deal with Luxottica? The Milan-based company started off pretty small back in 1961 with now chairman Leonardo Del Vecchio selling small parts to the optical industry.

By 1971, the company was able to produce a pair of glasses from start to finish. It then began wholesaling its first collection of eyewear. Recently the Italian company has practically taken over the eyewear market from manufacturing to distribution.

Today, Luxottica has cut out the middle man. It controls the whole operation. Not only is it making the glasses it but it’s also selling them directly through Sunglasses Hut, Lenscrafters, Pearle Vision–all are owned by Luxottica. That kind of model is known as vertical integration. In addition to its 7,000 retail stores and its roughly 10 production facilities the company owns some of the brands it sells including Ray-Ban which it bought in 1999, Oakley which it bought in 2007, Vogue, Oliver Peoples, Persol, Alain Mikli, Arnette and REVO. These proprietary brands accounted for 70% of frame sales with Ray-Ban and Oakley making up nearly 45% of the sales.
IS LUXOTTICA OPERATING AS A MONOPOLY
OR
WITHIN MONOPOLISTIC COMPETITION?
Most sunglasses made by Luxottica earn the company .64 cents on the $1.
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