Monopoly.

Lecture Series No:10 

In economics, a monopoly (from Greek monos / μονος (alone or single) + polein / πωλειν (to sell)) exists when a specific individual or an enterprise has sufficient control over a particular product or service to determine significantly the terms on which other individuals shall have access to it. (This is in contrast to a monopsony which relates to a single entity's control over a market to purchase a good or service, and contrasted with oligopoly where a few entities exert considerable influence over an industry)^{[1][clarification needed]} Monopolies are thus characterised by a lack of economic competition to produce the good or service and a lack of viable substitute goods.^[2] The verb "monopolise" refers to the process by which a firm gains persistently greater market share than what is expected under perfect competition.

  

Characteristics

• Single seller: In a monopoly there is one seller of the good who produces all the output.^[3] Therefore, the whole market is being served by a single firm, and for practical purposes, the firm is the same as the industry.

• Market power: Market power is the ability to affect the terms and conditions of exchange so that the price of the product is set by the firm (price is not imposed by the market as in perfect competition).^[4][5] Although a monopoly's market power is high it is still limited by the demand side of the market. A monopoly faces a negatively sloped demand curve not a perfectly inelastic curve. Consequently, any price increase will result in the loss of some customers.

•  Firm and industry: In a monopoly, market, a firm is itself an industry. Therefore, there is no distinction between a firm and an industry in such a market.

• Price Discrimination: A monopolist can change the price and quality of the product. He sells more quantities charging less price against the product in a highly elastic market and sells less quantities charging high price in a less elastic market.

PERFECT COMPETITION

This topic the principles which guide firms in their price and quantity decisions will be set out in the short and long run. Perfect competition is defined. The demand and marginal revenue are derived. The equivalence between profit maximization and equality of marginal revenue and marginal cost is established. The long run equilibrium is studied. The economic effect of this market form is shown to be optimum for society.

Definition:

 Theoretical free-market situation where (1) buyers and sellersdegree of individualcontrol over prices, (2) all buyers and sellers seek to maximize their profit (income), (3) buyers and seller can freely enter or leave the market, (4) all buyers and sellers have access to information regarding availability, prices, and quality of goodshomogeneous, hence substitutable for one another. Also called perfect market or pure competition.

introduction:

A perfectly competitive industry is highly unlikely to exist in its entirety given the strong assumptions made about the operation of the market.All markets are “competitive” to one degree or another, but the vast majority of markets are characterised as “imperfectly competitive”. We do, though get closer to perfect competition in many markets for agricultural and other primary commodities. These are the only markets where there are enough sellers of products that are near perfect substitutes for each other.

Main Assumptions of Perfect Competition

• Each firm produces only a small percentage of total market output. It therefore exercises no control over the market price. For example it cannot restrict output in the hope of forcing up the existing market price. Market supply is the sum of the outputs of each of the firms in the industry

• No individual buyer has any control over the market price - there is no monopsony power. The market demand curve is the sum of each individual consumer’s demand curve – essentially buyers are in the background, exerting no influence at all on market price.

• Buyers and sellers must regard the market price as beyond their control.

• There is perfect freedom of entry and exit from the industry. Firms face no sunk costs that might impede movement in and out of the market. This important assumption ensures all firms make normal profits in the long run.

• Firms in the market produce homogeneous products that are perfect substitutes for each other. This leads to each firms being price takers and facing a perfectly elastic demand curve for their product.

• Perfect knowledge – consumers have perfect information about prices and products.

• There are no externalities which lie outside the market.

 LECTURE SERIES NO.9

long run costs of production

Lectures Note series No.8b

The time periods that we use in Economics can sometimes appear somewhat arbitrary – they help to provide a framework within which we can analyse the behaviour of businesses in different markets and industries, but the length of time that constitutes the short run clearly varies across industries and the reality is that most businesses can vary the amount of capital input in the short run by leasing items of machinery and renting additional commercial property and factory space if it is available.

The key point about the long run is that all factors of production are assumed to be variable, in other words a business can vary all of its inputs and change the whole scale of production. How a firm’s output responds to a change in factor inputs is called returns to scale. The hypothetical returns for a business varying the scale of production is shown in the table below

Labour Input	Plant 1	Plant 2	Plant 3	Plant 4
10	40	100	130	150
20	100	160	180	210
30	130	180	240	250
40	150	200	255	275
50	160	210	270	290
Capital Input	10	20	30	40

In the example shown when the business increases the scale of production from Plant 1 (with 10 units of labour and 10 units of capital) to Plant 2 (a doubling of the inputs used), total output quadruples. This shows increasing returns to scale leading to a fall in the average total cost of production. A further increase in scale to Plant 3 demonstrates constant returns to scale where both inputs and output have increased by 50% and a further expansion of scale to Plant 4 illustrates decreasing returns to scale where inputs have grown by 33% but output has grown by just 15%. When a firm experiences decreasing returns to scale, then average total cost will rise – in other words diseconomies of scale exist.

Economies and Diseconomies of Scale

In the long run the scale of production can be increased or reduced, because all factors are variable. This allows the firm to move on to new average cost curves. For each size of firm there is an equivalent short run average cost curve. As the firm expands, it moves on to different short run average cost curves. If expanding the scale of output leads to a lower average cost for each level of output then the firm is said to be experiencing economies of scale.

The long run average total cost curve (LRAC) shown in the diagram below is the locus of points representing the minimum average total cost of producing any given rate of output, given current technology and resource prices. The LRAC curve or envelope curve is drawn on the assumption of infinite plant sizes. The points of tangency do not occur at the minimum points of the SRAC curves except at the point where the minimum efficient scale (MES) is achieved. MES is the minimum level of output required to fully exploit economies of scale in the long run:

One way of interpreting the minimum efficient scale is to consider the cost disadvantage of producing an output below the estimated MES. Consider the diagram below. The lowest point of the LRAC occurs at an output of 90,000 per month where average total cost = £10 per unit. At an output level of ½ of MES (45,000 per month) the average cost is estimated to be £25 per unit. At an output level of just 1/3 of MES the cost disadvantage is even greater with AC rising to £40 per unit.

The steeper the fall in the LRAC up to the MES, the greater the cost advantage in exploiting economies of scale. The LRAC will tend to fall steeply when the overhead costs of production are high and the marginal costs of producing extra output are low – the classic examples of industries where this occurs are in markets such as steel production, motor car manufacturing, pharmaceuticals and computer software.

Cost Of Production

 

In the previous chapter, we examined the production process where a producer uses different factor inputs to produce goods. In this chapter, we will explain the relationship between cost and output. We aslo define the cost of production, identify various types of costs and analyze short run cost.

Definition of Cost of Production:

By "Cost of Production" is meant the total sum of money required for the production of a specific quantity of output. In the word of Gulhrie and Wallace. "In Economics, cost of production has a special meaning. It is all of the payments or expenditures necessary to obtain the factors of production of land, labor, capital and management required to produce a commodity. It represents money costs which we want to incur in order to acquire the factors of production". In the words of Campbell, "Production costs are those which must be received by resource owners in order to assume that they will continue to supply them in a particular time of production".

Elements of Cost of Production:

The following elements are included in the cost of production:

(a) Purchase of raw machinery, (b) installation of plant and machinery, (c) Wages of labor, (d) Rent of Building, (e) Interest on capital, (f) Wear and tear of the machinery and building, (g) Advertisement expenses, (h) Insurance charges, (i) Payment of taxes, (j) In the cost of production, the imputed value of the factor of production owned by the firm itself is also added, (k) The normal profit of the entrepreneur is also included In the cost of production.

Family of Costs in the Short Run:

The total cost of a firm in the short run is divided into two categories (1) Fixed cost and (2) Variable cost. The two types of economic costs are now discussed in brief.

      

(1) Total Fixed Cost (TFC):

Total Fixed cost occur only in the short run. Total Fixed cost as the name implies is the cost of the firm's fixed resources, Fixed cost remains the same in the short run regardless of how many units of output are produced. We can say that fixed cost of a firm is that part of total cost which does not vary with changes in output per period of time. Fixed cost is to be incurred even if the output of the firm is zero. For example, the firm's resources which remain fixed in the short run are building, machinery and even staff employed on contract for work over a particular period.

(2) Total Variable Cost (TVC): 

  

Total variable cost as the name signifies is the cost of variable resources of a firm that are used along with the firm's existing fixed resources. Total variable cost is linked with the level of output. When output is zero, variable cost is zero. When output increases, variable cost also increases and it decreases with the decrease in output. So any resource which can be varied to increase or decrease with the rate of output is variable cost of the firm. For example, wages paid to the labor engaged in production, prices of raw material which a firm. incurs on the production of output are variable costs. A firm can reduce its variable cost by lowering output but it cannot decrease its fixed cost. These expenses remain fixed in the short run. In the long run there are no fixed resources. All resources are variable. Therefore, a firm has no fixed cost in the long run. All long run costs are variable costs.

(3) Total Cost (TC):

           

Total cost is the &um of fixed cost and variable cost incurred at each level of output. Total cost of production of a firm equals its fixed cost plus its:

TC = TFC + TVC

Where:  TC = Total cost; TFC = Total fixed cost and TVC = Total variable cost.

Lecture Note Series No.6