Microeconomics - Inefficiencies of Monopolies

Monopolies vs. Perfect Competitions
A market characterized by monopoly has only a single seller, while a perfectly competitive market has many sellers. There are high barriers of entry with the monopoly, but little to no barriers to entry in the perfectly competitive market. Because the product of a monopolist cannot be substituted readily, the monopolist can set a higher price and still get sales. The seller in a perfectly competitive market cannot get a higher price because potential buyers always can get the product from other sellers.

Major inefficiencies associated with monopolies include:

·Allocative inefficiency - prices will tend to be higher, and output lower, than what would exist in a market with low barriers to entry. Prices will tend to be higher than both marginal costs and average total cost.

·Weakened market forces - when consumers of a product have many alternatives, producers must serve their customers efficiently in order to stay in business. If consumers can't purchase competitive products easily, the monopolist doesn't need to worry a lot about losing customers when poor service or a poor quality good is provided.

·Rent or favor seeking - firms and/or individuals will put a great deal of effort into obtaining or maintaining high entry barriers; by doing so, they hope to achieve monopoly-type profits. Such efforts enrich some people, at the expense of many others.

Price Discrimination
Price searchers effectively price discriminate among their customers when they are able to:

a) identify sub-groups which have different elasticities of demand, and
b) ensure that the customers cannot resell the good.

A common example is airline travel. Travelers who plan in advance will have a higher elasticity of demand than travelers who must travel within a short period of time.



With price discrimination, some consumers pay higher prices than they would if there was a single price. However, many in the group paying lower prices will now be getting something they otherwise would not have purchased. Universities are increasing their use of price discrimination. Tuition rates for students without financial aid are increasing greatly while the average price charged is not going up as much because more financial aid is being offered. The colleges reap high revenues from wealthy families who can afford to pay high tuition while more students from lower-income families can now attend college.

In general, higher output will occur with price discrimination. Furthermore, there may be some businesses that could not exist without price discrimination. For example, a dentist in a small town may not have a viable business without performing price discrimination.

As price discrimination increases output and gains from trade, it reduces allocative inefficiency. Firms that successfully price discriminate will benefit by getting higher revenues.

Why Do Monopolies Exist?
If a natural monopoly is to exist, the government can regulate the price and output. In the graph below, the monopolist would prefer to charge price P1 and Q1 to maximize profits. A regulatory agency will often set the price at P2. At this price, the monopolist receives enough to cover costs and, in effect, it receives a competitive rate or return of its capital. The benefits to society from the increased production outweigh the increased costs to the monopolist.

Figure 3.13: Results of Regulating Price and Output

Monopolistic Competition
Related Articles
  1. Personal Finance

    Invest in Costco? First Understand Its Balance Sheet

    A strong balance sheet sets a company apart and boosts investor confidence. How healthy is Costco based on an analysis of its balance sheets from the last two years?
  2. Investing Basics

    Brokers and RIAs: One and the Same?

    Brokers and registered investment advisors have some key differences. Here's what you need to know.
  3. Professionals

    DCF Vs. Comparables: Which One To Use

    DCF and Comparables models are widely used in equity valuation. We explain the pros and cons of each method.
  4. Professionals

    How To Make Money Using Tobin's Q Ratio

    Although it seems simple, Tobin's Q Ratio is more complex than it appears. We explore some of its main strengths and weaknesses.
  5. Taxes

    3 Secrets You Didn't Know About Estate Planning

    Every advisor and saver needs to know these three estate planning secrets.
  6. Professionals

    Cash Flow Is King: How to Keep it Running

    Why is cash flow so important, and what steps can a business take to improve it?
  7. Entrepreneurship

    10 Ways to Nurse Cash Flow in Healthcare

    Running a business in healthcare? You might want to rethink cash flow management practices.
  8. Professionals

    How to Help Clients with Cash Flow Issues

    Sometimes your spending gets out of hand or income has a hiccup. Here's how financial advisors can help clients who have cash flow issues.
  9. Professionals

    How to Improve Your Cash Flow in Manufacturing

    Here are 10 ways to to improve a manufacturer's cash flow.
  10. Professionals

    10 Ways to Improve Cash Flow in Construction

    Improving cash flow in construction requires some sector-specific strategies.
RELATED TERMS
  1. Personal Financial Advisor

    Professionals who help individuals manage their finances by providing ...
  2. CFA Institute

    Formerly known as the Association for Investment Management and ...
  3. Chartered Financial Analyst - CFA

    A professional designation given by the CFA Institute (formerly ...
  4. Security Analyst

    A financial professional who studies various industries and companies, ...
RELATED FAQS
  1. What are the differences between a Chartered Financial Analyst (CFA) and a Certified ...

    The differences between a Chartered Financial Analyst (CFA) and a Certified Financial Planner (CFP) are many, but comes down ... Read Full Answer >>
  2. How do I become a Chartered Financial Analyst (CFA)?

    According to the CFA Institute, a person who holds a CFA charter is not a chartered financial analyst. The CFA Institute ... Read Full Answer >>
  3. What types of positions might a Chartered Financial Analyst (CFA) hold?

    The types of positions that a Chartered Financial Analyst (CFA) is likely to hold include any position that deals with large ... Read Full Answer >>
  4. Who benefits the most from prepaid expenses?

    Prepaid expenses benefit both businesses and individuals. Prepaid expenses are the types of expenses that are bought or paid ... Read Full Answer >>
  5. If I am looking to get an Investment Banking job. What education do employers prefer? ...

    If you are looking specifically for an investment banking position, an MBA may be marginally preferable over the CFA. The ... Read Full Answer >>
  6. Can I still pass the CFA Level I if I do poorly in the ethics section?

    You may still pass the Chartered Financial Analysis (CFA) Level I even if you fare poorly in the ethics section, but don't ... Read Full Answer >>
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!