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10.3  Sources Of Monopoly Power

Monopoly power of a firm grants the power to the company to set the price of its product or service above the marginal cost. The sum by which the price set by the monopoly firm, exceeds the marginal cost of the same product, is inversely proportional to the elasticity of the demand the firm faces for the product.

The equation, L= -1/Elasticity of demand, shows that how the monopoly power id dependent on the demands of the products in the market. The value of L determines the monopoly power. So, greater the value of L greater the monopoly power of the firm.

So, how come some firms manage to face the demands which are more elastic than the other firms? How come, some companies manage to get the monopoly power more than the others? What is the source of the monopoly power?

The three elemental factors that determine the monopoly power of the firm also answers all three questions asked above.

  • The flexibility of the demands in the target market. The monopoly power of the firm depends on the demand of the product in the target market.
  • The number of companies. The more the number, flexibility fluctuates the more. It becomes obvious that only one among all will be able to put an affect to price setting in the market.
  • Competition among the firms. If anyone increases the price and set it to a sufficient level, the other firms will also try to capture the market fast and efficiently.

The elasticity of the market:

The flexibility of the target market and the demand curve of the market determine the degree of monopoly power of the firm. If the market has got only one firm and if that firm is considered to be a pure monopolist one; then the demand curve of the same firm is similar to the demand curve of the market. The value of the elasticity of the curve is set to lower limit with an increase in completion among the firms. But the magnitude of the elasticity of the market cannot be lowered than -1.5 for each firm regardless the completion in the target market.

Now, this flexibility also depends on the product type. For instance, the demand for oil is pretty inelastic, so the first producers of the same were able to raise the price beyond the limit. It did not affect the demand of the product. But considering other products such as;

  • Coffee
  • Tin
  • Cocoa
  • Copper, etc

The demand curves for these products were purely elastic in nature with fluctuating demands. So, setting higher prices of the same resulted in a failure rather than profit, affecting the monopoly powers of the firms.

The number of firms:

The magnitude of the demand curve keeps on falling with the increase in firms’ numbers competing in the market. As the number of companies increases in the market producing the product or service, none can set the price of the product above the marginal cost. With an increase in price the firms, risk losing the sales of the products.

But consider if, there are two companies that are holding a significant percentage of market sales. Rest of the firms are holding less percentage of the sales. It is possible that among the two large companies one will exceed the monopoly powers of the other.

Factors that hinder other companies to enter the market are:

When the market is saturated, it is hard for new firms to enter the market.

Barriers to entry; some companies maintain the patent, copyright, government license. All these forbid new firms to enter the market producing the same product or service. So naturally only a single company is able to hold the market and which does not restrict the firm to set the price high, hence the company holds a high monopoly power.

Interaction among the firms:

If there are more than one firm in the market, the competing companies should maintain interaction among themselves. This is an elemental factor in determining the monopoly power. If there are many firms, then the companies should decide about the price to be set for the products. This is necessary to avoid losing market shares.

No one company can manage to increase the price or decrease the price. As, setting the price too above the marginal cost, will lose consumers and decreasing the same, will decrease the monopoly power.

So, at those stagnant times, the companies should interact among themselves to limit the production and increase the price. This helps in maintain the monopoly power of a certain company in the target market. It is also seen that monopoly power of a firm is dynamic in nature. With a change in the demand curve, the power also changes. Some companies manage to gain high power during the beginning, but those also manage to make competitors for the long run.

10.4 Factors to limit social costs

A market can face two situations. If the market conditions are competitive, the prices of the product are usually lesser than the marginal costs. But on the other hand in monopoly powers, the prices of the product are set above the marginal cost. In the later, the production of the goods are maintained low, hence the price of the goods increases.

This may result in affecting either the consumers or the producers. This issue can be solved by comparing the curves of both the consumers and producers. When a company tries to maintain its monopoly power over the market, it loses its consumers due to higher prices. But the graph representing deadweight loss from monopoly power shows that due to monopoly other firms also fail its customers.

In total the former graph shows the social cost of inefficiency. The inefficiency is due to low produced quantity of products in a highly competitive market.

The measures were taken by the governments to limit monopoly powers:

Rent seeking: There are two triangles in the graph representing the deadweight loss. A firm can easily engage itself in those two triangles.

Rent seeking is a described as, expending a large sum of money in a product which is unproductive in a social manner. This is solely done to acquire or maintain the monopoly power. This includes;

  • Lobbying activities,
  • Campaign activities,
  • Programs to obtain regulations, from the government.
  • Advertising,
  • Legal efforts to avoid auditing

All these are done to prevent other companies from entering the target market and increase the competition. The larger the number of consumers transfers from another firm, when the amount of social cost of monopoly is larger. Rent seeking helps in convincing other companies that the monopolist firm can produce and sell a large number of products. Hence other firms do not take the risk to enter the market.

Price regulation: It is another experiment conducted by the government to downsize excessive monopoly powers. Antitrust laws prevent firms from storing large sums of money from monopoly powers.

It is generally seen that in a competitive market any type of price regulations drives the companies in the deadweight loss zone. But this same situation can be avoided if the deadweight loss zone is a result of a monopoly power.

From the graph, it is calculated that, after price regulation, new marginal revenue curve of a firm will become new average revenue curve of the same. For competitive market, if the average revenue of a firm which will be kept constant and the value of average revenue and marginal revenues are equal. To maintain the profit of the firm, the company should have the quantity determined from the graph, when the value of marginal revenue curve gets intersected to marginal cost curve.

With the decrease in monopoly power, decreases the price which increases the productivity of the product. Hence as the production of the product enhances deadweight loss declines.

Now price regulation is not that easy. If the price of the product is minimized a bit more, the quantity of production starts reducing to cope with the expenditure. It starts developing a shortage in the market. If the price of the goods is reduced further, there is a high possibility, which the firm will cease from producing the product any further and the firm goes out of business. So, price regulation can decline monopoly power or even can make the firm run out of money.

Natural Monopoly: It is a type of firm that is able to produce the quantity of the product to satisfy the whole market alone. Also, a natural monopoly firm maintains the cost to a level, which is lesser than it, can be when there are other firms with the same product in the market.

Usually, it is seen that it is most efficient to a natural monopoly firm to dominate the market, than other new firms taking part in the market to increase competition. Price regulation is often used for theses natural monopoly companies. The regulatory part of the firm may try to push the price of the product more down to avoid any competition, but reducing the price below a certain level in the graph can make the firm go out of business. During such cases, the price should be maintained where the average cost and average revenue intersects in the deadweight loss graph, which results in no monopoly profits but the company does not shut down.

Regulation in Practice: Regulation of prices for the competing firms is easy in theory. But in real practice, it is tough as well as uncertain in nature. Competitive price is considered at the point of intersection of marginal cost and regular income of the firm. While, the minimum price for natural monopoly company can be found where the intersection of average cost and demand interest of the product.

But with the change in market demands and cost curves, the result and prices may change or evolve in the real scenarios. To keep these assumptions real, they follow rate-of-return regulation. The firm has to maintain a constant return on its capital. This return process is maintained to keep the competition and the condition of the firm fair.

The rate of return is calculated on the basis of;

  • The firm’s capital stocks,
  • The actual cost of the stocks,
  • Behaviour of the regulatory agency,
  • Perception of the investors.

The regulatory agencies may face hurdles while agreeing on the values that can be earned in return. So, most of the times there are delays in price regulation or changes that have to be made to maintain the market. These lead to regulatory lag.

How to set a price cap?

The factors considered while setting the price caps are;

  • Variable costs,
  • Past prices,
  • Inflation,
  • Productivity growth.

Regulation of prices can also be achieved by price cap process. It is considered to be more flexible that the former. In this method, the firm is allowed to set the price and raise the price every year depending on the inflation in the market. But the productivity of growth is ignored in this particular method. This is an effective method to limit monopolies.

10.5 Monopsony: Meaning and definition

Often it is seen that the profit of the product and the power over the market is maintained by the seller. But the buyers can also have market power, and the consumers can use that power so that it produces the affect on price of the product to use it efficiently.

What is monopsony?

It is a term which refers to a market condition with only a single buyer. If the market has fewer customers, it is known as oligopsony.

Monopsony power is considered as the ability of the single or few buyers to affect price of the product of a firm. This power allows the consumers to buy the product at a much lesser price in a competitive market.

What is the marginal value?

This refers to the benefits a consumer can get while purchasing one extra unit of the product along with all the units of the same product. To avail this beneficial purchase, the buyer has to apply the marginal principle to buy the goods. In which the customer has to keep on buying the units until the price of the last unit proves to be profitable. The marginal value can be determined from the demand curve for the goods.

Marginal expenditure: It is the term used to refer to the extra cost paid by the purchaser to buy one more unit of the goods. This value depends on two factors;

  • Is the buyer a competitive buyer?
  • Does the customer possess monopsony power?

A competitive buyer cannot influence the price of the product. So to buy an additional unit, a competitive buyer pays the same value the consumer pays for each unit. This price is also known as average expenditure which will beper unit stance to marginal expenditure for competitive buyers.

The marginal expenditure gives the estimate to the buyer about a number of goods to be purchased. A customer should keep on buying till the price of the last unit is equal to the marginal expenditure of the product. It can be determined from the graph as the point of intersection of marginal expenditure and demand curve.

For competitive buyers, to maximize the benefits of purchasing the goods can be done by buying smaller quantity which can be obtained at lower price. For setting this price, one must consider the market supply curve to determine the cost of per unit. The supply curve is known as average expenditure curve. It is proved from the graph that if the price for one unit rises, the price of all the units raises too.

Comparison between monopsony and monopoly:

A monopoly firm can set price above the value of marginal cost. This is because of a downward slanting slope. This helps in reducing the average revenue cost.  The price calculated from the marginal cost and marginal revenue proves to be very less in the competitive market.

Furthermore, in a monopsony environment, a buyer can purchase the available goods below the marginal value of the same product. As the average expenditure curve, it is the upward sloping. So, in a monopsonist situation, marginal expenditure is more than average expenditure. The value of the product calculated from the curve proves that the prices of the goods are lower than the price of competitors with same goods.

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