Intro_Notes_on_Monopoly - Industrial Organization (EC 460)...

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Unformatted text preview: Industrial Organization (EC 460) Spring 2009 Instructor Thomas D. Jeitschko Some Introductory Notes on Monopoly Definition : A monopoly is defined as a market structure in which there is one single provider of a good or service present in the market the monopolist. The implication of this particular form of market structure is that the prices for these goods and services are then determined by the objectives of the mo- nopolist, and are limited only by the buyers willingness to pay for the good or service. This is precisely because there are no other providers, so the monopolist is not constrained by any rival firms. The polar opposite of a monopoly is a market structure characterized as perfectly competitive usually thought of as a market with many firms that compete against each other. However, regardless of the actual number of firms, a market is perfectly competitive if each firm can essentially only charge the going market price, or otherwise risk losing all of its customers to competing firms. Profit-maximization in monopoly and perfectly competitive mar- kets : Economists usually assume that the objective of a privately run firm is to maximize the profit it makes, where profit is measured as the total revenue earned by the firm minus the total costs incurred in producing the good or ser- vice. This profit motivation is assumed to be the same regardless of the type of market structure that the firm operates in. It is instructive to contrast how this profit motive plays out in both a monopoly and in the polar opposite, a perfectly competitive market, as this will reveal how a monopolist maximizes profit and what is necessary for it to do so. One of the defining features of a perfectly competitive market is that firms can freely enter (or exit) the market. If firms are pricing above the cost of the product that is sold, firms will be able to make a profit. However, firms outside the industry are also looking to make profits, and given that they are free to enter the market, they will enter and charge a slightly lower price than the incumbent firms, but will still stay above costs. Such an adjustment on the supply side of the market increases the number of firms in the market and lowers prices competition is fiercer now than before. Provided that profit opportunities still exist in the market, firms will continue to enter; again, resulting in more competition, i.e., lower prices. This adjustment process goes on, until prices are so low that they are at or near the cost of producing the product, so that it is no longer profitable for new firms to compete in the market. Thus, a desirable feature of the perfectly competitive market is that although firms maximize profits, the end result of free entry is that goods and services are actually sold at (or near) cost, that is, with little or no mark-up....
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This note was uploaded on 03/29/2009 for the course ECON 460 taught by Professor Boyer during the Spring '08 term at Michigan State University.

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Intro_Notes_on_Monopoly - Industrial Organization (EC 460)...

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