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monopoly-application - Market power alters the relationship...

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Market power alters the relationship between a firm’s costs and the price at which it sells its product to the market. Perfectly competitive firm takes the price as given and then chooses the quantity it will supply so that price equals marginal cost . By contrast, the price charged by a monopoly exceeds marginal cost. Important note on Monopoly It is perhaps not surprising that monopolies charge high prices for their products. Consumers of monopolies might seem to have little choice but to pay what ever the monopoly charges. But if so, why does copy of Window not cost $1000? Or $10,000. The reason, of course, is that if Microsoft set the price that high, fewer people would buy the product. People would buy fewer computers, switch to other operating systems, or make illegal copies. Monopolies cannot achieve any level of profit they want because high prices reduce the amount that their consumers buy. Although monopolies can control the prices of their goods, their profits are not unlimited. As we examine the production and pricing decisions’ of monopolies, we also consider the implications of monopoly for society as a whole. Monopoly firms, like competitive firms, aim to maximize profit. But this goal has very different ramification for competitive and monopoly firms. In competitive markets, the buying decisions of self-interested consumers and the selling decisions of self- interested producers are unwittingly guided by an invisible hand to promote general economic well- being. By contrast, because monopoly firms is often unchecked by competition, the outcome in a market with a monopoly is often not in the best interest of society. Why monopolies arise? A firm is a monopoly if it is the sole seller of its product and if its product does not have close substitutes. The fundamental cause of monopol`y is Barriers to entry. A monopoly remains the only seller in its market because other firms can not enter the market and compete with it. Barrier to entry, in turn, have three man sources. 1) A key resource is owned by a single firm The simplest way for a monopoly to arise is for a single firm to own key resources. A monopolist could command a quite high price even if the marginal cost is low. (Example market for water in a small town) or DeBeers Diamond Monopoly. 2) The government gives a single firm the exclusive right to produce some good or services. In many cases monopolies rise because government has given one person or firm the exclusive right to sell some good or service. Sometimes monopolies arise from the sheer political clout of the would-be monopolist. 1
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At other times, the government grants a monopoly because doing so is viewed to be in the public interest. The patent and copy right laws are two important examples of how government creates a monopoly to serve the public interest.
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