Tag Archives: price

Barriers to entry in a Pure Monopoly

19 Jul

Barriers to entry a monopoly
   A pure monopoly is a market model in which entry is blocked. So what factors (barriers to entry) prohibit firms to enter this industry?

Economies of Scale
   Modern technology in some industries is such that it permits extension of economies of scale- declining ATC (average total cost). So a firm’s production price will decline if a wide range of output is produced. Given a market demand, only a few large firms, or even a single one, can achieve low average total costs. When long-run ATC is declining only a single producer, a pure monopolist will be able to produce any particular output at minimum total cost.
   If pure monopoly exists in an industry, then economies of scale will serve as entry barriers and will protect the monopolist from competition. New firms will try to enter the industry as small-scale producers but they won’t be able to produce the output at that small price produced by monopolists, so these small firms won’t be able to obtain normal profits needed for survival. A new firm might try to enter as a big producer, but the massive plant output will require very huge amount of financing, which for a new and untried firm will be very difficult to get. In most cases the financial obstacles and risks to start a big business are hinders, that’s why entering in a pure monopoly market system is rarely successful.
   There may be some cases in which market demand curve is cutting long-run ATC curve in a point where ATC curve is still declining  we say that in this case a natural monopoly exists.  So if ATC curve is declining we might say that this firm may set a lower price for its products, but this doesn’t really happen. Conversely, a natural monopolist might set its product’s price far above ATC, so that it obtains an economics profit, that’s why government has to regulate price charged by natural monopolists.

Patent
    A patent is investor’s right to use his or her own invention. Patent and patent’s law protects inventor from rivals who use the invention without helping with expenses or effort at developing it.
   Research and development is what provides our world with new amazing inventions. Firms may get monopoly power by researching or purchasing patents from other firms so they may strengthen current market position.
   The profit from one patent can finance the research for other patentable products. So, monopoly power achieved through patents may self-sustain firm, even if they eventually expire.

Licenses
   Government may limit entry into an industry by licensing. In a country only a small number of licenses for telephone operators may exist. That’s why new telephone operators can’t enter this industry. In some cases government may license itself at providing some products and that’s how it creates a pure monopoly.

Private Property
   A monopolist may use private property as an obstacle to eliminate rivals. So a firm that controls an important resource needed for production of a specific good may effectively block entry of new rival firms.

Pricing
   In some cases a monopolist may create entry barriers by cutting products’ prices, stepping up advertising, or taking other strategic actions to make entrance for a new firm difficult.

Pure Competition and Efficiency

12 Jul

Pure Competition and efficiency
      A purely competitive industry whether decreasing cost, increasing cost or a constant cost one should have some basic characteristics so that in long-run we may be able to talk about its economic efficiency. In a long Run a triple equation exists: P (Marginal Revenue) =MC =minimum ATC, which besides giving us information about economic profit or loss that our firm gains in short-run, tells us that in long-run a firm may get only a normal profit. This equation also suggests certain conclusions about Allocative and Productive efficiency of our economic unit in long-run.

   Productive efficiency requires goods to be produced at least costly way, but allocative efficiency requires goods to be divided among industries that yield most needed combination of products by society. Let’s see how productive and allocatice efficiency is realized in purely competitive market.
Productive efficiency: P= Minimum ATC
   In long run, pure competition forces firms to produce their goods at minimum average total costs and to charge price relative to cost of production, which is a situation that benefits consumers. If firms don’t use these least-cost production methods they may get high losses and at a point in time leave the market. In this case minimum quantity of resources is used to produce these goods.
   Let’s take for example a firm that produces 1000 kg of tomatoes. To cover all its cost of production it should sell all this quantity at price of 5$ per kg ( 5000$ totally). If another firm produces the same quantity for 9000$ then society will face a loss of 4000$ of alternative products. However, this loss can’t happen in pure competition, because this big loss may require our firm to leave the market.
Consumer benefits this kind of efficiency by paying lowest possible cost.

Allocative Efficiency: P=MC
     Productive efficiency alone doesn’t ensure to get the efficient mix of good, also least cost production must be used to provide society the most needed mix of products. But what does the products’ price means?

  • Price of any product is the society’s measure of marginal unit of a good. Price of a tomato is the marginal benefit society gets from using it.
  • Price of one more unit of any good is the opportunity cost society sacrifice to get it. If we produce any additional tomatoes we sacrifice growing more units of corn.

Let’s see the cases when this equation doesn’t take place.
Underallocation P>MC
     In pure competition a firm realizes the maximum profit when price of a good equals to its marginal cost. Producing tomatoes at points where MR (Price) is greater than MC (P>MC) yields less than maximum profit. This means that society is underallocating resources for producing this good, so that one more unit of tomato is valued by society higher than other products that our resources can produce.
Overallocation P<MC
   Production of tomatoes shouldn’t go beyond the price where marginal cost exceeds marginal revenue (Price). If we produce at a point where MC (marginal cost) is higher than marginal revenue, than the producers won’t obtain maximum profit. So it is an overallocation of resources to this produce. In our case by producing tomatoes at the point where (P<MC) means that we sacrifice goods used at production of tomatoes, which society values higher than tomatoes.
 Efficient Allocation
   So conclusion is that in a pure competition, firms should produce at a point where MR(Price)=MC, so that each item will be allocated efficiently in our society. To produce cucumber at a point where P>MC, means that we sacrifice production of goods, which society values very high, but at the point where P<MC it’s overallocation of resources, at production of which are used resources that may produce goods valued higher.
 Fast Adjustments
   Another important characteristic of purely competitive market is ability to change quantity output when there are some changes in consumer’s taste. So if cucumbers now become more popular initially their price will increase, so that P>MC, this fact will permit cucumber industry to take away resources from less profitable uses, let’s say potato.  So cucumber industry will expand.
   Similarly a change in supply of a particular resource will create a change in labor force, production technique or capital (machines). Thus managers have to reallocate all resources very fast until P=MC.
Invisible Hand
     Highly efficiency of allocating resources in a purely competitive market makes resource suppliers to seek to further their self-interests. This is the invisible hand which operates in our competitive market system. This kind of market system not only makes a patter to maximize profits but also maximized consumers’ satisfaction. Invisible hand operates good suppliers in such a way that society’s interests are maximized by using scarce resources.

Theory of Consumer Choices

5 Jul

Theory of Consumer Choices

   This theory will explain how consumers allocate their money among all goods and services which are available on the market.

Consumer Choice and Budget Constraint
       Rational behavior- Consumers are rational individuals who try to spend their money and to get maximum amount of satisfaction. They want to maximize Total Utility (TU) they get.
Preferences- Each consumer has different preferences. We assume that buyers have a good idea of how much marginal utility they will get after each unit of good or service they purchase.
      Budget Constraints–   At any period of time consumers have a limited quantity of money, because they can provide society only a limited amount of human and property resources. Economists call this fact budget constraint (budget limitation). Even these people who own millions of dollars face budget constraint, but it is not severe as at that people who have low incomes.
Prices– Since all goods are scarce relative to demand of them they carry a price tag. Each person purchases are minuscule relative to total demand, because they have relatively small amount of income, so that consumers may buy only a limited amount of goods.
   Consumers must choose the most satisfying mix of goods and services. Different consumers will choose different combinations of items.

 Utility-Maximization Rule
      From all possible combinations of goods and services, which are available for their budget, consumers must choose the mix that offers them maximum utility. But which combination yields more utility?
   In order to maximize satisfaction, consumers should allocate their incomes so that the last dollar spent on each product offers the same MU (marginal utility).This is called Utility Maximization rule.

Marginal Utility per Dollar
      A rational consumer must compare the extra-utility with its cost (price). Suppose you prefer coffee which is 18 UT (units of Utility, at least I call them like that) to a tea whose MU is 6 UT. Coffee’s price is 6$ but price of tea is 1$. Even if coffee provides more total UTs, but when we make a ratio between MU and price we see that coffee offers 3UT/$ but tea gives us 6UT/$. So tea offers more satisfaction than does coffee. To calculate the amount of extra-utility derived from each product we should put MU on per dollar basis.

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