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Monopolies often mean that prices will be higher and output lower than is the case for an industry where competition prevails. Firms in one industry are producing under conditions of perfect competition, while the other firm is operating under conditions of monopoly.
The costs of production are the same for each industry.
High profits made by the monopolist are not necessarily an indication of efficient methods of production. The monopolist may, in fact, be using its market power to raise prices above marginal costs in order to increase its revenues.
Under competition, firms strive to minimize their inputs to produce a given level of output. Firms do not necessarily have to produce at the minimum efficient scale to be technically efficient, as long as they produce at the lowest costs for their given scale of output. Firms which produce on the average cost curve are technically efficient or x-efficient. In other words, they produce at the lowest cost possible given their respective sizes.
Competition normally implies that firms will be x-efficient. However, if firms are insulated from competition, as is the case for monopoly, then there is less incentive to minimize costs. Firms may instead adopt ‘expense preference’ behavior by investing in activities to maximize the satisfaction of senior managers, at the subsequent sacrifice of profitability.
Monopolists as sole suppliers can discriminate between different groups of customers (based on their respective elasticity’s of demand) separated into different geographic or product segments.
A monopolist can practice price discrimination in several ways:
•First-degree price discrimination. Often referred to as perfect price discrimination, this involves the monopolist charging each customer what he or she is willing to pay for a given product. By doing this the monopolist can increase revenue and erode any consumer surplus which consumers might enjoy.
•Second-degree price discrimination. The monopolist charges customers different prices based on their usage. In other words, consumers might be charged a high price for initial usage, but lower prices for subsequent units consumed. This type of pricing has been used in industries such as electricity, gas, water and telephony.
•Third-degree price discrimination. In this case, the monopolist separates customers into markets based on different demand elasticity’s. Customers with inelastic demand are charged higher prices than those with elastic demand.
Monopolists often use unfair practices to keep potential rivals out of the market. Even if rivals are successful in entering the market, the monopolist may choose to eliminate these firms by various restrictive price and non-price strategies such as predatory pricing and vertical restraints.
Some evidence suggests that technical progress is often slow when a single firm or group of firms dominates an industry. As they face no real competitive pressures, monopolists are under no real pressure to spend any abnormal profits earned on research and development of new product and processes, which is often seen as a risky investment. Consequently, technical progress in these industries is likely to be slow.
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