Monopoly Market

Monopoly market

                The word monopoly is made up of two syllabus Mono and poly, mono means “single” and poly means “selling”. Monopoly is a form of organization in which there is only one seller of the commodity. There are no close substitutes for the commodity sold by the seller.

Characteristics

Single seller: In a monopoly there is one seller of the monopolized good who produces all the output. Therefore, the whole market is being served by a single firm, and for practical purposes, the firm is the same as the industry.

Market power: Market power is the ability to affect the terms and conditions of exchange so that the price of the product is set by the firm (price is not imposed by the market as in perfect competition). Although a monopoly's market power is high it is still limited by the demand side of the market. A monopoly faces a negatively sloped demand curve not a perfectly inelastic curve. Consequently, any price increase will result in the loss of some customers.

No close substitutes: The product sold by seller will not have any close complimentary substitute

Price maker:  Since the monopolist controls the whole supply of the commodity, he is a price maker; he can set the price and alter it.

Downward sloppy demand curve -- The demand curve of monopoly slops down from left to right. It means that he can sell only by lower price. 

Sources of Monopoly

Monopolies derive their market power from barriers to entry - circumstances that prevent or greatly impede a potential competitor's entry into the market or ability to compete in the market. There are three major types of barriers to entry; economic, legal and deliberate.

·         Economic barriers: Economic barriers include economies of scale, capital requirements, cost advantages and technological superiority.

o    Economies of scale: Monopolies are characterised by declining costs over a relatively large range of production. Declining costs coupled with large start up costs give monopolies an advantage over would be competitors. Monopolies are often in a position to cut prices below a new entrant's operating costs and drive them out of the industry. Further the size of the industry relative to the minimum efficient scale may limit the number of firms that can effectively compete within the industry. If for example the industry is large enough to support one firm of minimum efficient scale then other firms entering the industry will operate at a size that is less than MES meaning that these firms cannot produce at an average cost that is competitive with the dominant industry.

o    Capital requirements: Production processes that require large investments of capital, or large research and development costs or substantial sunk costs limit the number of firms in an industry.^[9] Large fixed costs also make it difficult for a small firm to enter an industry and expand.

o    Technological superiority: A monopoly may be better able to acquire, integrate and use the best possible technology in producing its goods while entrants do not have the size or fiscal muscle to use the best available technology. In plain English one large firm can sometimes produce goods cheaper than several small firms.

o    No substitute goods: A monopoly sells a good for which there are no close substitutes. The absence of substitutes makes the demand for the good relatively inelastic enabling monopolies to extract positive profits.

·         Control of Natural Resources: A prime source of monopoly power is the control of resources that are critical to the production of a final good.

·         Legal barriers: Legal rights can provide opportunity to monopolise the market in a good. Intellectual property rights, including patents and copyrights, give a monopolist exclusive control over the production and selling of certain goods. Property rights may give a firm the exclusive control over the materials necessary to produce a good.

·         Deliberate Actions: A firm wanting to monopolize a market may engage in various types of deliberate action to exclude competitors or eliminate competition. Such actions include collusion, lobbying governmental authorities, and force.

In addition to barriers to entry and competition, barriers to exit may be a source of market power. Barriers to exit are market conditions that make it difficult or expensive for a firm to leave the market. High liquidation costs are a primary barrier to exit. Market exit and shutdown are separate events. The decision whether to shut down or operate is not affected by exit barriers. A firm will shut down if price falls below minimum average variable costs.

Natural monopoly

A natural monopoly is a firm which experiences increasing returns to scale over the relevant range of output. A natural monopoly occurs where the average cost of production “declines throughout the relevant range of product demand.” The relevant range of product demand is where the average cost curve is below the demand curve. When this situation occurs it is always cheaper for one large firm to supply the market than multiple smaller firms, in fact, absent government intervention in such markets will naturally evolve into a monopoly. An early market entrant who takes advantage of the cost structure and can expand rapidly can exclude smaller firms from entering and can drive or buy out other firms. A natural monopoly suffers from the same inefficiencies as any other monopoly. Left to its own devices a profit seeking natural monopoly will produce where marginal revenue equals marginal costs. Regulation of natural monopolies is problematic. Breaking up such monopolies is counter productive^{[citation needed]}. The most frequently used methods dealing with natural monopolies is government regulations and public ownership. Government regulation generally consists of regulatory commissions charged with the principal duty of setting prices. To reduce prices and increase output regulators often use average cost pricing. Under average cost pricing the price and quantity are determined by the intersection of the average cost curve and the demand curve.This pricing scheme eliminates any positive economic profits since price equals average cost. Average cost pricing is not perfect. Regulators must estimate average costs. Firms have a reduced incentive to lower costs. And regulation of this type has not been limited to natural monopolies.

Government-granted monopoly

A government-granted monopoly (also called a "de jure monopoly") is a form of coercive monopoly by which a government grants exclusive privilege to a private individual or firm to be the sole provider of a good or service; potential competitors are excluded ffrom the market by law, regulation, or other mechanisms of government enforcement. Copyright, patents and trademarks are examples of government-granted monopolies.

Perfect competition

Perfect competition 

In economics, perfect competition occurs in markets in which no participant has market power. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets. Nonetheless, the concept of perfect competition can serve as a useful benchmark against which to measure real life, imperfectly competitive markets

Generally, a perfectly competitive market exists when every participant is a "price taker," and no participant influences the price of the product it buys or sells. Specific characteristics may include:

§  Infinite Buyers/Infinite Sellers – Infinite consumers with the willingness and ability to buy the product at a certain price, Infinite producers with the willingness and ability to supply the product at a certain price.

§  Zero Entry/Exit Barriers – It is relatively easy to enter or exit as a business in a perfectly competitive market.

§  Perfect Information - Prices and quality of products are assumed to be known to all consumers and producers.

§  Transactions are Costless - Buyers and sellers incur no costs in making an exchange [Perfect mobility].

§  Firms Aim to Maximize Profits - Firms aim to sell where marginal costs meet marginal revenue, where they generate the most profit.

§  Homogeneous Products – The characteristics of any given market good or service do not vary across suppliers.

Some subset of these conditions is presented in most textbooks as defining perfect competition. More advanced textbooks try to reconcile these conditions with the definition of perfect competition as equilibrium price taking; that is whether or not firms treat price as a parameter or a choice variable. It should be noted that a general rigorous proof that the above conditions indeed suffice to guarantee price taking is still lacking (Kreps 1990, p. 265).

In the short term, perfectly-competitive markets are not productively inefficient as output will not occur where marginal cost is equal to average cost, but allocatively efficient, as output will always occur where marginal cost is equal to marginal revenue, and therefore where marginal cost equals average revenue. In the long term, such markets are both allocatively and productively efficient.

Under perfect competition, any profit-maximizing producer faces a market price equal to its marginal cost. This implies that a factor's price equals the factor's marginal revenue product. This allows for derivation of the supply curve on which the neoclassical approach is based. (This is also the reason why "a monopoly does not have a supply curve.") The abandonment of price taking creates considerable difficulties to the demonstration of existence of a general equilibrium  except under other, very specific conditions such as that of monopolistic competition .

n a perfectly competitive market, a firm's demand curve is perfectly elastic.

As mentioned above, the perfect competition model, if interpreted as applying also to short-period or very-short-period behaviour, is approximated only by markets of homogeneous products produced and purchased by very many sellers and buyers, usually organized markets for agricultural products or raw materials. In real-world markets, assumptions such as perfect information cannot be verified and are only approximated in organized double-auction markets where most agents wait and observe the behaviour of prices before deciding to exchange (but in the long-period interpretation perfect information is not necessary, the analysis only aims at determining the average around which market prices gravitate, and for gravitation to operate one does not need perfect information).

In the absence of externalities and public goods, perfectly competitive equilibria are Pareto-efficient, i.e. no improvement in the utility of a consumer is possible without a worsening of the utility of some other consumer. This is called the First Theorem of Welfare Economics. The basic reason is that no productive factor with a non-zero marginal product is left unutilized, and the units of each factor are so allocated as to yield the same indirect marginal utility in all uses, a basic efficiency condition (if this indirect marginal utility were higher in one use than in other ones, a Pareto improvement could be achieved by transferring a small amount of the factor to the use where it yields a higher marginal utility).

A simple proof assuming differentiable utility functions and production functions is the following. Let w_j be the 'price' (the rental) of a certain factor j, let MP_j1 and MP_j2 be its marginal product in the production of goods 1 and 2, and let p₁ and p₂ be these goods' prices. In equilibrium these prices must equal the respective marginal costs MC₁ and MC₂; remember that marginal cost equals factor 'price' divided by factor marginal productivity (because increasing the production of good i by one very small unit through increase of the employment of factor j requires increasing the factor employment by 1/MP_ji and thus increasing the cost by w_j/MP_ji, and through the condition of cost minimization that marginal products must be proportional to factor 'prices' it can be shown that the cost increase is the same if the output increase is obtained by optimally varying all factors). Optimal factor employment by a price-taking firm requires equality of factor rental and factor marginal revenue product, w_j=p_iMP_ji, so we obtain p₁=MC₁=w_j/MP_j1, p₂=MC_j2=w_j/MP_j2.

Now choose any consumer purchasing both goods, and measure his utility in such units that in equilibrium his marginal utility of money (the increase in utility due to the last unit of money spent on each good), MU₁/p₁=MU₂/p₂, is 1. Then p₁=MU₁, p₂=MU₂. The indirect marginal utility of the factor is the increase in the utility of our consumer achieved by an increase in the employment of the factor by one (very small) unit; this increase in utility through allocating the small increase in factor utilization to good 1 is MP_j1MU₁=MP_j1p₁=w_j, and through allocating it to good 2 it is MP_j2MU₂=MP_j2p₂=w_j again. With our choice of units the marginal utility of the amount of the factor consumed directly by the optimizing consumer is again w, so the amount supplied of the factor too satisfies the condition of optimal allocation.

Monopoly violates this optimal allocation condition, because in a monopolized industry market price is above marginal cost, and this means that factors are underutilized in the monopolized industry, they have a higher indirect marginal utility than in their uses in competitive industries. Of course this theorem is considered irrelevant by economists who do not believe that general equilibrium theory correctly predicts the functioning of market economies; but it is given great importance by neoclassical economists and it is the theoretical reason given by them for combating monopolies and for antitrust legislation.

Profit


In contrast to a monopoly or oligopoly, it is impossible for a firm in perfect competition to earn economic profit in the long run, which is to say that a firm cannot make any more money than is necessary to cover its economic costs. In order not to misinterpret this zero-long-run-profits thesis, it must be remembered that the term 'profit' is also used in other ways. Neoclassical theory defines profit as what is left of revenue after all costs have been subtracted, including normal interest on capital plus the normal excess over it required to cover risk, and normal salary for managerial activity. Classical economists on the contrary defined profit as what is left after subtracting costs except interest and risk coverage; thus, if one leaves aside risk coverage for simplicity, the neoclassical zero-long-run-profit thesis would be re-expressed in classical parlance as profits coinciding with interest in the long period, i.e. the rate of profit tending to coincide with the rate of interest. Profits in the classical meaning do not tend to disappear in the long period but tend to normal profit. With this terminology, if a firm is earning abnormal profit in the short term, this will act as a trigger for other firms to enter the market. They will compete with the first firm, driving the market price down until all firms are earning normal profit only.

It is important to note that perfect competition is a sufficient condition for allocative and productive efficiency, but it is not a necessary condition. Laboratory experiments in which participants have significant price setting power and little or no information about their counterparts consistently produce efficient results given the proper trading institutions (Smith, 1987, p. 245).

Demand Forecasting

The opinion poll methods:

The opinion poll methods aim at collecting opinion of those who are supposed to possess knowledge of the market e.g. sales representative, professional marketing experts and consultants. The opinion poll method include

1.     Expert opinion method: - Firms having a good network of sales representative can put them to work of assessing the demand for the product in the areas that they represent. Sales representative, beings in close touch with the consumers are supposed to know the future purchase plans of their customer, their reaction to the market changes, their response to the introduction of new products and the demand for competing products. They are, therefore, in a position to provide an estimate of likely demand for their firm’s product in the area. The estimates of demand thus obtained from different regions are added up to get the overall probable demand for a product.

2.     Delphi Method: - Delphi method is used to consolidate the divergent expert opinions and arrived at a compromise estimate of future demand.

Under Delphi method the expert are provided information on estimates of forecast of other experts along with the underlying assumptions. The experts may revise their own estimates in the light of forecast made by other experts. The consensus of experts about the forecasts constitutes the final forecast.

Although this method is simple and inexpensive, it has its own limitations. First estimates provided by sales representations and professional experts are reliable only to extend depending upon their skill to analysis the market and their experience. Second, demand estimates way involve the subjective judgement of the which may lead to over or under estimation, finally, the assessment of market demand is usually based on inadequate information’s, such as changes in GNP, available of credit, future prospects of the industry etc, fall outside their purview.

3.     Market studies and Experiments:- It is a method of collecting necessary information regarding demand is to carry out market studies and experiments on consumer’s behavior under actual through controlled market conditions. This method is known in common parlance market conditions. This methods is known in common parlance as market experiment method under this method, firms first select some areas of the representative markets – three or four cities having similar features viz. Population, income levels, cultural and social background, occupational distribution, choices and preferences of consumers. Then, they carry out market experiments by changing prices, advt. Expenditure and other controllable variable in the demand function under the assumption that other thing remains same. The controlled variable may by changed over time either simultaneously in all the markets or in all the markets or in the selected markets. After such changes are introduced in the market, the consequent changes in the demand over a period of time (a week, a fortnight or month) are recorded. On the basis of data collected elasticity coefficient are computed. These coefficients are then used along with the variables of the demand function to assess the demand for product

The market experiments methods have certain serious limitations. First, this method is very expensive and hence cannot be afforded by small forms. Second, being a costly affair, experiments are usually carried out on a scale too small to permit generalization with a high degree of reliability.

Third experimental methods are based on short – term and controlled conditions that may exist in an uncontrolled market. Hence, the results may not be applicable to the uncontrolled long-term conditions of the market.

Statistical Methods:

Trends Projection Method

Trend projection method is a classical method of business forecasting. This method is essentially concerned with the study of movement of variable through time. The use of this method requires a long and reliable time series data. The trend projection method is used under the assumption that the factors responsible for the past trends in variables to be projected (e.g. sales and demand) will continue to play their part in future in the same manner and to the same extend as they did in the past in determining the magnitude and direction of the variable.

There are three (3) techniques of trend projection based on time – series data.

1.     Graphical Method: - under this method, annual sales data is plotted on a graph paper and a line is drawn through the plotted points. Then a free hand line is so drawn that the total distance between the line and the point is minimum. Although this method is very simple and least expensive, the projections made through this method are not very reliable. The reason is that the extension of the trend line involves subjectivity and personal bias of the analysis.

2.     Fitting Trend Equation: Least square method: - Fitting trend equation is a formal technique of projecting the trend in demand. Under this method, a trend line (or curve) is fitted to the time – series data with the aid of statistical techniques. The form of the trend equation that can be fitted to the time series data is determined either by plotting the sales data or by trying different forms of trend equations for the best fit.

o    When plotted, a time series date may show various trends. The most common types of trend equation are

1) Liner and
2) exponential trends

• Linear Trend: - When a time series data reveals a rising trend in sales than a straight-line trend equation of the following form is fitted. (S = A + BT ; Where S = annual sales , T = Time (in year) , A & B are constant. The parameter b given the measure of annual increase in sales)

• Exponential trend:- When sales ( or any dependent variable) have increased over the past years at an increasing rate or at a constant percentage rate, than the appropriate trend equation to be used is an exponential trend equation of any of the following type ( Y = aebt , Or its semi – logarithmic form -> Log y = = log a + bt; This form of trend equation is used when growth rate is constant.)

3.     Moving Averages Method:    In statistics, a moving average, also called rolling average, rolling mean or running average, is a type of finite impulse response filter used to analyze a set of data points by creating a series of averages of different subsets of the full data set.

·         Given a series of numbers, and a fixed subset size, the moving average can be obtained. The average of the first subset of numbers is calculated. The fixed subset is moved forward to the new subset of numbers, and its average is calculated. The process is repeated over the entire data series. The plot line connecting all the (fixed) averages is the moving average. Thus, a moving average is not a single number, but it is a set of numbers, each of which is the average of the corresponding subset of a larger set of data points. A moving average may also use unequal weights for each data value in the subset to emphasize particular values in the subset.

·         A moving average is commonly used with time series data to smooth out short-term fluctuations and highlight longer-term trends or cycles. The threshold between short-term and long-term depends on the application, and the parameters of the moving average will be set accordingly. For example, it is often used in technical analysis of financial data, like stock prices, returns or trading volumes. It is also used in economics to examine gross domestic product, employment or other macroeconomic time series. Mathematically, a moving average is a type of convolution and so it is also similar to the low-pass filter used in signal processing. When used with non-time series data, a moving average simply acts as a generic smoothing operation without any specific connection to time, although typically some kind of ordering is implied.

Limitation

The first limitations of this method arise out of the assumption that the past rate of change in the dependent variable will persist in the future too. Therefore, the forecast based on this method may be considered to be reliable only for the period during which this assumption holds.

Second, this method cannot be used for short-term estimates. Also it cannot be used where trend is cyclical with sharp turning points of trough and perks.

Barometric Forecasting Techniques:

Barometric techniques examine the relationships between causal or coincident events to predict future events. This approach is based on the logic that key current developments can serve as a barometer of the future. This approach assumes the key developments can be identified, measured and recorded as a statistical time series. The barometric or what is also called the leading indicators approach to forecasting is often traced to work done at the National Bureau of Economic Research from the 1920s through the 1940s.

A leading indicator predicts three to six months in the future another event. Examples of indicators include: payroll employment, personal income less transfer payments, an index of industrial production, stock prices, changes in business inventories, consumer expectations, building permits, new orders for goods and materials and retail sale

Regression analysis method:

The moving average method does not respond well to a time series that increases or decreases with time. Here we include a linear trend term in the model. The regression method approximates the model by constructing a linear equation that provides the least squares fit to the last m observations.

Simulated interaction:

Simulated interaction is a form of role playing for predicting decisions by people who are interacting with others. It is especially useful when the situation involves conflict. For example, one might wish to forecast how best to secure an exclusive distribution arrangement with a major supplier.

To use simulated interaction, an administrator prepares a description of the target situation, describes the main protagonists’ roles, and provides a list of possible decisions. Role players adopt a role and read about the situation. They then improvise realistic interactions with the other role players until they reach a decision; for example to sign a trial one-year exclusive distribution agreement. The role players’ decisions are used to make the forecast.

Using eight conflict situations, Green (2005) found that forecasts from simulated interactions were substantially more accurate than can be obtained from unaided judgement. Simulated interaction can also help to maintain secrecy. Information on simulated interaction is available from conflictforecasting.com.