A single seller in the market means monopoly market structure. A monopoly is a price maker. He sets the price where marginal revenue (MR) equals marginal cost (MC). However, since he has a price making power; hence, he sets the profit-maximizing price P1 at point E1, where MC equals average revenue (AR). The efficient output would be Q2 at price P2 at where AC = MC = AR. But, a monopoly produces less output Q1 at a higher price P1, which is higher than MC. Thus, there exists allocative inefficiency in the market (Stiglitz & Rosengard, 2015).
Economies of scale: since, there is no other seller in the market, the single seller, i.e., the monopoly can increase its plant size and grow large without any barrier and enjoy economies of scale. Thus, it can produce large quantities at lower cost and still keep the price high to increase the profit margin (Dorman, 2014).
Reinvestment of supernormal profit and dynamic efficiency: since the monopolist earns supernormal profits, they can reinvest that profit for research and development activities for innovation of new technology. This makes the monopolist dynamically efficient for larger profit earning.
Absence of duplication of resources and infrastructure: as there is lack of competition, there is also absence of wasteful repetition of scarce resources and infrastructures.
Generating higher export revenue: the monopolist not only earns higher revenue from the domestic market, it can also export more products to the international market due to its cost advantage and earn a greater amount of foreign currency (Kirzner, 2015).
Less choices and high prices: consumers have to pay high prices for restricted and lesser choices of products in the monopoly market. Hence, sometimes they have to a high price for a bad quality product (Hawley, 2015).
Lower consumer surplus: a higher price for a lower output than a competitive market leads to loss of consumer surplus.
Asymmetry in information: the monopoly market is dominated by asymmetric information and monopolists take advantage of this feature for pricing decisions.
Productive inefficiency: lack of competition makes a monopolist productively inefficient as it does not reduce its average costs to a minimum.
Allocative inefficiency: a monopolist is a price maker, thus, it sets a higher price for lower level of output than the competitive market; hence, it is allocatively inefficient.
Lower level of employment: as employment is determined by the level of output, monopolies cannot create much employment in the economy due to lower level of production (Holmes, Hsu & Lee, 2014).
The allocative efficiency is achieved in perfect competition market structure. When a firm produces the socially optimum output at P = MC =AR, then it is allocatively efficient. At perfect competition, a firm produces output at MC = AR. Hence, there is allocative efficiency. Perfect competition is considered to be hypothetical benchmark for efficiency in the long run (Kirzner, 2015).
In the above diagram, a firm in perfect competition produces optimum output Q at the lowest point of the average cost (AC) curve, i.e. point E. At this point, P = MC = AC = AR = MR for the firm. Hence, allocative efficiency is achieved since, P = MC (Holmes, Hsu & Lee, 2014).
The equilibrium structure of monopolistic competition is almost similar to that of the monopoly. The price in monopolistic competition is higher and output is lower than the socially optimum level (Booth, 2014).
The allocative inefficiency in monopolistic competition. The firm produces at the equilibrium point E1, corresponding to price P and output Q. At this point, MC = MR, but it is not the lowest point on the average cost (AC) curve, i.e. point E2. At output Q, P > MC, hence, it is not efficient allocation of resources.
Under collusive oligopoly, firms behave like a monopolist to maximize profit. The firms collude for price fixing and they know about each other’s output level. Hence, the profit maximizing output occurs at MC =MR, just like a monopoly (Currarini & Marini, 2015).
The above figure shows that under collusive oligopoly, the allocation of factors of production occurs at point E, where MC = MR. At E, price is P and output is Q. The collusive firms achieve monopoly outcome at this point.
If any of the firms cheats the others in collusive oligopoly, then there would be price war, and that would lead to fall in profits for all firms. If one firm reduces its price, others would reduce their price too for retaining the market share. Hence, profits decline. Sometimes the firms operate in a loss due to price war (Fudenberg & Tirole, 2013).
Under price wars, when a firm lowers its prices from P1 to P2, the output level increases from Q1 to Q2. However, when MC falls from MC1 to MC2, then the price and output change. But, if the marginal cost is between MC2 and MC3, then there will be no change in price and output. Hence, there will be no profit for the firms.
The long run supply of constant cost firm, and 6(b) shows that of the industry. As price increases for a constant cost firm, from P1 to P2, it follows the SMC curve and output rises to q2 from q1, as P = SMC. When all firms act in the similar way, then each firm would earn positive profit and new firms would enter the market. Hence, in 6(b), the supply increases and the supply curve shifts from S1 to S2. The new equilibrium reaches at B, and output expanded from Q1 to Q2. Firms earn zero profit in the long run. The long run supply curve for the constant cost industry is the horizontal SL, where price equals long run minimum average cost of production (Wiseman, 2017).
It shows the long run supply of an increasing cost firm and 7(b) shows the same for the industry. As it is an increasing cost industry, when the demand rises, it leads to a price rise from P1 to P2. Output increases to q2, at the point where P2 = SMC1. The long run supply curve for the industry is upwards sloping SL. As input prices increases, the new long run equilibrium is higher than the initial equilibrium. Hence, more output is produced at a higher price (Belleflamme & Peitz, 2015).
Pollution creates negative externalities for the society and environment. The government can impose taxes on the activities causing pollution, or it can issue tradable pollution permits to the organizations to control the pollution as a negative externality (Grolleau, Ibanez & Lavoie, 2016).
It Shows the effects of corrective taxation on the firms. MSB is the marginal social benefit for the firm, which equals to the marginal private benefit (MPB). MPC is the marginal private cost for the firm. The firm initially produced Q1 at price P1. But this output is also generating pollution, which creates negative externality for the society. Hence, the marginal social cost (MSC) is higher than marginal private cost (MPC). To control the negative externalities due to pollution, the government imposes corrective taxation, T, on the firm. That raises its price to P2 by the tax amount. P2 = P1 + T. It shifts the MPC curve by T and MPC becomes equal to MSC. Due to increase in cost, the firm reduces its optimum output from Q1 to Q2 (Edgar, 2013).
The government sells tradable permits to firms for the right to generate a certain amount of pollution. These permits are tradable because, high pollution generating firms would buy it initially and trade it later on with low pollution generating firms. The number of permits is fixed, hence, they have a vertical supply curve, S. The quantity of permits along with the demand for it determines the price of the pollution (Ferrier, 2014). As demand increases for permits, the price rises, but supply of permits remains fixed at Q0. Hence, the permit to emit pollution becomes costlier.
References:
Belleflamme, P., & Peitz, M. (2015). Industrial organization: markets and strategies. Cambridge University Press.
Booth, A. L. (2014). Wage determination and imperfect competition. Labour Economics, 30, 53-58.
Currarini, S., & Marini, M. A. (2015). Coalitional approaches to collusive agreements in oligopoly games. The Manchester School, 83(3), 253-287.
Dorman, P. (2014). Monopoly Power. In Microeconomics (pp. 275-295). Springer Berlin Heidelberg.
Edgar, T. (2013). Corrective Taxation, Leverage and Compensation in a Bloated Financial Sector.
Ferrier, C. (2014). Tradable Permits for Greenhouse Gases. In Global Environmental Change (pp. 533-541). Springer Netherlands.
Fudenberg, D., & Tirole, J. (2013). Dynamic models of oligopoly. Taylor & Francis.
Grolleau, G., Ibanez, L., & Lavoie, N. (2016). Cause-related marketing of products with a negative externality. Journal of Business Research, 69(10), 4321-4330.
Hawley, E. W. (2015). The New Deal and the problem of monopoly. Princeton University Press.
Holmes, T. J., Hsu, W. T., & Lee, S. (2014). Allocative efficiency, mark-ups, and the welfare gains from trade. Journal of International Economics, 94(2), 195-206.
Kirzner, I. M. (2015). Competition and entrepreneurship. University of Chicago press.
Stiglitz, J. E., & Rosengard, J. K. (2015). Economics of the Public Sector: Fourth International Student Edition. WW Norton & Company.
Wiseman, T. (2017). When Does Predation Dominate Collusion?. Econometrica, 85(2), 555-584.
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