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ECO100 - NOV 19 Natural Monopoly, Oligopoly

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University of Toronto St. George
James Pesando

Monopoly: “Real World” Relevance 1) Legal; Example: patent 2) “Near” Monopoly; Example: Microsoft, Windows operating system 3) Natural (High fixed costs, low marginal cost); Example: pipelines, electrical power. Natural Monopoly ● Fixed cost: 10 million (constructing the pipeline) ● Marginal Cost (per barrel of oil): $0.50 ● Size of market: 2 million barrels of oil transferring from point A to B ● What is the ATC? (if market is divided evenly among firms) ○ 1 firm: 5.50 ○ 10 firms: 50.50 ○ 50 firms: 250.50 ● If you force competition on this industry, would only push the ATC up. ● Policy response: regulate a single firm in the case of natural monopoly ○ Not to try to create competition How to Regulate a Natural Monopoly? ● Only makes sense to have one firm, to protect consumers, we can only regulate the firm ● Unregulated Natural Monopoly: Sell Pm and Qm ● Regulation of a Natural Monopoly: P(Regulated) < Pm, Q(Regulated) > Qm ○ Often, P(Regulated) = ATC ■ Price to cover ATC of the monopolist ■ Only allowed to earn the normal rate of profit, zero economic profit - the opportunity cost of invested capital ○ Set P=ATC ■ MR becomes irrelevant ● The monopoly is not allowed to profit maximize ■ Quantity determined by price ○ Observation of regulated natural monopolies. ■ 1) Not Allocatively Efficient ● Value to buyers (P) > MC of producer ■ 2) Monopolist breaks even <=> earns zero economic profit ■ 3) Problem: Monopolist has no incentive to control cost ● There are a lot of natural monopolies Take away: 1. Makes no sense to force competition. 2. How government regulates them. 1.Market Structures Perfect Competition Monopoly Imperfect Competition Oligopoly Monopolistic Competition Oligopoly and Monopolistic Competition 2.Oligopoly: Key Example Features of Oligopoly - Auto Manufacturers (North America) ● 1) Few firms (GM, Chrysler, Ford) ● 2) Face downward-sloping demand curves ○ Should GM raise price of its compact cars? ■ You know that quantity demanded would fall but might be in your interest, profit wise, to do so ● 3) Mutual Interdependence ○ If GM raises price, what will competitors do? Oligopolists (few sellers, aware of interdependence) - possibilities ● 1) If engage in cut-throat competition, industry profits may equal competitive level of profits (zero economic profits) ○ ● 2) If fo
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