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Chapter 4 summary
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Summary of 8 pages for the course EKN 310 at UP (Chapter 4 summary)
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Chapter 4Allocative efficiency, imperfect competition and regulation
Types of monopolies:
Imperfect competition (IC) → market form that deviates from the perfectly competitive
(PC) market → market efficiency is only achievable in a PC market (Pareto sense)
We don’t have PC markets → looking at impacts of IC markets have on market outcomes
and societal welfare and what government can do to correct it.
- Statutory (artificial) monopoly → operates in a market where perfect competition is
technically feasible but prevented by legal restriction imposed by government,
professional bodies or entry-limiting behaviour done by firms.
o E.g business licenses in place, limitations on patents by government → when
the barriers are removed, they attract entries and move towards perfect
competition.
- Natural monopoly → operates in a market where technical factors prevent
competition (usually there will only by one producer)
o Caused by expensive capital requirements to start up → excludes those who
cannot afford the start-up costs from competing.
o Cost structure is such that they produce along the decreasing part of AC
curve.
o E.g Eskom.
Social costs of statutory monopolies:
Graph analysis:
- Perfectly competitive equilibrium → point E where Qc (demand=supply) is
produced at Pc.
- Equilibrium F occurs under the monopoly → MR = MC → market produces less at a
higher price than at E (profit maximisation occurs)
- Loss in consumer surplus under monopoly = PmGEPc → straight transfer from
consumer to producer = PmGHPc → net welfare (deadweight) loss = GEH.
Notes by Georgia Taylor EKN 310 1
, MCx Px
MRPTxy = =
MCy Py
- From chapter 2
- Condition satisfied under perfect competition.
- When a monopoly is present → monopoly is producer Y → Py > MCy while Px=MCx
o Violation of the second and third Pareto-optimality.
o Price charged by monopoly Y exceeds that priced by a non-monopoly Y.
R1
R0 C
Yc M3 M2
Quantity of Y
M0
Ym
M1
0 Xc Xm T0 T1 Quantity of X
Graph analysis:
- Line tangent to C → price ratio
- Pareto optimality (PO) → allocative and technical efficiency → C (competitive
equilibrium) on production possibility curve R0T0.
- Equilibrium moves to M0 (monopoly equilibrium) → prices charged for Y increase →
therefore quantity of Y drops (buying less of Y) and quantity for product X increases
Px
→ price ratio ≠ MRPT (MRPTxy > )
Py
- Distance between C and M0 → allocative inefficiency → too little of good Y
produced compared to good X at point M0.
o Reallocation of resources is needed → would increase production of Y
relative to X and move economy towards C.
- PmPm (green line at M0) → not tangent because of the monopoly (hypothetical
tangent tt (blue line)) → intercepts the PPC → leads to X inefficiency.
o Resources not used to their best possible means → society falls to a
consumption level of below the PPC (e.g M1) (violates PO condition) →
monopolies do not produce at the output they should (only provider in the
market and therefore no need to compete)
Arguments regarding efficiency of monopolies:
Against monopolies (Liebenstein)
- No incentive to cut costs or find better technology.
- Lack of incentive to maintain high labour productivity levels.
- Do not take sufficient time and effort necessary to acquire correct information.
- When monopolies fail to achieve PO allocation of resources → end at point M1
(point below the PPC).
Notes by Georgia Taylor EKN 310 2
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