SummaryA simple definition would be that a monopoly is just a market where there is only one seller. However, monopolies must be well understood, in order to understand why they are so harmful. In this LP we learn about monopolies, starting with a few basic definitions and starting to learn about a few types of monopolies.
Types of monopolies:
- Bilateral monopoly
- Multiproduct monopoly
- Multiplant monopoly
Multiproduct monopolies are those monopolistic firms that sell, at least, more than one product. The firm will have to take into account how a change in the price of one of its products affects the demand of the rest of them, especially when they are complementary or substitutive goods. The magnitude of the cross elasticity of demand will be of great importance as it will measure this effect. The multiproduct monopoly will maximise its profits as:
It is noteworthy to comment the different effects that an increase in price of one product will have in the rest of the products depending if they are substitute or complementary goods. For substitute goods the loss of demand in the market when prices are raised will be balanced by the increase of demand of the other good as consumers will just switch to the other product. However, for complementary goods the loss of demand will be amplified in the other market. To understand this second effect let’s think of petrol and cars. When price of petrol increases, demand for cars will be negatively affected as their overall cost will be increased.
Multiproduct monopolies can set prices to each of its products either jointly, or by division, each division setting the price for the product it sells. If the goods are substitutes, and each division sets the price, prices will be low, since each firm has an incentive to lower the price and steal some sales from other divisions, thus behaving as oligopolists. This is commonly known as cannibalization. Therefore, a multiproduct monopoly producing substitute goods must set its prices jointly.
If the multiproduct monopoly sells goods that are perfect complements, it must take into account the necessity of setting the right price in order to sell both products. When each division sets these products’ prices separately, these divisions will have an incentive to increase the price, acting as a regular monopoly, which will increase the total price of both products. If set jointly, the price of each product will be lower, but total profits will be higher. Therefore, for both complementary and substitute goods the multiproduct monopoly should set its prices jointly.