Tag Archives: Monopoly

Monopsony v Monopoly – Tesco v Unilever

Geoff Riley did a very good post on Tutor2u that outlined the recent dispute between Tesco and Unilever. Marmite, PG Tips tea and Pot Noodles are among dozens of brands currently unavailable on Tesco’s online site due to this dispute with Unilever. Unilever raised its price by 10% in the UK to compensate for the sharp drop in the pound’s value.

Tesco is resisting the move and has removed Unilever products from its website. Unilever see the price increase as a  “normal” reaction to shifts in currency values – since the Brexit vote there has been a 17% decrease in the value of the pound which has added to the cost of importing goods. The products currently absent from Tesco’s website also include Comfort fabric conditioner, Hellmann’s mayonnaise and Ben & Jerry’s ice cream. With the A2 exam looming here are some notes on Monopoly and Monopsony.

Monopoly and Monopsony theory

Monopoly. Perfect competition is not to be found in the real world and absolute or pure monopoly is also virtually impossible to achieve since it applies operating in the absence of competition (i.e. no substitutes). While it is not difficult for a firm to become a sole supplier it is extremely difficult to achieve a situation where there are no substitutes for the product. A more realistic definition of monopoly would be ‘a sole supplier of a commodity for which there are no good substitutes’. In fact the degree of monopoly power in the real world tends to be judged on the basis of the share of the total market accounted for by any particular supplier.

The graph below shows that at profit maximising equilibrium, output Qm is less than that in a competitive market (Qe), and the demand and supply (MC) curves do not intersect. Qe represents the Allocative Efficiency level of output and Pe the price. The shaded area therefore represents the loss of allocative efficiency or the deadweight loss.

monopoly-dwl 

Therefore monopolists restrict output and mis-allocate resources leading to a deadweight loss to the economy. However the government, using price controls, can force a shift from the preferred monopoly equilibrium (MC=MR) to one equivalent to the perfectly competitive equilibrium (MC=AR). At the less-preferred equilibrium, a monopolist’s supernormal profit may be either reduced or turned into a subnormal profit. In the latter case, a permanent subsidy may be necessary to keep the firm in business.

Monopsony. Two areas are worthy of mention, including the monopsony power of the large supermarkets (as stated above), who can dictate terms to smaller suppliers, and the monopsony power associated with buyers of labour in the labour market.

A monopsony occurs in the labour market when there is a single or dominant buyer of labour. The buyer therefore is able to determine the price at which is paid for services. Unlike other examples we have looked at, in this situation we are now dealing with an imperfect rather than a perfectly competitive market. The monopsonist will hire workers where:

monopsony-labour

Marginal Cost of labour (MCL) = Marginal Revenue product of labour (MRPL)

You will remember from the notes on the Perfect Labour Market that this is known as the profit maximising position.

From the perspective of the monopsonist firm facing the supply curve directly, if at any point it wants to hire more labour, it has to offer a higher wage to encourage more workers to join the market – after all, this is what the ACL curve tells it. However, the firm would then have to pay that higher wage to all its workers so the marginal cost of hiring the extra worker is not just the wage paid to that worker, but the increased wage paid to all workers as well. So the marginal cost of labour curve (MCL) can be added to the diagram.

If the monopsonist firm wants to maximise profit, it will hire labour up to the point where the marginal cost of labour is equal to the marginal revenue product of labour. Therefore it will use labour up to level of Eq which is where MCL=MRPL. In order to entice workers to supply this amount of labour, the firm need pay only the wage Wq. (Remember that ACL is the supply of labour). You can see, therefore, that a profit-maximising monopsonist will use less labour, and pay a lower wage, than a firm operating under perfect competition.

In this situation the power of the employer in the labour market is of overriding importance and the employer can set a low wage because of this buying power.

Sunglasses – a true monopoly.

With summer approaching in the southern hemisphere and the days getting brighter you will be looking to don sunglasses on a more regular basis. Sunglasses come in various styles and brands, eg. Rayban, Oakley, Gucci, Prada, Versace to name but a few,  but can be quite expensive when you consider the so-called competition that is in the market which in theory should driving down the price. Sunglasses these days are reasonably homogeneous in that the frames and materials are very similar and it surprised me that 80% of the major sunglass brands are controlled by Luxottica, in a market that is worth US$28 billion.

Luxottica produced the following brands of sunglasses under their name:

Prada, Chanel, Dolce & Gabbana, Versace, Burberry, Ralph Lauren, Tiffany, Bulgari, Vogue, Persol, Coach, DKNY, Rayban, Oakley, Sunglasses Hut, LensCrafters, Oliver Peoples, Pearle Vision, Target Optical and Sears Optical.

This list of brands is fairly comprehensive and by controlling 80% of the market you have a monopoly and dictate the price consumers have to pay for each specific brand since the industry isn’t competitive. Therefore they are Price Makers. But Luxottica also dictate what goes in the shops as they own Sunglass hut, Oliver peoples and Pearle Vision where consumers shop for sunglasses. This makes it very difficult for a brand outside one that is produced by Luxottica to compete as you can’t get your product into those shops. So not only do they have a monopoly in the production but they also control the distribution of sunglasses. See monopoly graph below.

Monopoly

In the clip below from ’60 Minutes’ they mention Oakley’s dilemma when their sunglasses became more popular than those produced by Luxottica. When this happen Luxottica proceeded to hold fewer Oakely sunglasses in their Sunglass Hut shops causing Oakley’s stock to plunge. Then in 2007 Oakley was left with no choice but to merge with Luxottica.

 

 

Economics of Seinfeld – The Soup Nazi

Here is one of my favourite clips from Seinfeld which shows how a monopoly is broken.

The Soup Nazi makes delicious soup—so good there’s always a line outside his shop. He refuses service to Elaine, and by a stroke of luck she comes across his stash of soup recipes. She visits his shop and informs him that his soup monopoly is broken, while waving his recipes in his face. Also in this clip, George gets charged $2 for a roll that everyone else gets for free. This example of price discrimination shows that in order to charge different customers different prices, you must have market power. Source: Seinfeld Economics