Question

"No firm is completely sheltered from rivals; all firms compete for consumer dollars. If that is so, then pure monopoly does not exist." Do you agree? Explain. How might you use Chapter 6 's concept of cross elasticity of demand to judge whether monopoly exists? \lfloor 012.1

Short answer

Pure monopoly rarely exists; cross elasticity shows substitutability.

Step-by-step solution

Understanding Monopoly

A monopoly exists when a single firm is the sole provider of a particular product or service in a market, meaning there are no close substitutes available, and the firm has significant control over the market price.

Concept of Cross Elasticity of Demand

Cross elasticity of demand measures how the quantity demanded of one good changes in response to a change in the price of another good. It is used to determine the degree of substitutability between two products.

Cross Elasticity and Monopoly

In a pure monopoly, the cross elasticity of demand between the monopolist's product and other products is very low or near zero, indicating that there are no close substitutes and consumers have few alternatives.

Evaluating Existence of Monopoly

If the cross elasticity of demand is significantly positive, it suggests that consumers are willing to switch to substitutes when the monopolist firm increases its prices, indicating that a pure monopoly may not truly exist.

Conclusion on Pure Monopoly Existence

While some firms may have monopolistic characteristics, if they face competition from substitute products with positive cross elasticity, then they do not operate as pure monopolies in the market.

Key concepts

Cross Elasticity of Demand

Cross elasticity of demand is a handy tool in economics to figure out how interconnected different products are. Imagine you're looking at how much people would change their buying habits for one item when another item's price changes. That's what cross elasticity measures. It's like asking, "If Company A raises the price of its chocolate, will people run to Company B instead?"

This is measured mathematically by the percentage change in the quantity demanded of one good divided by the percentage change in the price of another good:
\[ E_{xy} = \frac{\text{Percentage Change in Quantity Demanded of Good X}}{\text{Percentage Change in Price of Good Y}} \]
If this number is high and positive, it shows that the two goods are close substitutes. For example, if the price of Coca-Cola goes up and people start buying Pepsi instead, they are considered substitutes. On the flip side, if the cross elasticity is low or near zero, it means the goods aren't seen as interchangeable in consumers' eyes.

Pure Monopoly

A pure monopoly is like the unicorn of the business world – rare and often mythical. In a pure monopoly, one company is the only source for a specific product or service. This means they hold absolute power over pricing.
There are a few characteristics that define this elusive market structure:

• Only one firm provides the product or service.
• There are no close substitutes available for consumers.
• High barriers to entry keep other companies from competing.

A classic example often referenced is a utility company – like those that provide water or electricity. However, even these face some competition with technological advances and regulatory changes.
The critical aspect that separates pure monopoly from other market forms is the absence of alternatives. Without substitutes, consumers must buy from the monopolist, leaving them at the sole mercy of price changes decided by the company.

Market Competition

Market competition involves the rivalry among businesses to capture the attention and loyalty of consumers. Unlike in a monopoly, in a competitive market, multiple firms try to offer products that meet consumer needs at the best price and quality.
Here are a few common features of competitive markets:

• Multiple firms offer similar or identical products.
• Consumers have the power to switch suppliers freely.
• Prices are set by the market forces of supply and demand.

The level of competition in a market influences how firms operate – they continually innovate, optimize costs, and improve products to stay ahead of rivals.
The existence of market competition is often considered when evaluating if a monopoly truly exists. If a company faces competition from substitute products or other firms offering similar goods, it might not be considered a pure monopoly. This is where cross elasticity of demand helps, by showing how easily consumers could switch to alternatives if prices rise or product quality declines.

Substitute Products

Substitute products are goods that can be used in place of each other. When one product's price rises, consumers may switch to a substitute to maintain their consumption levels without spending more money. These substitutes play a crucial role in determining the market dynamics and understanding the concept of monopoly.
In essence, substitutes can limit the market power of a firm. If substitutes become available, the company's control over market pricing diminishes. Here are some key points about substitutes:

• They provide consumers with options.
• High availability of substitutes increases market competition.
• Consumer preferences can shift towards substitutes if they present better value.

When examining if a monopoly exists, the presence of substitutes is a central factor. If people can easily switch to other products, it challenges the monopolist's power.
In essence, substitutes ensure that no single firm can entirely dominate a market without concern for potential rival products.