Last updated: July 26, 2019
Topic: LawGovernment
Sample donated:

Tweak the article- “Oligopoly meets oligopsony: the case of permits”

Introduction:

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In the article, namely, “Oligopoly meets oligopsony: the case of permits” by Franz Wirl, the writer has tried to demonstrate that in a market structure having two dimension, oligopoly from the supply side and oligopsony from the demand side, the market equilibrium can exist, but the trade volume will be very low and the equilibrium price will either be high or low. This outcome signifies that in the non-competitive permit market though the equilibrium will be reached, the equilibrium price will not show the correct signal of price to the market. However, such an outcome needs to be justified further to give the market players some idea on their probable strategic movements. We can do it by changing the assumption of Oligopoly in the non-competitive supply side and modify it by assuming a monopolistic framework. In our study we then try to see that whether or not such a framework of the permit market can still bring equilibrium through the interaction between the monopolist supplier and oligopsonist demanders. Further, we examine the market equilibrium condition by considering the existence of monopsony in the demand side of permit and evaluate whether or not the equilibrium such achieved is efficient. Finally the evaluation of the equilibrium market condition has done in a framework of bilateral monopoly where the market equilibrium is achieved by collective bargaining through the unions of buyers and sellers.

Monopoly from the supply side:

In case of an oligopolistic framework of the permit market, there exist mainly two types of strategic players, a dominant firm having considerably larger share of market (almost 40 percent or more) and a competitive fringe, the pool of firms, having relatively smaller share in market. Dominant firms have the power to independently set the prices. So, they are responsible for raising competition in the market. Such a market structure clearly indicates that there exists an asymmetric oligopoly in the market because the sizes of all the firms are not equal. However, the competitive fringe can create a competitive environment in the market, though it is generally assumed that they are the price taker whereas the dominant firm is the price maker in the industry. In the competitive fringe there are also some potential for a new player to take an entry. So this type of structure can also be thought as a market that practices monopolistic competition by considering the dominant firm as the monopolist which faces the possible entrants. The demand curve that a dominant firm faces is negatively sloped like the demand curve of a monopolist. But due to the existence of the competitive fringe, the dominant firm has to consider its presence for deciding any decision on the price or quantity strategy. It is normally believed that the dominant firm has some competitive advantage in comparison with the fringe. (Dominant Firm, March 15, 2002). However, since we assume a monopolistic market structure for our analysis, we consider the dominant firm of the oligopoly market as the monopolist. In this case we doubt on the existence of the competitive fringe. More specifically one may think that the role of the competitive fringe regarding decision making is very limited here. However, in practical case we cannot neglect the part of the competitive fringe. Therefore, if we derive a powerful collaboration of the monopolist firm or the dominant firm with the fringe in achieving any strategic decision on the market price or quantity, then it will be easy for us to analyze our study more practically. For this, let us now see whether it is possible to achieve market equilibrium between the dominant firm and the fringe. The supporting graph has been shown by the figure-1 as follows.

 

Figure-1: Equilibrium between the dominant firm and the competitive fringe

 
pH

SF

MRM

p*

q dF

 
q dM

 
q dD

pL

MCM

DM

D

e

E

 

 

 

 
0

 

 

In figure-1 we have depicted the equilibrium condition between the monopolistic firm and the competitive fringe. Suppose D is the total demand of permit in the market. Without the possibility of fringe this is also the demand faced by the monopoly supplier in the permit market. When the fringe operates in the market, it consumes some of the market demand of the monopoly supplier. In this condition the monopoly firm faces the residual demand, i.e., the market demand which is not supplied by the other small suppliers at any market price. In figure-1 the residual demand faced by the monopoly supplier is shown by D M, the horizontal difference between D, the market demand curve and S F, the supply curve of the competitive fringe. At the price pL or any other lower price the fringe will not supply anything. Then the residual demand is same as the total market demand. This is the case when the competitive fringe is not present in the market and the dominant firm has the monopoly power over the price and the supply of the permit. When the competitive fringe is present in the market, the monopoly supplier will supply up to the point where its marginal revenue (MRM) will be equal to its marginal cost (MRC) as the profit maximizing strategy. In figure-1, at the point E, the marginal revenue of the monopoly or the dominant supplier cuts its marginal cost curve. The corresponding quantity supply of the dominant firm is qdM. Equilibrium will be reached at the point e. At this equilibrium point total market demand is 0 qdD and the market clearing price is p*. Out of this total market demand, the dominant firm will supply 0 qdM  amount at the price p* and the competitive fringe will provide qdM qdD amount taking the price p* set by the dominant supplier. Note that 0 qdF =  qdM qdD= the amount of supply of the fringe. So at the equilibrium point e, the total amount provided by the dominant firm and the competitive fringe is 0 qdM + qdM qdD =  0 qdD = Market demand at the equilibrium price p*. When equilibrium is reached, neither the supplier nor the demander of the permit will be in a mood to change their market behavior because both the party believe that this is the best market condition available before them for their permit trading business. At the price pH, there is zero residual demand and total market demand is supplied by the competitive fringe. Therefore, the price pH is actually the competitive price. The residual demand curve faced by the monopoly supplier, DM, is flatter in comparison with the market demand curve D and lies below the supply curve of the competitive fringe which is upward sloping. Thes conditions have led the dominant firm to face more elastic demand than the demand faced by a monopoly. In turn such things forced the dominant supplier to set a lower price in the market. At this market clearing price emerged from the equilibrium between the dominant supplier and the competitive fringe, the trade of permit will increase through the collective operation of the dominant supplier and the competitive fringe in comparison with the single operation of the monopoly supplier. Therefore the presence of competitive fringe grinds down the market power of the monopoly supplier, but not completely eliminates it. The demanders are benefitted by the entry of the competitive fringe in market which removes some of the deadweight loss or economic inefficiency created by the monopoly supplier. (Dominant Firm and Competitive Fringe, 2010).

All these findings state that if there is monopoly power in the permit market, then the monopoly supplier have the complete control over the market in determining the level of price of the permit. In such case, the permit prices and the quantity supplied will not be efficient since it is possible that the monopoly supplier by supplying less asks for higher prices for permit that the demanders want to pay. If this condition appears then the monopoly supplier may not find any demander to purchase the permit from it. However, in the presence of competitive fringe in the market, if the equilibrium between the monopolist and the fringe is achieved, the monopolist will be forced to lessen the level of permit price. This in turn will move the equilibrium price and quantity close to the competitive level and help to increase the trade of permit between the suppliers and the demanders in the permit market.

Monopsony from demand side:

A market with a single buyer and many sellers is known as monopsony market. A monopsony market is just the opposite of monopoly market. In a monopsony market the demand for a good is entirely controlled by a single buyer. (Economics A-Z, 2010). With the provisions of inefficiency, a monopsony market is highly comparable with a monopoly market. In a monopsony market it is not certain whether the allocation of resources will be efficient. If we compare a monopsony market with a perfectly competitive market we will notice that both the given price and the exchanged quantity of goods are lower and not efficient. A monopsony market has mainly three characteristics. First we will see that the total market output is consumed by a single firm. Second we will notice that there are no substitute buyers in the market and third we will find that the restriction is very high to get an entry into the industry. The first characteristic implies that since a monopsony buyer is the only market player from the demand side of the market, therefore it has complete control over the market functionalities from the demand side. In a monopsony market, a seller will not find any buyer rather than the monopsony buyer. This is the reason for which a monopsonist has achieved the status of a single buyer. A monopsonist has become able to maintain such a status by keeping restrictions on the other buyers to enter into the market. Like a monopoly market, a monopsony market has roughly similar types of restrictions. For example the start up cost is very high in a monopsony market. Besides, it is very difficult to get the license from the government to enter into or to set up a franchise in a monopsony market. If there emerge a vertical integration of the demanders, then existence of monopsony in the permit market is quite possible. However, if monopsony exists in the demand side of the permit market, then the permit demanders will have the complete bidding power. This implies that the demanders will be the ultimate price maker of permits. If this situation exists then it is very difficult to reach to equilibrium. This in turn implies that the demanders will not get anyone from which they can purchase. (Definition of Monopsony, 2010).

Co existence of monopoly and monopsony:

If there are monopoly from the supply side and monopsony from the demand side of the permit market, we will actually end up with a permit market of bilateral monopoly. Actually a bilateral monopoly market is made up by only one buyer who faces only a single seller. When such market conditions emerge, both the single buyer and the single seller enjoy some market power to fix the price for transaction between them. The functioning of bilateral monopoly rejects the market power to be enjoyed by either the monopoly supplier or the monopsony demander by closing the channel of profits to go to only one direction. Actually the presence of bilateral monopoly nullifies the degree and extent of market power of each other.  Actually through the negotiation between the monopolist supplier and the monopsonist demander, the equilibrium price and quantity of goods and services are reached. As we know that there is a single seller of goods in a monopoly market who can charge a price over the competitive level through the price discrimination principle. A monopsonist buyer on the other hand, can achieve a market price lower than that of the competitive level as it is the only buyer in the market. But a bilateral market having both the dimension can control such price fluctuation and stabilize the market price. However, a bilateral monopoly cannot allocate the resources to reach to the efficient point of a purely competitive market. (Bilateral Monopoly Definition, 2010; Friedman, n.d.). The equilibrium point thus achieved in a bilateral monopoly market is undoubtedly more efficient than that of monopoly, monopsony or an oligopoly market structure. Therefore, a bilateral monopoly is not completely a monopoly or a monopsony. In our case we can thought such a market structure in the presence of more than two firm by the horizontal summation of the demanders and so that of the suppliers. The presence of bilateral monopoly in the permit market can lead a lower price than that of a monopoly market and higher price than that of a monopsony market. Similarly, a bilateral monopoly can guide to higher quantity of permit than that of a monopoly and lower quantity of permit than that of monopsony. (Bohringer and Loschel, n.d., p 5).

Conclusion:

So in our analysis we have found that many firms in the permit market have perceived the equilibrium price of the permits as the main factor that influences their competitiveness. When the firms have been provided the free permit allocation, the more will be the asset value of permit holdings. However, if the firms want to purchase permits, they are required to spend more. It is very important that no firms should hold sufficient amount of permit quantity for influencing the price at the time of permit allocation. There should not be any combination of permit holders for influencing the price of permits by market power. Boemare and Quirion (2001) regarding the number of participants in the EU have studied that ‘Standard theory suggests that, providing administrative and monitoring costs are not disproportionate, as many emitters as possible should be covered by the permit scheme’. Such provisions increase the scenario of variety in marginal abatement costs. The market power risk can also be mitigated through such provisions. Sartzetakis (2002), on the other hand, studied that when there exist an oligopolistic framework in the market, one cannot guaranty the efficiency of the permit market. This argument strictly contradicts the general thought that efficiency in permit allocation can be achieved through a competitive market. (Convery, Dunne, Redmond and Ryan, March 2003, p 5). Therefore, we can conclude that the incidence of imperfect competition in the permit market has definitely lessened the efficiency of the market equilibrium of a competitive market. Both the price and the quantity indicators show that the demand supply mechanism in an imperfect market cannot bring efficiency for the biding price and cannot increase the trade volume of permits in comparison with a perfectly competitive market. However, consideration of one imperfect market over the other may increase the efficiency of equilibrium and lead it to be stable closer to the competitive level.

 

 

 

 

 

Reference:

 

1)      “Dominant Firm” (March 15, 2002), Glossary of Statistical Terms, OECD.

Available at: http://stats.oecd.org/glossary/detail.asp?ID=3199

Access on: 07/05/2010

2)       “Economics A-Z” (2010), The Economist.

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6)      Friedman, D (n.d.), “Bilateral Monopoly”, Virginia Polytechnic Institute and State University.

Available at: http://www.daviddfriedman.com/Academic/Bilateral_Monopoly_%C4/Bilateral_Monopoly.html

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7)      Convery, J, Dunne, L, Redmond, L and L,B, Ryan (March 2003), “Political Economy of Tradeable Permits- Competitiveness, Co-operation and Market Power”, OECD.

Available at: http://www.oecd.org/dataoecd/11/60/2957631.pdf

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8)      Bohringer, C and A, Loschel (n.d.), “Market Power in International Emission Trading: The Impacts of U.S. Withdrawal from the Kyoto Protocol”, ZEW.

Available at: http://www.econstor.eu/bitstream/10419/24479/1/dp0158.pdf

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