Monopoly has been a source of concern for economists for a long time
because of the welfare distorting effects that are associated with
it. For a theoretical discussion of monopoly markets
In a monopoly market, there is a single seller with several (or many)
buyers. The monopolist witholds output below the point where the
price is equal to the marginal cost in order to maximize his
profits. This leads to a decrease in total welfare.
Vernon Smith ran monopoly experiments with different market institutions.
Smith (1981) ran experiments to illustrate the effects of the type of
trading institutions on a monopolist's ability to exercise market power.
He compared the results between the double auctions and posted offers.
The sessions were conducted under conditions of private incomplete
information. In the double auction trading he found that there was a
downward trend and that price were about mid way between the competitive
and monopoly levels in the last half of the sessions. The index of
monopoly effectiveness defined as below was approximately 0.6
in the final periods of the session.
M = (actual profit - competitive profit)/(monopoly profit - competitive profit)
In contrast, in the posted offer sessions achieved monopoly outcomes
with five units sold and M = 1
Other double auction monopolies that fail to yield monopoly prices are reported in Smith and Williams (1989).
Plott (1989) points out that the monopolist has trouble exercising power
in a double auction because buyers do not behave as passive price takers.
Instead they withhold purchases to curb monopolist's market power. A key
to the monopolist's success in the posted offer market is due to the
buyer's incentives as Kagel and Roth point out in their handbook on
experimental economics. In the posted offer scenario if a buyer doesn't
shop when he is given the opportunity there is no chance of recovering
that lost profits later. So it is a dominant strategy for buyers to
purchase all profitable units. In contrast, in the double auction setup
buyers can hold out in the early period, knowing that if the price is
not lowered as a result, they have a chance to make purchases later in
the same period.
The MarketLink experiment software can be used to compare monopoly
outcomes from the Posted Offer market with those from the Double
Auction market, as in Smith's experiment. For a discussion of the parameters used in Smith's experiment click here.
- Smith, V. (1981). An empirical study of decentralized institutions
of monopoly restraint. In Essays in contemporary fields of economics
in honor of E.T. Weiler, J. Quirk and G. Horwich, editors, West Lafayette: Purue University Press. 83-106
- Plott, Charles R. (1989). An updated review of industrial
organization: Applications of experimental methods. In The Handbook
of Industrial Organization Vol. II, R. Schmalensee and R.D. Willig,
editors, Amsterdam: North Holland, 1109-76.
- Smith, V. and A. Williams (1983). An experimental comparison of
alternative rules for competitive market exchange, In Auctions,
Bidding, and Contracting: Uses and Theory, R. Englebrecht-Wiggans
et al., editors, New York: New York University Press. 307-34