2.9. Monopoly

Question 1

Monopoly

Answer 1

the market structure that has one firm (or one dominant firm).

Question 2

Monopolist

Answer 2

the firm (or most dominant firm) in a monopoly market structure.

Question 3

Pure Monopoly

Answer 3

one firm with 100% market share

Question 4

Legal Monopoly

Answer 4

a company considered to be a monopoly by government rules e.g. for the UK, legal monopoly if market share > 25%.

Question 5

Natural Monopoly

Answer 5

when the most efficient number of firms is one due to very high fixed costs e.g. railways, utilities (water, electricity).

Question 6

Assumptions

Answer 6

1) One large firm with complete market power (pure monopoly) selling a unique product (no substitutes).
2) There are high barriers to entry / exit.
3) Firm is a price maker (but faces a downward sloping demand curve).
4) Firm is a profit maximiser (output level where MC = MR).

Question 7

Sources of Monopoly Power

Answer 7

1) Barriers to entry (e.g. sunk costs, legal barriers, capital costs, natural advantages, economies of scale, anti-competitive practices, advertising): keeps out new entrants, which allows monopolist to control the market.
2) Product differentiation: the higher product differentiation → the fewer the number of competitors → the stronger the monopoly power.
3) Growth of the firm: through internal expansion and/or external mergers → market share increases.

Question 8

Revenue Curves (DRAW DIAGRAMS)

Answer 8

(PRICE MAKER)

• Total Revenue curve - same shape as DMU total utility curve
• Marginal Revenue curve - downwards sloping going below x axis like DMU marginal utility curve
• AR = D - downwards sloping but doesn’t go below x axis and is above MR curve
• where total revenue is at maximum and MR = 0, the PED is unitary
• before MR = 0, the PED is elastic
• after MR = 0, the PED is inelastic

Question 9

Barriers to entry

Answer 9

1) Cost advantage - a major cost advantage, such as economies of scale, means other firms will not be able to compete.
2) Control over supplies - if a firm controls supply in an industry, other firms cannot compete.
3) Patents and trademarks - these provide firms with legal protection for their ideas and designs, which prevents new entrants.
4) Legislation - the government may restrict the ability of new firms to enter the market and compete.
5) Product differentiation - through physical differences or through advertising and branding.
6) Control over outlets - new firms will be unable to sell their products.
7) Fear of reaction - new firms may not enter if they think a price war might occur.

Question 10

Monopoly in equilibrium (DRAW DIAGRAM)

Answer 10

makes abnormal profits

Question 11

Loss-making monopoly (DRAW DIAGRAM)

Answer 11

makes economic losses / subnormal profit

Question 12

Productive Efficiency in monopolies (MC = AC, bottom of AC)

Answer 12

none

Question 13

Allocative Efficiency in monopolies (P = MC)

Answer 13

none (P > MC)

Question 14

X-Efficient in monopolies (lowest possible AC)

Answer 14

unlikely (no competition)

Question 15

Dynamic (over time) in monopolies (lowest possible AC)

Answer 15

possible (funded by abnormal profits, protected by B to E)

Question 16

Advantages of Monopolies

Answer 16

• Scope for economies of scale.
• Abnormal profits fund product innovation / R&D
• Barriers to entry protect innovation / R&D (intellectual property)
• Dynamic efficiency (technological progress)
• Globally competitive (export revenues)
• Monopoly power might be due to greater efficiency e.g. Google
• Creative destruction (Schumpeter) e.g. Apple v.s. Nokia
• Natural monopolies (e.g. railways)

Question 17

Disadvantages of Monopolies

Answer 17

• Higher prices than PC.
• Allocative inefficiency (because P > MC).
• Loss of consumer surplus / consumer sovereignty.
• Restricted output.
• Deadweight loss (lower welfare).
• Productive inefficiency (not at bottom of AC).
• X-inefficiency (not on lowest possible AC).
• Abnormal profit → unequal distribution of income
• Possible diseconomies of scale
• Lack of choice for consumers
• Lack of incentives for monopolist
• Less competitive economy

Question 18

Natural Monopoly Characteristics

Answer 18

1) Very high start-up costs.
2) Economies of scale occur over a large range of output.
3) Most efficient number of firms is one.
4) Duplication causes inefficiency.

Question 19

Natural Monopoly Profit Maximisation (MC = MR) (DRAW DIAGRAM)

Answer 19

• Price = P1
• Output = Q1
• Abnormal profits (AR > AC) occur

Question 20

Natural Monopoly Normal Profits (AC = AR) (DRAW DIAGRAM)

Answer 20

• Price = P2
• Output = Q2
• Normal profits (AR = AC) occur

Question 21

Natural Monopoly Allocative Efficiency (AC = AR) (DRAW DIAGRAM)

Answer 21

• Price = P3
• Output = Q3
• Subnormal profits (AR < AC) occur.
• Requires subsidy from Govt.

Question 22

Examples of Monopoly

Answer 22

• Microsoft and Windows

- De Beers Diamonds