3.4 - Monopoly Flashcards
Market structures
Characteristics of Monopoly
- Single Seller:
In a monopoly, there is only one firm or seller that dominates the entire market, with no close substitutes for its product. - Unique Product:
The monopolist typically offers a unique product that has no perfect substitutes. This lack of substitutes gives the monopolist significant control over pricing. - High Barriers to Entry: Monopolies often maintain their dominant position due to high barriers to entry, which can include factors like patents, economies of scale, control over essential resources, and government regulations.
- Price Maker:
A monopoly has the power to set the price of its product, and it faces a downward-sloping demand curve. It can choose the price and quantity of output to maximise its profits. - Market Power: Monopolies have substantial market power, meaning they can influence market conditions, restrict output, and charge higher prices than would be possible in a competitive market.
- Long-Run Profitability: Monopolies can earn long-term economic profits because of their ability to set prices above their production costs.
Profit maximising equilibrium - monopoly
As a single seller of goods/services, the firm in a monopoly market is also the entire market. Its concentration ratio is CR1=100%
There is no differentiation between the firm and the industry
It is a price maker or price setter
This means that its demand and revenue curves are downward sloping
In order to maximise profits, it produces at the point where marginal cost (MC) = marginal revenue (MR)
Diagrammatic Analysis - monopoly
- The firm produces at the profit maximisation level of output, where MC = MR (Q1)
At this level, the AR (P1) > AC (C1)
The firm is making supernormal profit
- A diagram of a monopoly market typically shows the demand curve, marginal revenue curve, and marginal cost curve. The monopolist’s profit-maximising point is where MC intersects MR. The price is found on the demand curve corresponding to the quantity produced. Any difference between price and average total cost represents the monopolist’s profit.
Third-degree price discrimination
involves a firm charging a different price for the same good/service to different groups of consumers based on their willingness and ability to pay (different elasticities of demand)
Necessary conditions for third degree price discrimination
- Market Segmentation: The firm must be able to segment the market into distinct groups with different price elasticities of demand.
- Price Discrimination:
The firm must have the ability to charge different prices to each segment. - No Arbitrage:
Resale between segments should be prevented or discouraged.
The cost of separating the markets must not exceed the additional revenue gained from charging different prices - Market Power
The firm must have the ability to change prices, which works best when there are no/few substitutes
Diagrammatic analysis for price discrimination
- In the diagrammatic analysis, the firm will charge higher prices to the group with less elastic demand and lower prices to the group with more elastic demand.
- This maximizes the firm’s total profit
- The firms’ total profits are higher than if they had charged a single price to all customers
Costs and benefits of Third-degree price discrimination to producers
- The total revenue of producers increases, leading to higher profits assuming there is no change in costs
- Firms increase their producer surplus at the expense of a decrease in consumer surplus
- Setting up and enforcing price discrimination can increase average costs. The costs of price discrimination must not outweigh the additional revenue gained
Costs and Benefits of Third-Degree Price Discrimination to Consumers
- Many price inelastic consumers will lose out as they pay higher prices, lowering consumer surplus
- Other price elastic consumers will benefit as they will be able to take advantage of the lower prices, increasing consumer surplus
- Some consumers will gain as a higher price decreases the quantity demanded and in some markets this can increase consumer utility (eg: reducing overcrowding on trains at peak times)
The Advantages Of Monopoly Power for firms
- Supernormal profits generate finance for continued investment in technology and product innovation
- Market power enables the firm to increase its global competitiveness
- Economies of scale can increase, thereby lowering the average cost
- Producer surplus increases
- Price discrimination can increase total revenue
The disadvantages of monopoly power for firms
- Due to a lack of competition, there is a reduced incentive to be efficient
- Cross subsidisation can create inefficiencies
- Monopolies lead to a misallocation of resources as P > MC. The price is above the opportunity cost of providing the product
- Due to a lack of competition, innovation sometimes lacks effectiveness
Cross subsidisation
Using the profit generated by one product to lower the prices of another
Advantages of monopoly power for employees
- Supernormal profits often result in higher wages and greater job security
Disadvantages of monopoly power on employees
- Having only one supplier in the industry limits the opportunity to change employers
Advantages of monopoly power on consumers
- Product innovation due to the firm’s supernormal profits may result in a better-quality product (funds R&D)
- Cross subsidisation can lower prices on some products that the firm provides
- Prices may fall If firms pass on their cost savings (due to economies of scale) in the form of lower product prices + LR effieciency
Disadvantages of monopoly power on consumers
- A lack of competition is likely to result in higher prices as no substitute goods are available
> consumers are more PED inelastic - A lack of competition may result in no product innovation and worse product quality over time
- May experience worse customer service as the incentive to improve it is limited due to lack of competition
- Cross subsidisation is likely to increase prices on some products offered by the firm
- Consumer surplus decreases
Advantages of monopoly power of suppliers
- Increased sales volume for some suppliers as they are able to supply products that are distributed nationally or internationally with a secure contract
Disadvantages of monopoly power on suppliers
- There is less competition for their products and a monopoly often has the power to dictate what price they will pay to suppliers (monopsony power)
> This price may not be profitable in the long run
Natural monopoly
- A natural monopoly occurs when a single firm can efficiently serve the entire market due to significant economies of scale.
- The optimum number of firms in the industry is one
features of a natural monopoly include
- associated infrastructure issues
> where it does not make sense to have multiple firms producing same service - Ability of economies of scale to lower prices for consumers
> Declining average total cost as production scales up. - High fixed costs relative to variable costs.
> significant cost that is generated when entering or exiting the industry, e.g. the sunk costs - Even one firm in the industry cannot achieve an output at the lowest average cost where AC=MC, productive efficiency. More competition would simply increase average costs, further increasing prices for consumers
Common examples of natural monopolies
- It is often found in industries like utilities (water, electricity) and infrastructure (railways, telecommunications).
Natural monopolies usually occur in utility industries and are regulated by the (1) to ensure that consumers are not charged higher monopoly prices
This regulation is often in the form of a maximum price or a price cap
(1) Government
Natural monopolies can benefit consumers by providing services at lower costs than multiple competing firms would achieve, but they require (1) to prevent potential abuse of market power.
regulation
advantages of monopolies on society
- large firms pay higher corporate taxes (good for gov budget - can increase spending…)
- creates ‘national champions’ which boosts exports - good for current account deficit
where is loss minimising level of output
mr = mc
