3.4.5 Flashcards
define monopoly
a firm with more than 25% market share
What are the characteristics of a 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 maximize 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.
What happens when a monopoly is able to achieve significant economies of scale (diagram + analysis + eval)?
One advantage of a monopoly is that the dominant firm can experience significant internal economies of scale that mean that the average cost of supplying the market is lower than if the market were fragmented with lots of smaller competing businesses. In theory, if the economies of scale are large enough, the profit maximising monopoly equilibrium price may even be lower than the competitive equilibrium price, leading to an increase in consumer surplus.
However, this depends on the size of internal economies of scale experienced, it takes large effects for this to happen. Also the lack of competition may lead to the monopoly experiencing X-inefficiencies arising from low productivity and rising fixed costs that are independent of output
Why is an unregulated monopoly likely to lead to high prices that cause a loss of allocative efficiency? (Analysis+ diagram + eval)
Firms with monopoly power can set higher prices than in a competitive market. An unregulated monopoly supplier is highly likely to be allocativley inefficient because in monopoly the price is greater than MC. In a competitive market, the price would be lower and more consumers would benefit from purchasing the good, leading to deadweight welfare loss of consumers.
In theory monopoly can lead to an inefficient allocation of scarce resources, but much depends on the pricing strategies used and also weather the firm with monopoly power does face a degree of contestability. The monopoly can also have prices regulated.
Show the possible effect of price cap on monopoly supplier (analysis + diagram + eval)
Without government regulation, monopolies could put a price above the competitive equilibrium. This would lead to allocative inefficiency and a decline in consumer welfare. So a price cap aims to limit the price that a monopoly can charge. To be effective, a price cap needs to be set below the normal profit maximising price for a monopolist.
Capping the price leads to an expansion in demand and an increase in consumer surplus. But the level of monopoly profit is lower. Capped prices can improve allocative efficiency but lower profits might limit how much a firm can spend on investment and research which might have consequences for the dynamic efficiency of a market.
Draw 3rd degree pricing diagram (3 graphs)
How does a rise in advertising spending by a business affect revenues, costs and profits? (Diagram +analysis + eval)
Advertising and marketing is a key form of non price competition in imperfectly competitive markets. Advertising aims to increase demand by shifting AR and MR curves outwards. This allows the firm to sell higher quantities of their products at higher prices, as successful advertising builds brand loyalty and makes demand less price elastic. With a lower PED, consumers are less responsive to changes in price, enabling firms to increase profit margins and achieve greater total revenue, assuming the advertising is effective. For example, a well targeted social media campaign using influencers can generate viral success and strengthen brand recognition.
However, advertising is typically a fixed cost, as it does not vary with level of output, causing ATC to increase, potentially reducing short run profitability if the additional revenues generates do not sufficiently outweigh these higher costs. Furthermore, advertising is not guaranteed revenue as it depends of the effectiveness of the campaign, which requires strategic planning
How does the price elasticity affect a firm’s profit margins ?
Profit margin = Price - AC
In contestable markets where demand is highly price elastic, firms face intense competition, and consumers are highly responsive to price changes. As a result, firms have limited pricing power, forcing them to price close to costs to avoid losing sales, which leads to narrow profit margins. By contrast, in markets where firms have significant monopoly power, demand is often price inelastic due to a lack of substitutes or strong barriers to entry. This allows firms to raise prices with minimal impact on demand, enabling them to set prices significantly above costs and achieve high profit margins. For example, monopolists can sustain supernormal profits by exploiting inelastic demand, as seen in industries like pharmaceuticals or utilities.
However, the impact of PED on profit margins can be mitigated by regulatory intervention in monopolistic markets or increased competition in contestable markets, which limits firms’ ability to charge higher prices.
define a natural monopoly
A natural monopoly occurs when it is more efficient for a single firm to provide a good or service to the entire market due to high fixed costs and low marginal costs of production.
how is a natural monoply different from other indutries?
chains of analysis + diagram
A natural monopoly is a special case where one large business can supply the entire market at a lower unit cost contrasted with multiple providers. This is because of the nature of costs in a natural monopoly industry. Typically there are very high fixed costs and low marginal costs. For example, the supply of water or electricity to houses and businesses involves building a big network infrastructure. As a result, fixed costs are enormous but the marginal cost of adding an extra user is very low. Therefore, the average total cost will continue to fall as extra users are added to the network. This is an internal economy of scale. This means thatlong run average cost (LRAC) may fall across all ranges of output. Only one firm might reach the minimum efficient scale.
Evaluate the following points
1. gains in productive efficency from supplying products on large scale
2. industry regulators may set price caps to help poorer families and improve allocative efficency
3. high barriers to entry causing X inefficencies. eg: water utiity leads to higher bills for consumers
- single suppliers could charge high prices, damaging consumer welfare
- if MR< LRAC then will make a loss (diagram) and so have less to invest into innovation and investment, reducing dynamic efficency in lomg run
- supply chain to final consumer might be deregulated to stimulate competiton and lower prices
How can a monoploy power make supernormal profit in the long run?
chains of analysis
- A monopolist maximisises profits, where MR=MC at a price above AC.
- This leads to supernormal profits being made.
- In competitive markets, abnornal profits act as a signal for th entry of new firms leading to lower procs and profits.
- But this assumes costless entry in the industry. In realsity there are often barriers to entry.
- For example, a monopoly uses patents and marketing spending to build brand loyalty and make entry harder, which if effective protect the monoply’s supernormal profits.
define 3rd degree price discrimination
charging different prices to different groups of consumers for exactly the same good/ service
what are the negative effects on consumer welfare from 3rd degree price discrimination?
- higher prices for some reduces consumer surplus
- allocative inefficency: inelastic segment
- inequalities: regressive effects
- anti-competitive pricing : elastic segment the lower prices drive out competition
what are some of the advanatages of 3rd degree price discrimination?
- dynamic efficency
- economy of scales benefits
- some consumers do benefit
- cross subsidises other goods and services: premium prices in one group can fund discounts for other groups on lower incomes
