3.4.5 Monopoly

Question 1

What is a monopoly?

Answer 1

When one seller dominates the market.

Question 2

What are the characteristics of a monopoly market structure?

Answer 2

• differentiated products
• firm is a price maker
• high barriers to entry and exit
• imperfect information
• firm is a profit maximiser

Question 3

Is a monopoly firm allocatively efficient?

Answer 3

No because MC does not equal the price (AR=D).

Question 4

When a monopoly firm is being allocatively inefficient, what happens to consumers?

Answer 4

They are exploited, consumer surplus is reduced.

Output is low, choice is restricted, quality could be low due to lack of competition

Question 5

Is a monopoly firm being productively efficient?

Answer 5

No, because the market is not operating at its lowest point on the AC curve.

Question 6

When a monopoly firm is being productively inefficient, what happens?

Answer 6

Voluntarily forgoing economies of scale, leading to higher prices

Question 7

Is a firm being X efficient in a monopoly market?

Answer 7

Yes, as it is an uncompetitive market firms are not incentivised to cut waste.

The firm is statically inefficient

Question 8

In a monopoly market, are firms dynamically efficient?

Answer 8

Yes, because they make supernormal profit in the long run.

Question 9

What is price discrimination?

Answer 9

When a firm charges a different price to a different consumer for an identical good or service when the cost of production is the same

Question 10

What 3 conditions do firms need to be able to price discriminate?

Answer 10

1. price making ability (monopoly power)
2. information to separate the market i.e. elasticities for different consumers
3. prevent resale

Question 11

What is 3rd degree price discrimination?

Answer 11

Occurs when a firm is able to segment the market into different elasticises of demand

Question 12

How can a firm know about different elasticities of demand (3rd degree price discrimination)?

Answer 12

• geography
• time
• demographic of population

Question 13

Explain the diagram for 3rd degree price discrimination…

Answer 13

There are different elasticities for different consumers. For instance peak and off peak. Elasticity shown by steepness. Firm operates when MR = MC, so read up to the AR to get the given price. Inelastic have a higher price compared to elastic.

Question 14

What are the drawbacks of price discrimination ?

Answer 14

• allocatively inefficient… charging prices well beyond MC… consumer surplus
• inequality… low incomes
• anti competitve nature of pricing… what occurs at elastic end… if prices being driven may force out some firms from the market

Question 15

What are the advantages of price discrimination?

Answer 15

• dynamic efficiency
• economies of scale
• some consumers benefit
• cross subsidisation

Question 16

What is a natural monopoly?

Answer 16

When a firm is in a market with huge fixed costs and other barriers to entry

Question 17

What are the 3 characteristics of a natural monopoly?

Answer 17

• huge fixed costs
• enormous potential of economies of scale
• rational for 1 firm to supply the market

Question 18

Explain the high fixed costs characteristic of a natural monopoly?

Answer 18

Huge fixed costs on infrastructure etc, with a startup.

Question 19

Explain the potential for economies of scale function of a natural monopoly?

Answer 19

Because of the high fixed costs, leading to high total costs, a huge amount of ‘quantity’ will have to be supplied to the market to bring down average cost (AC). Minimum efficient scale.

Question 20

Exalting the rational for 1 firm to supply the market characteristic of a natural monopoly?

Answer 20

1 firm must supply the whole market because competition is undesirable. Competition would result in a wasteful duplication of resources as the firm firm into the market has got the economies of scale advantage. Firms that enter a market in a natural monopoly state will be priced out of the market (due to other firm having economies of scale) so therefore will leave the market leaving behind their infrastructure (waste).

Question 21

What do multiple firms in a natural monopoly market lead to?

Answer 21

• Productive inefficiency (can’t operate on lowest point on AC)
• allocative inefficiency (as firm leaves behind wasteful infrastructure)