3.4.5 Monopoly

Question 1

What market share is needed for a monopoly?

Answer 1

25% or more

Question 2

Market share

Answer 2

The proportion of total revenue a firm controls in a particular market.

Question 3

What is a natural monopoly?

Answer 3

A market with only one firm in it. The firm has (close to) 100% market share.

Question 4

Give an example of industries with a natural monopoly

Answer 4

Railways: Network Rail.
Water: United Utilities.

Question 5

Why do natural monopolies exist?

Answer 5

It is more efficient for one firm to operate in a market.
Competition would decrease efficiency.

E.g. Competition in water industry would mean water companies would have to lay seperate pipes.

E.g. Competition in the railway industry would mean new tracks would have to be laid.

Question 6

Are monopolies price makers?

Answer 6

Yes - firms can influence the price of a particular good on their own.

Question 7

Why does monopoly power happen?

Answer 7

• High barriers to entry.
• Advertising and product differentiation.
• Few competitors in the market.

Question 8

How do high barriers to entry cause monopoly power?

Answer 8

They prevent new competition entering a market to compete away large profits.

Question 9

How does advertising and product differentiation cause monopoly power?

Answer 9

A firm may be able to act as a price maker if consumers think of its products as more desirable than those produced by other firms.

Example: Apple

Question 10

How does a lack of competition cause monopoly power?

Answer 10

If a market is dominated by a small number of firms, these are likely to have some price-making power. They’ll also find it easier to differentiate their products.

Question 11

What determines demand in a monopoly market?

Answer 11

Price - the higher the price, the lower the demand will be.

Question 12

Do monopolies make supernormal profits?

Answer 12

Short term - Yes

Long term - Yes (because profits aren’t competed away - due to high barriers of entry).

Question 13

Are monopolies productively efficient?

Answer 13

No - monopolies don’t operate at the lowest point on the AC curve.

Question 14

Are monopolies allocatively efficient?

Answer 14

No - the price charged by the firm is greater than Marginal Cost. (Producers are being over-rewarded for the products they’re providing).

Question 15

What leads to natural monopolies?

Answer 15

If an industry has high fixed costs and/or large economies of scale.

Question 16

What does the government do to ensure that consumers are not charged higher monopoly prices.

Answer 16

Regulation - often in the form of maximum prices.

Question 17

Why might a government be reluctant to break up a natural monopoly?

Answer 17

It could reduce efficiency.

Question 18

Benefits of monopolies

Answer 18

• They can exploit economies of scale (allowing them to keep AC - and therefore prices - low).
• The security a monopolist has in the maret can lead to dynamic efficiency and innovation.
• Increased financial security means that a monopolist can provide stable employment for its workers.

Question 19

Drawbacks of monopolies

Answer 19

• There is no need for a monoply to innovate or respond to changing consumer preferences in order to make a profit, so they become complacent.
• There is no need to increase efficiency, so x-inefficiency can remain high.
• Consumer choice is restricted, since there are no alternative products.
• A monopsonist power can be used to exploit suppliers.

Question 20

Price discrimination

Answer 20

This when a seller charges different prices to different customers for exactly the same product.

Question 21

What must the products be for price discrimination to happen?

Answer 21

The products must be exactly the same.

For example, Economy vs Business plane tickets are not an example of price discrimination because it costs more to provide a business class seat.

Question 22

What does price discrimination do to consumer surplus?

Answer 22

A consumer surplus is the difference between the actual selling price of a product and the price a consumer would be willing to pay. For example, if the price of a cinema ticket was £7 but a consumer would have been willing to pay £10, then the consumer surplus is £2.

Price discrimination attempts to turn consumer surplus into additional revenue for the seller.

Question 23

Conditions for price discrimination

Answer 23

• The seller must have price making power (monopoly/oligopoly).
• The firm must be able to distinguish seperate groups of customers who have different PED. - The more groups that the market can be subdivided into, the greater the gains for the seller.
• The firm must be able to prevent seepage - it must be able to prevent customers who have bought the product at a low price re-selling it themselves at a higher prices to customers who could have been charged more.

Question 24

Examples of price discrimination

Answer 24

• Theatres and cinemas offer ‘concession’ prices for certain groups (e.g. students and pensioners).
• Window cleaners could charge more in a smart neighbourhood than in a lower-income area.
• Train tickets at rush hour cost more than the same train ticket at other times of the day.
• Pharmaceutical drugs may be sold at different prices in different countries.

Question 25

Third degree price discrimination

Answer 25

When a firm charges different prices for the same product to different segments of the market.

Question 26

Give an example of segments that the market could be broken down into (for 3rd degree price discrimination).

Answer 26

• Customers of different ages – for example, a leisure centre might have different prices for adults, children and pensioners.
• Customers who buy at different times – for example, a telephone company might charge different amounts for phone calls made during office hours and phone calls made in the evening.
• Customers in different places – for example, a pharmaceutical company might sell its goods at different prices in different countries.

Question 27

To maximise profit, the seller would set the price for each group at a level where MC = MR. What prices would they charge to a group with a more elastic/inelastic PED?

Answer 27

• It will charge a higher price to the group with a more inelastic PED.
• It will charge a lower price to the group with a more elastic PED.

Question 28

Costs and drawbacks of price discrimination

Answer 28

• It means that consumer surplus is converted into revenue for the seller. (The seller increasing revenue at the expense of the consumer).
• The average revenue is greater than MC - so price discrimination doesn’t lead to allcoative efficiency.
• Consumers are not treated equally.

Question 29

Advantages of price discrimination

Answer 29

• It increases total revenue for producers, leading to higher profits.
• Firms increase their producer surplus.
• Setting up and enforcing price discrimination can increase average costs (due to administration fees).