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Theme 3 > 3.4.5 Monopoly > Flashcards

3.4.5 Monopoly Flashcards

1
Q

Characteristics of a monopoly

A

o Profit maximisation (in both the short run and the long run)
o Sole seller in a market (a pure monopoly)
o High barriers to entry
o Price maker
o Price discrimination

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2
Q

Monopoly power in the UK

A

In the UK, when one firm dominates the market with more than 25% market share,
the firm has monopoly power.
- e.g, Google dominates the search engine
market, with 90% share.

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3
Q

Factors influencing monopoly power

A
  • barriers to entry
  • the number of competitors
  • advertising
  • the degree of product differentiation
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4
Q

Types of barriers to entry

A
  • economies of scale
  • limit pricing
  • owning a resource
  • sunk costs
  • brand loyalty
  • set up costs
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5
Q

Types of barriers to entry: economies of scale

A

As firms grow larger, the AC falls because of economies of scale. = existing
large firms have a cost advantage over new entrants to the market, which maintains their monopoly power.
- It deters new firms from entering the market, because they are not able to compete with
existing firms.

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6
Q

Types of barriers to entry: limit pricing

A

This involves the existing firm setting the price of their good below the production costs of new entrants, to make sure new firms cannot enter profitably
- designed to protect monopoly power and supernormal profit

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7
Q

Types of barriers to entry: owning a resource

A
  • Early entrants to a market can establish their monopoly power by gaining control of a resource.
  • e.g, BT owns the network of cables = difficult for new firm to enter the market.
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8
Q

Types of barriers to entry: sunk costs

A
  • If unrecoverable costs, e.g advertising, are high in an industry = deter new firms from entering the market since because if they are unable to compete, they do not get the value of the costs back.
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9
Q

Types of barriers to entry (brand loyalty)

A

: If consumers are very loyal to a brand, which can be
increased with advertising, it is difficult for new firms to gain market
share.

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10
Q

Types of barriers to entry: set up costs

A

: If consumers are very loyal to a brand, which can be
increased with advertising, it is difficult for new firms to gain market
share.

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11
Q

Monopoly graph

A

Since the firm is the sole supplier in the market, the firm’s cost and revenue curve is
the same as the industry’s cost and revenue curve. Firms are price makers in a
monopoly.
P>MC in the diagram, due to profit maximisation which occurs at MC = MR, so there
is allocative inefficiency in a monopoly.
AR > AC, so there are supernormal profits

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12
Q

Price discrimination is an monopoly

A

Price discrimination occurs in a monopoly and is when the monopolist decides to charge different groups of consumers different prices for the same g/s to a degree.
- Examples of third degree price discrimination to rail passengers might be higher prices at peak times on trains or adults and students paying different prices.

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12
Q

Price discrimination is an monopoly

A

occurs in a monopoly, when the monopolist decides to charge
different groups of consumers different prices, for the same good or service. This is
not for cost reasons.

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13
Q

Elasticity and monopolies

A

The diagram shows the different price elasticities in a market, which might mean the
monopolist charges different prices. A market with an elastic demand curve (the
second graph) will have a lower price, while a market with an inelastic demand curve
will have a higher price (first graph). The third graph shows the firm’s costs and
revenues. The area of supernormal profit is represented by the yellow shaded
rectangle.

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14
Q

Third degree price discrimination

A

when different groups of consumers are charged a different price for the same good or service. For example, the higher price at peak times on trains is a form of third degree price discrimination, because generally, a different group of consumers (usuallycommuters) use trains at peak times, than off-peak times. Similarly, adults,students and children pay different prices to see the same film at a cinema. It costs the cinema the same to show the film, but the consumers have been
divided into groups based on age.

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15
Q

Costs of price discrimination on consumers

A
  • a loss of consumer surplus.
    -Since P > MC,= a loss of allocative efficiency = strengthens the monopoly power of firms = could result in higher prices in the long run for consumers
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16
Q

Costs of price discrimination to producers

A

If it is used as a predatory pricing method, the firm could face investigation by the Competition and
Markets Authority.
- It might cost the firm to divide the market, which limits the benefits the could gain.

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17
Q

What are the benefits of price discrimination to consumers?

A
  • Consumers could benefit from a net welfare gain as a result of cross subsidisation, if they
    receive a lower price.
  • Some consumers, who were previously excluded by high prices, might now be able to benefit from the g/s.
    E.g, drug companies might charge consumers with higher incomes more for the same drugs, so that the less well-off can also access the drugs at a lower price. This can yield positive externalities
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18
Q

Benefits of price discrimination to producers

A

The higher supernormal profits, which result from price discrimination = help stimulate investment.
- If more profits are made in one market, a different market which makes losses could be cross
subsidised, especially if it yields social benefits.
-This will limit or prevent job losses, which might result from the closure of the loss-making market.

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19
Q

Disadvantages of monopolies

A
  • higher prices
  • decline in consumer surplus
  • inefficient
  • diseconomies of scale
  • monopsony power
  • gain political power
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20
Q

Disadvantages of monopolies (higher prices)

A
  • Monopolies face inelastic demand and so can increase prices – giving consumers no alternative
  • e.g in the 1980s, Microsoft had a monopoly on PC software and charged a high price for Microsoft Office.
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21
Q

Disadvantages of monopolies (decline in consumer surplus)

A

Consumers pay higher prices and fewer consumers can afford to buy. This also leads to allocative inefficiency because the price is greater than marginal cost.

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22
Q

Disadvantages of monopolies (inefficient//0

A

Monopolies have fewer incentives to be efficient. With no competition, a monopoly can make profit without much effort, therefore it can encourage x-inefficiency (organisational slack)

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23
Q

Disadvantages of monopolies (diseconomies of scale)

A

A big firm may become inefficient because it is harder to coordinate and communicate in a big firm.

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24
Q

Disadvantages of monopolies (monopsony power)

A

Monopolies often have monopsony power in paying a lower price to suppliers. For example, farmers have complained about the monopsony power of large supermarkets – which means they receive a very low price for products. A monopoly may also have the power to pay lower wages to its workers.

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25
Q

Disadvantages of monopolies (gain in political power)

A
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26
Q

Monopoly diagram

A

https://www.economicshelp.org/wp-content/uploads/2007/12/monopoly-diagram.png.webp

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27
Q

Inefficiency of monopoly

A

Monopolies set the price of Pm – which is higher than Pc (allocative inefficiency)
Monopolies produce at Qm (which is productive inefficient – not the lowest point on AC curve)
Monopolies lead to deadweight welfare loss of blue triangle

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28
Q

Advantages of monopolies

A
  • economies of scale
  • innovation
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29
Q

Advantages of monopolies (economies of scale)

A
  • In an industry with high fixed costs, a single firm can gain lower long-run average costs – through exploiting economies of scale.
  • This is particularly important for firms operating in a natural monopoly (e.g. rail infrastructure, gas network).
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30
Q

Economies of scale graph

A

https://www.economicshelp.org/wp-content/uploads/2014/05/economies-of-scale-growth-in-firm.png

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31
Q

Disadvantages of monopolies (innovation)

A

Without patents and monopoly power, drug companies would be unwilling to invest so much in drug research. The monopoly power of patent provides an incentive for firms to develop new technology and knowledge, that can benefit society. Also, monopolies make supernormal profit and this supernormal profit can be used to fund investment which leads to improved technology and dynamic efficiency.
E.g, large tech monopolies, such as Google and Apple have invested significantly in new technological developments.

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32
Q

Disadvantages of monopolies (innovation) evaluation

A

this can also have downsides with drug companies able to charge excessively high prices for life-saving drugs. It also gives drug companies an incentive to push pharmaceutical treatments rather than much cheaper solutions to promoting good health and avoiding the poor health in the first place.

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33
Q

Evaluation of monopolies

A
  • depends whether market is contestable
  • depends on the ownership structure
  • depends on management
  • depends on the industry
  • depends on govt regulation
  • environmental factors
  • depends on how you define the industry
34
Q

Evaluation of monopolies (depends whether market is contestable)

A

A contestable monopoly will face the threat of entry. This threat of entry will create an incentive to be efficient and keep prices low.

35
Q

Evaluation of monopolies (depends on the ownership structure)

A

Some former nationalised monopolies had inefficiencies, e.g. British Rail was noted for poor sandwich selection and some inefficiencies in running the network. However, this may have been partly monopoly power but also the lack of incentives for a nationalised firm.

36
Q

Evaluation of monopolies (depends on management)

A

Some large monopolies have successful management to avoid the inertia possible in large monopolies. For example, Amazon has grown by keeping small units of workers who feel a responsibility to compete against other units within the firm.

37
Q

Evaluation of monopolies (depends on the industry)

A

In an industry like health care, there are different motivations to say banking. Doctors and nurses do not need a competitive market to offer good service, it is part of the job. If we take the banking industry, the economies of scale in offering a national banking network are limited. If it was a merger of two steel firms, which has much higher fixed costs, the economies of scale may be greater.
If two pharmaceutical firms or aeroplane manufacturers merged, there could be a good case to say they would use their combined profit for research and development.

38
Q

Evaluation of monopolies (depends on govt regulation)

A

If governments threaten price regulation or regulation of service, this can reduce the excesses of some monopolies.

39
Q

Evaluation of monopolies (environmental factors)

A

A monopoly which restricts output may ironically improve the environment if it lowers consumption.

40
Q

Evaluation of monopolies (depends on how you define the industry)

A

A domestic monopoly in steel may still face international competition – from foreign steel companies. Eurotunnel faces a monopoly on trains between the UK and France but it faces competition from other methods of transport – e.g. planes and boats.

41
Q

Advantages of being a monopoly for a firm

A
  1. can charge higher prices
  2. can benefit from economies of scale
  3. can use monopoly profits
42
Q

Advantages of being a monopoly for a firm (can charge higher prices)

A

They can charge higher prices and make more profit than in a competitive market.

43
Q

Natural monopolies

A
  • arises when there are high fixed costs, usually in the form of
    infrastructure.
  • e.g water and gas pipes, electricity cables and rail networks are expensive forms of infrastructure. In these industries, natural monopolies supply the services.
44
Q

Motive for price discrimination

A
  • unexploited surplus
  • see graph
45
Q

Types of price discrimination

A
  • demographic (age, gender)
  • time of day/year
  • off peak
  • different incomes
  • 2 for 1
46
Q

First degree/perfect price discrimination (when to use it)

A
  1. The firm has market power and can prevent resale
  2. The firm’s customers have different demand curves
  3. The firm has complete information about every customer and can identify each one’s level of demand before purchase
47
Q

First degree/perfect price discrimination

A

Each consumer is charged the maximum he/she is willing to pay

48
Q

Perfect competition graph

A
49
Q

Monopoly graph

A
50
Q

Perfect price discrimination graph

A
  • Firm tries to charge the maximum amount consumers are willing to pay- allocative efficient
51
Q

When first degree/perfect price discrimination is used?

A

1) A firm has market power and can prevent resale
2) The firm’s customers have different demand curve
3) The firm has complete information about every customer & can identify each one’s level of demand before purchase

52
Q

When third degree price discrimination is used?

A

1) A firm has market power and can prevent resale
2) The firm’s customers have different demand curve
3) The firm can directly identify specific groups of customers (but not individual customers) with different price sensitivities before purchase

53
Q

What are some ways to directly segment customers (third degree)?

A
  • By customer characteristics
  • Age (e.g senior citizens discounts)
  • Gender (e.g ladies night specials)
  • By past purchase behaviour
  • Location (based of location demand over time)
  • Over time
54
Q

Ways to directly segment customers (third degree) - by past purchase behaviour

A

repeat customers may be more price sensitive)

55
Q

Ways to directly segment customers (third degree) - over time

A
  • Christmas
  • Holiday
  • Books & movie for fans who want to buy instantly
56
Q

Third degree graph

A
57
Q

Limit pricing results

A

As a result, potential rival firm decide that risks of entering industry are too high = leave = market is likely to remain highly concentrated
- successful = market is likely to remain highly concentrated at business can continue to earn supernormal profit with P>AC

58
Q

Natural monopoly

A

where one large business can supply the entire market at a lower unit cost contrasted with multiple providers.

59
Q

In a natural monopoly, why can one large firm supply the entire market at lower costs?

A
  • this is due to the nature of costs in a natural monopoly industry = Typically there are very high fixed costs & low marginal costs.
  • e.g, the supply of water or electricity to houses and businesses involves building a big network infrastructure.
  • so fixed costs are enormous but the MC of adding an extra user is very low.
  • so the ATC 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.
60
Q

The impact of natural monopoly on consumer welfare

A
  • there are gains in productive efficacy from supplying products on a large scale
  • lower prices: an industry regulator might decide to cap the price of a natural monopoly to help achieve allocative efficiency and protect poorer families
61
Q

The impact of natural monopoly on consumer welfare (productive efficiency evaluation)

A

However in a natural monopoly, a single supplier could in theory charge a very high price which might damage consumer welfare.

62
Q

The impact of natural monopoly on consumer welfare (lower prices due to price caps evaluation)

A

But if MC<LRAC, then capping prices at marginal cost will inflict losses on the industry which might have damaging effects on investment and innovation.

63
Q

The impact of natural monopoly on consumer welfare (lower prices evaluation)

A

A natural monopoly such as regional water utility has high barriers to entry causing X-inefficiency and higher bills for consumers

Eval: However, some of the supply chain to the final consumer might be deregulated to stimulate competition and thus lower prices

64
Q

Benefits of price discrimination to rail passengers

A

1) cheaper rail fares for specific groups
2) improved service due to investment

65
Q

Benefits of price discrimination to rail passengers (cheaper rail fares)

A

For example, students who might have been previously excluded by high prices of rail fares, might now be able to benefit from the service.

66
Q

Benefits of price discrimination to rail passengers (cheaper rail fares) evaluation: short run vs long run

A
  • can result in loss of consumer surplus since price is above MC = strength monopoly power = higher prices in long run
  • therefore benefit only significant in short run
67
Q

Benefits of price discrimination to rail passengers (cheaper rail fares) evaluation: monopoly power

A

The rail industry is a monopoly therefore even if they decided raised the price, some rail passengers might still be willing to buy the tickets due to lack of alternatives.

68
Q

Benefits of price discrimination to rail passengers (cheaper rail fares) evaluation: unfair

A
  • Some adults who are price sensitive will not benefit greatly
  • It’s not income which determines elasticity but need (pd is regressive) since allowing adults with lower income forced to travel
  • Some adults will struggle to pay and some young people will be well off.
  • E.g during peak times, you are having people having a worse service whilst paying more.
69
Q

Price discrimination (should not be based on age but income)

A
  • We having a growing number of people in poverty.
  • Young people might be able to chooses off peak times whereas adults might have to choose peak times.
  • Those with higher incomes are more able to travel at off peak times than public sector
  • e.g teacher has to pay the high fare but needs to go at peak times. They don’t have the flexibility of higher income earners.
70
Q

Why might rail industry not be considered a natural monopoly?

A
  • we can have rail operator competing for franchise, running their service = more competitive.
  • “bid to build new rail lines”
    However, overall, rail is good example since having duplicable firms = ineffective and wasteful therefore strong evident that rail is a natural monopoly
71
Q

Importance of natural monopoly

A

it would make no sense to have many small companies providing tap water because these small firms would be duplicating investment and infrastructure.
- The large-scale infrastructure makes it more efficient to just have one firm – a monopoly.

72
Q

Costs of price discrimination to consumer

A
  • price discrimination results in a loss of consumer surplus. Since price is above the marginal cost curve there is a loss of allocative efficiency. This could strengthen the monopoly power of firms, which could result in higher prices in the long run for consumers. Therefore the benefit of rail passengers will only be significant in the short run.
  • Additionally, the PEDs for rail fares might vary. The rail industry is a monopoly therefore even if they decided raised the price, some rail passengers might still be willing to buy the tickets due to lack of alternatives. Some adults who are price sensitive will not benefit greatly from the price discrimination.
73
Q

What are the economies of scales like natural monopoly?

A
  • in natural monopoly, economies of scale are vast implying that only one supplier can fully exploit them.
  • In this case, competition is likely to remain limited and market power will remain strong in the long run
74
Q

Name two factors that limit monopoly power of a business

A
  • industry regulators
  • technological change
75
Q

Name two reasons for monopoly power

A
  • brand loyalty
  • economies of scale
76
Q

Example of monopoly with brand loyalty

A
  • Coca Cola which has over 40 percent of the US carbonated drinks market, has huge scope to keep their prices higher
  • brand loyalty (patents) = barriers to entry = abnormal profits in long run = higher return for shareholders perhaps at the expense of consumer welfare
77
Q

Example of monopoly exploiting economies of scale

A
  • commercial banks such as Barclays, Lloayds
  • due to taking advantage of internal economies of scale = reducing LTAC = gives a significant cost advantage over smaller rivals & potential entrants
  • many are finding it hard to grow quickly enough to become a threat to incumbent firms
  • If new banks make little impact = commercial banks with market power can continue to offer low interest rates for savers & Harte ore for loans
78
Q

Example of technology disrupting monopolies

A
  • in retail banking services with the relative success of tech-savvy businesses such as Starling and Monzo which is currently the fastest-growing bank in the UK
79
Q

Regulation of monopoly

A
  • subsidies to promote competition
  • price cap
  • regulation
  • breaking up a monopoly
80
Q

Monopoly regulators

A

OFGEM – gas and electricity markets
OFWAT – tap water.
ORR – Office of rail regulator.

81
Q

Disadvantages of regulators in monopolies

A
  • It is costly and difficult to decide what the level of X should be.
82
Q

Examples of regulators breaking up monopoly

A

the US looked into breaking up Microsoft, but in the end, the action was dropped.
- This tends to be seen as an extreme step, and there is no guarantee the new firms won’t collude.

83
Q

What must happen for price discrimination to happen?

A

Firm must have some market power

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