3.4.5 Monopoly Flashcards
What are the characterisics of a monopoly?
- There are no substitute products
- The firm has complete market power and is able to set prices and control output
- This allows the firm to maximise supernormal profit in the short-run
- There is no long-run erosion of supernormal profit as competitors are unable to enter the industry
- High barriers to entry exist
- One of the main barriers is the ability of the monopoly to prevent any competition from entering the market. E.g. by purchasing companies who are a potential threat
Define monopoly
A monopoly is a market structure in which there is a single seller
The UK Competition and Markets Authority defines a legal monopoly as any firm having more than 25% market share.
What is price discrimination?
Price discrimination occurs when a firm charges a different price for the same good/service in order to maximise its revenue
What is third degree price discrimination?
When firms charge different prices to different consumers for the same product with no difference to cost of production.
What are the 3 conditions a firm has to meet to be able to third degree price discriminate?
- Market Power
- Varying Consumer Price Elasticity of Demand (PED) AND the infomation to do this.
- Ability To Prevent Resale of Tickets (must be able to prevent consumers from buying in the low PED market and reselling in the high PED market. The cost of this must not exceed the additional revenue gained from charging different prices (eval point).
what does 3rd degree price discrimination assume?
A constant cost of supply so MC = AC.
What are the impacts of third degree price discrimination on consumers?
PED > 1 consumers pay higher prices lowing consumer surplus
However PED < 1 consumers pay 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
What are the impacts of third degree price discrimination on 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.
However, setting up and enforcing price discrimination can increase average costs. The costs of price discrimination must not outweigh the additional revenue gained (EVAL).
What are the advantages of monopoly power on a firm?
- More SNP -> More reinvestment and product innovation.
- Market power enables firm to increase its global competitiveness.
- Economies of scale can increase, thereby lowering the average cost.
- Producer surplus increases.
- Can price discriminate -> increase total revenue.
What are the disadvantages of monopoly power on a firm?
- Due to a lack of competition, there is a reduced incentive to be efficient - X inefficiency
- Cross subsidisation (profits from one product used in another) can create inefficiencies - distort price signals as true cost isnt there.
- Monopolies lead to a misallocation of resources as P > MC. The price is above the opportunity cost of providing the product - no allocative efficiency.
- Due to a lack of competition, innovation sometimes lacks effectiveness
Advantages AND disadvantages of monopoly power on employees?
- Supernormal profits often result in higher wages and greater job security.
- Having only one supplier in the industry limits the opportunity to change employers if you are specialised.
Advantages of monopoly power on consumers?
- Product innovation due to the firm’s supernormal profits may result in a better-quality product
- 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
What is cross subsidisation?
It’s when a firm uses profits from one product or market to support lower prices in another.
Disadvantages of monopoly power on consumers?
- A lack of competition is likely to result in higher prices as no substitute goods are available
- 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
- Cross subsidisation is likely to increase prices on some products offered by the firm, e.g. First class air ticket prices are used by some airlines to subsidise lower economy ticket prices
- Consumer surplus decreases
Advantage of suppliers regarding monopoly power?
Increased sales volume for some suppliers as they are able to supply products that are distributed nationally or internationally with a secure contract
Disadvantages for suppliers regarding monopoly power?
- 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
What is a natural monopoly?
A natural monopoly occurs when the optimum number of firms in the industry is one.
Use a natural monopoly to argue in favour of a monopoly market structure.
Why might there be a natural monopoly?
- Often due to associated infrastructure issues e.g. delivery of utility services like water, where it does not make sense to have multiple pipelines
- It can also be due to the significant cost that is generated when entering or exiting the industry, e.g. the sunk costs
- It can also be due to the ability of economies of scale to lower prices for consumers, e.g. it makes sense to have one firm building five nuclear power stations as opposed to five firms, as average costs will be lower with one firm constructing
- More competition would simply increase average costs, further increasing prices for consumers
Where do natural monopolies often occur?
Natural monopolies usually occur in utility industries and are regulated by the Government 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.
When evaluating natural monopolies, consider the government failure that may occur with the regulation and the imposition of maximum prices. There is a lot of disagreement about the level of profits that natural monopolies should be allowed to make.
