3.5.4 - Monopoly and Monopoly Power

Question 1

What is a monopoly?

Answer 1

Only one firm in a market.

Question 2

Can monopolies make long run supernormal profit? If so, why?

Answer 2

No.

Barriers of entry protect the monopoly by preventing new firms entering the market in the short run, but they are eroded in the long run, which opens the market up to competition.

Question 3

Why can monopolies make supernormal profit in the short-run?

Answer 3

There are multiple barriers to entry and/or exit to prevent other firms from competing supernormal profits away.

Question 4

Draw a profit maximisation graph of a monopoly?

Answer 4

Question 5

Where is profit maximised on this graph?

Answer 5

Price P₁

MC = MR therefore profit is maximised.

Question 6

What is the maximum price a monopoly can charge to output Q1?

Answer 6

P1.

Question 8

What is abnormal profit known as in monopolies?

Answer 8

Monopoly profit.

Question 9

What is monopoly power?

Answer 9

The ability of a monopoly to raise and maintain price above the level that would prevail under perfect competition.

Question 10

What are natural barriers?

Answer 10

Barriers to entry caused by geography. i.e. resource control.

Question 11

What are sunk costs?

Answer 11

Costs that have already been incurred and therefore cannot be recovered.

Question 12

What are artificial barriers?

Answer 12

‘man-made’ barriers to market entry such as patents.

Question 13

What are the two types of entry barrier?

Answer 13

Artificial.
Natural.

Question 14

What are the main types of natural entry barrier?

Answer 14

Economies of Scale.
Indivisibilities.
Sunk costs.

Question 15

Why are economies of scale a natural entry barrier?

Answer 15

Incumbent firms are larger and therefore produce at a lower long-run average cost, so are more productively efficient.

Question 16

Why are indivisibilities a natural entry barrier?

Answer 16

Technical economies of scale prevent certain goods being produced in plants below a certain size.

Question 17

Why are sunk costs a natural entry barrier?

Answer 17

Sunk costs cannot be recovered if a firm decides to leave a market therefore deterring entry and incurring added risk.

Question 18

What are indivisibilities?

Answer 18

The fact that below a certain volume of production, it is impossible to produce certain goods such as metal smelting or oil refining industries.

Question 19

Why do incumbent firms erect artificial barriers?

Answer 19

To prevent new firms from entering the market and competing away supernormal profits.

Question 20

What are some examples of strategic entry barriers?

Answer 20

(also known as artificial barriers)

Patents
Product differentiation
High expenditure on advertising and marketing
Benefiting from ‘first-mover’ advantage
Limit and predatory pricing

Question 21

Why are patents examples of artificial barriers?

Answer 21

Legal protection is gained for an invention, ensuring no other firm can use their product.

Question 22

Why is product differentiation an example of an artificial barrier?

Answer 22

By differentiating products, they can then protect the product by intellectual property or trade mark legislation.

Question 23

Why is high expenditure on advertising and marketing an example of an artificial barrier?

Answer 23

Established firms have much more money to spend on advertising than new firms. These are examples of sunk costs so new firms are deterred from entering as they are unrecoverable costs.

Question 24

Why is benefiting from ‘first-mover’ advantage an example of an artificial barrier?

Answer 24

‘First-movers’ such as Apple can establish themselves and build a customer base making it more difficult for later arrivals to compete.

Question 25

Why is limit pricing and predatory pricing an example of an artificial barrier?

Answer 25

Limit pricing involves incumbent firms reducing prices to make normal profit in the short-run in order to force new firms out of the market to make supernormal profit in the long-run.

Predatory pricing involves incumbent firms reducing prices below costs in the short-run to force new firms out of the market sooner than limit pricing to make supernormal profit in the long-run.

Question 26

What market famously defends patents fervently?

Answer 26

Drug companies.

Question 27

What way does a monopolies demand curve slope?

Answer 27

Downwards.

Question 28

What is the monopolies demand curve?

Answer 28

The average revenue curve.

Question 29

What is the difference between monopoly and monopoly power?

Answer 29

Monopoly firms possess the power to restrict output and raise price.
Imperfectly competitive firms possess a certain level of monopoly power.

Question 30

Draw a monopsony power diagram.

Answer 30