5.1 - Imperfect Competition: The Monopoly

Question 1

What are the three main market forms?

Answer 1

Answer: Perfect Competition, Monopoly, and Oligopoly

Question 2

What two key characteristics define a monopoly?

Answer 2

Answer:
- It is the sole seller of its product
- Its product lacks close substitutes

Question 3

What is the main difference between monopolies and competitive firms regarding price?

Answer 3

Answer: Monopolies are price makers, while competitive firms are price takers

Question 4

Name three barriers to entry that can create monopolies.

Answer 4

Answer:
- Ownership of key resources
- Government-granted exclusive rights (patents, copyrights)
- Natural monopoly conditions

Question 5

What is a natural monopoly?

Answer 5

Answer: A natural monopoly occurs when a single firm can supply a good or service to an entire market at a lower cost than multiple firms, usually due to economies of scale.

Question 6

Using the water utilities example, list the characteristics of natural monopolies.

Answer 6

• High capital costs
• Long-lived assets
• Large fixed costs creating economies of scale
• Assets have no alternative use

Question 7

How does marginal revenue differ for a monopoly compared to price?

Answer 7

Answer: For a monopoly, marginal revenue is always less than price due to the downward-sloping demand curve.

Question 8

What are the two effects on total revenue when a monopoly increases its output?

Answer 8

• Output effect: more output is sold so Q is higher
• Price effect: price falls, so P is lower

Question 9

How does profit maximization differ between monopolies and competitive firms?

Answer 9

Answer: For monopolies, profit is maximized when P > MR = MC, while for competitive firms, profit is maximized when P = MR = MC

Question 10

What are the four ways governments can respond to monopolies?

Answer 10

Answer:
1. Increasing Competition
2. Regulation
3. Turning private monopolies into public enterprises
4. Non-intervention

Question 11

What is antitrust law?

Answer 11

Answer: Laws designed to allow governments to prevent mergers, break up companies and prevent companies from performing activities that make markets less competitive

Question 12

Name the three types of regulatory approaches for price and quality regulation.

Answer 12

• rate of return regulation → monopolistic firms are allowed to earn a specified rate of return on their capital investments, with prices set to achieve this target return while covering operating costs
• price cap regulation → sets maximum prices a monopoly can charge, typically adjusted for inflation and efficiency improvements, designed to incentivize cost reduction while protecting consumers from excessive pricing
• revenue cap regulation → sets a maximum amount of revenue a monopolistic utility company can collect in a given period, typically adjusted for factors like inflation and efficiency improvements, to balance consumer protection with operational sustainability

Question 13

What is regulatory lag?

Answer 13

Answer: A period during which regulators maintain fixed price controls, allowing monopolistic firms to keep additional profits from any cost reductions they achieve, thus creating incentives for efficiency improvements

Question 14

What are the two types of disaggregation in competition regulation?

Answer 14

Answer:
- Vertical disaggregation: breaking up the supply chain
- Horizontal disaggregation: splitting up supply by area/region

Question 15

What is benchmarking in monopoly regulation?

Answer 15

Answer: A regulatory approach where monopolies’ performance is evaluated by comparing their efficiency, costs, and service quality against similar companies in different regions or markets

Question 16

List three challenges of public ownership of monopolies.

Answer 16

Answer: Any three of:
- Reduced incentives for innovation
- Higher bureaucracy
- Political interference
- Transparency issues

Question 17

What are three challenges of private ownership of monopolies?

Answer 17

Answer: Any three of:
- Efficiency concerns under natural monopoly
- Public good considerations
- Universal service provision
- Manager incentives deviating from firm overall

Question 18

When might a government choose non-intervention for a monopoly?

Answer 18

Answer: When the market failure costs are less than the policy implementation costs

Question 19

What makes water utilities a good example of a natural monopoly?

Answer 19

Answer: Water utilities have high capital costs, long-lived assets, large fixed costs creating economies of scale, and their assets have no alternative use. Additionally, duplicating established networks would be inefficient.

Question 20

How do monopolies affect consumer welfare?

Answer 20

Answer: Monopolies create welfare loss due to prices being set above marginal cost, making them undesirable from the consumer’s standpoint as they must pay higher prices than they would in a competitive market.

Question 21

Contrast monopolies and competitive firms.

Answer 21

Monopoly:

• Sole producer
• Downward-sloping demand curve
• Price maker
• Price reductions increase sales

Competitive Firm:

• One of many producers
• Horizontal demand curve
• Price taker
• Can sell any amount (as much or as little) at market price

Question 22

What happens when P > MC?

Answer 22

• as P > MC, there is a wedge between consumers’ willingness to pay and the producer’s costs
  
  • Creates welfare loss due to prices above marginal cost