Concentrated markets; theory of monopoly Flashcards
What are the assumptions of a monopoly? (2)
The firm is the industry
There are barriers to entry
What are barriers to entry?
Obstacles that stop new firms entering a market
Why does the marginal revenue curve lie within the average revenue curve?
As more units are sold the price of all units has to be reduced
What is X-inefficient? (organisational slack)
Not reducing costs to their lowest level - the gap between the actual and lowest possible cost
What are the types of barriers to entry? (6) ( PNLSPC)
Patent laws Nationalised Limit pricing Sunk costs Product differentiation Control over raw materials
What are patent laws?
A grant of temporary monopoly rights over a new product
How to patent laws act as a barrier to entry?
Only the person who deigned a product can exploit the invention for a number of years, it prevents other firms from producing the same product
What is nationalised?
Taking a firm/industry into public ownership
What does incumbent mean?
Existing firms in the industry
What is limit pricing?
Setting a price so low that other firms will not enter the industry
How does limit pricing act as a barrier to entry?
Incumbent firms will be able to exploit economies of scale and decrease their prices, so new entrants will be unable to compete
What are sunk costs?
Irretrievable costs that occur when a firm exits the industry
How do sunk costs act as a barrier to entry?
The incumbent firm can create fixed costs that will make it extremely expensive for new entrants
What is an example of a sunk cost acting as a barrier to entry?
Advertising on a massive scale that makes it too costly for any new entrant to enter the market
What is a legal monopoly?
A firm with 25% or more of the market share
What is product differentiation?
A way of distinguishing a product from that of competitors
How does product differentiation act as a barrier to entry?
Firms may produce a variety of products, new entrants may not have the finance to produce as many products
What is marginal cost pricing?
Where MC = AR
The point of allocative efficiency
What is average cost pricing?
Where ATC = AR
The lowest price at which the firm will remain in the industry
What are the characteristics of a natural monopoly? (2)
They have an extremely high capital cost to set up
The MES doesn’t occur until a high level of output
Where does the consumer surplus lie?
Above the price
Where does the producer surplus lie?
Below the price
What is dead weight loss?
Reduction in consumer and producer surplus when output is restricted to less than the optimum level
Why are monopolies not economically efficient?
Because they are not allocative or productively efficient
If a firm cannot reach the MES, why will the firm find it hard to compete?
The unit costs will be too high
What can monopolies use their short term profits for?
Invest in research and development
What is price discrimination?
Where an identical product is sold to different customers at different prices
What are the conditions necessary for price discrimination? (3)
No other firms that can sell the product for a lower price
That resale can be prevented from one buyer to another
That there are different elasticities of demand - some buyers are prepared to pay more than others
What are the methods of price discrimination? (3)
Geographical
Time
Age of consumer
What are the types of price discrimination? (3)
First, Second and Third degree
What is first degree price discrimination?
This involves charging consumers the maximum price that they are willing to pay.
What is second degree price discrimination?
This involves charging different prices depending upon the quantity consumed
What is third degree price discrimination?
This involves charging different prices to different groups of people
What are the advantages of price discrimination? (3)
Increased profits redistribute income from consumers to producers
Profitable and will provide a higher level of total revenue
Output will be larger
What are the effects of price discrimination on consumers? (2)
Loss of welfare
Inequitable
In what price type of price discrimination does the consumer surplus totally disappear?
First degree
