Concentrated markets; theory of monopoly

Question 1

What are the assumptions of a monopoly? (2)

Answer 1

The firm is the industry

There are barriers to entry

Question 2

What are barriers to entry?

Answer 2

Obstacles that stop new firms entering a market

Question 3

Why does the marginal revenue curve lie within the average revenue curve?

Answer 3

As more units are sold the price of all units has to be reduced

Question 4

What is X-inefficient? (organisational slack)

Answer 4

Not reducing costs to their lowest level - the gap between the actual and lowest possible cost

Question 5

What are the types of barriers to entry? (6) ( PNLSPC)

Answer 5

Patent laws 
Nationalised 
Limit pricing 
Sunk costs 
Product differentiation 
Control over raw materials

Question 6

What are patent laws?

Answer 6

A grant of temporary monopoly rights over a new product

Question 7

How to patent laws act as a barrier to entry?

Answer 7

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

Question 8

What is nationalised?

Answer 8

Taking a firm/industry into public ownership

Question 9

What does incumbent mean?

Answer 9

Existing firms in the industry

Question 10

What is limit pricing?

Answer 10

Setting a price so low that other firms will not enter the industry

Question 11

How does limit pricing act as a barrier to entry?

Answer 11

Incumbent firms will be able to exploit economies of scale and decrease their prices, so new entrants will be unable to compete

Question 12

What are sunk costs?

Answer 12

Irretrievable costs that occur when a firm exits the industry

Question 13

How do sunk costs act as a barrier to entry?

Answer 13

The incumbent firm can create fixed costs that will make it extremely expensive for new entrants

Question 14

What is an example of a sunk cost acting as a barrier to entry?

Answer 14

Advertising on a massive scale that makes it too costly for any new entrant to enter the market

Question 15

What is a legal monopoly?

Answer 15

A firm with 25% or more of the market share

Question 16

What is product differentiation?

Answer 16

A way of distinguishing a product from that of competitors

Question 17

How does product differentiation act as a barrier to entry?

Answer 17

Firms may produce a variety of products, new entrants may not have the finance to produce as many products

Question 18

What is marginal cost pricing?

Answer 18

Where MC = AR

The point of allocative efficiency

Question 19

What is average cost pricing?

Answer 19

Where ATC = AR

The lowest price at which the firm will remain in the industry

Question 20

What are the characteristics of a natural monopoly? (2)

Answer 20

They have an extremely high capital cost to set up

The MES doesn’t occur until a high level of output

Question 21

Where does the consumer surplus lie?

Answer 21

Above the price

Question 22

Where does the producer surplus lie?

Answer 22

Below the price

Question 23

What is dead weight loss?

Answer 23

Reduction in consumer and producer surplus when output is restricted to less than the optimum level

Question 24

Why are monopolies not economically efficient?

Answer 24

Because they are not allocative or productively efficient

Question 25

If a firm cannot reach the MES, why will the firm find it hard to compete?

Answer 25

The unit costs will be too high

Question 26

What can monopolies use their short term profits for?

Answer 26

Invest in research and development

Question 27

What is price discrimination?

Answer 27

Where an identical product is sold to different customers at different prices

Question 28

What are the conditions necessary for price discrimination? (3)

Answer 28

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

Question 29

What are the methods of price discrimination? (3)

Answer 29

Geographical
Time
Age of consumer

Question 30

What are the types of price discrimination? (3)

Answer 30

First, Second and Third degree

Question 31

What is first degree price discrimination?

Answer 31

This involves charging consumers the maximum price that they are willing to pay.

Question 32

What is second degree price discrimination?

Answer 32

This involves charging different prices depending upon the quantity consumed

Question 33

What is third degree price discrimination?

Answer 33

This involves charging different prices to different groups of people

Question 34

What are the advantages of price discrimination? (3)

Answer 34

Increased profits redistribute income from consumers to producers
Profitable and will provide a higher level of total revenue
Output will be larger

Question 35

What are the effects of price discrimination on consumers? (2)

Answer 35

Loss of welfare

Inequitable

Question 36

In what price type of price discrimination does the consumer surplus totally disappear?

Answer 36

First degree