Market Power - Monopoly and Oligopoly

Question 1

Monopoly characteristics

Answer 1

• Only 1 firm
• High barriers to entry/exit
• Abnormal profit in the long run

Question 2

Barriers to entry in a monopoly (5)

Answer 2

• Economies of scale
• Natural monopoly
• Legal barriers
• Brand loyalty
• Anti competitive behaviour

Question 3

Barriers to entry in a monopoly - economies of scale

Answer 3

Decrease in average costs of production as a firm increases their output - caused by specialisation, division of labour, bulk buying, financial economies, transport economies, marketing/promotional economies

Question 4

Financial economies

Answer 4

Large firms can borrow money at a lower cost/interest rate than smaller firms who borrow less

Question 5

Marketing/promotional economies

Answer 5

As output increases, COP is spread out over a higher number of units, advertising cost per unit falls.

Question 6

Economies of scale is a barrier because…

Answer 6

A large monopoly can produce more goods at a lower price than smaller entrants so can cut them out using predatory pricing.

Question 6

Natural monopoly barrier to entry

Answer 6

A monopoly that operates in a market that can only support one firm, very difficult for new entrants

Question 7

Legal barriers barrier to entry

Answer 7

A monopoly may be given a legal right to be the only producer in an industry (patents/copyrights etc)

Question 8

Anti-competitive behaviour barrier to entry

Answer 8

Monopolists prevent competition from entering the market by entering a price war (lowering prices so it is unsustainable for the smaller firm to continue)

Question 9

Brand loyalty barrier to entry

Answer 9

Long term brand loyalty will make it difficult for new entrants

Question 10

Three types of profit in a monopoly

Answer 10

Supernormal profit (more than sufficient), normal profit (just enough to continue), economic loss (making profit less than expected)

Question 11

Monopoly abnormal profits in the short run

Answer 11

A monopoly can make abnormal profit

Question 12

Monopoly abnormal profits in the long run

Answer 12

Because there are high barriers to entry, the monopoly can make abnormal profits in the long run as well

Question 13

Monopoly productive and allocative efficiency

Answer 13

Not productive or allocatively efficient

Question 14

Monopoly advantages

Answer 14

Long term abnormal profits allows money to be put into research, benefiting consumers.

Question 15

Monopoly disadvantages

Answer 15

If a monopoly does not experience economies of scale, it charges a higher price and produces less compared to a perfect competitor. It is also productively and allocatively inefficient in the long run, unlike a perfect competitor.

Question 15

Oligopoly characteristics

Answer 15

• A few large firms dominating the industry
• Produce identical but differentiated products
• Distinct barriers to entry (usually size of existing firms or strong branding)
• Interdependence (collusion)
• Price remain stable

Question 16

Oligopoly examples

Answer 16

Petrol stations, banks

Question 17

Collusion

Answer 17

When firms charge the same prices as each other on purpose

Question 18

Formal (overt) collusion

Answer 18

Firms openly agree on a price they will charge. This is called cartel. Results in higher prices for consumer and less output.

Question 19

Informal collusion

Answer 19

Firms charge the same prices but there is no specific agreement between producers

Question 20

In formal and informal collusion…

Answer 20

Oligopolists act as monopolies

Question 21

Issues with collusion

Answer 21

• Incentive to cheat to gain a large share of the market
• May lead to a price war

Question 22

Non collusive oligopolies

Answer 22

Don’t agree on price or output but are very aware of the possible reactions

Question 23

How do oligopolies engage in non-price competition? (5)

Answer 23

Advertising and marketing, location, other services, loyalty, packaging of product

Question 24

Oligopoly profits

Answer 24

As it can act as a monopoly when colluding/non colluding have market power so can make abnormal profit in the long run.

Question 25

Is an oligopoly allocatively efficient?

Answer 25

No, it does not produce where supply = demand

Question 26

Is an oligopoly productively efficient?

Answer 26

No, it does not produce where AC is a minimum

Question 27

Why would the government intervene in monopoly/oligopolies?

Answer 27

• Restricting output below socially desirable level
• Prices are higher than socially desirable level
• Fewer firms –> less consumer choice
• Both firms are productively and allocatively inefficient
• Both firms earn long term abnormal profit through high prices which exploits lower income

Question 28

Government intervention methods monopoly/oligopolies (3)

Answer 28

• Pass laws that restrict ability of firms to grow (combining or takeover)
• Pass laws that prevent price fixing
• Set up regulatory bodies

Question 29

What do regulatory bodies do?

Answer 29

• Set price limits
• Impose anti competitive fines
• Break up monopoly into several businesses
• Make firms who have control over a key resource share it