Market Structures

Question 1

What is a monopoly market (MM)?

Answer 1

Entails that one firm supplies the market.

• this single firm is a PRICE MAKER (we assume relatively inelastic demand curve as consumers are likely to have less choice over whether to consume the good the monopolist makes)
• one essential characteristic of this market is the BARRIER TO ENTRY which prevents other firms from entering the market

Question 2

What are the barriers to entry in a monopoly market (MM)?

Answer 2

Structural (natural) barriers:
- where the characteristics of the industry to be more efficient results into making it difficult for new entrants to join

Strategic barriers:
- where there are deliberate actions of a firm for the sole purpose of deterring potential entrants
- one of these deliberate actions is LIMIT PRICING where a monopolist (or oligopolist) charges a PRICE BELOW SHORT-RUN PROFIT MAXIMISING LEVEL in order to deter new entrants

Question 3

What are the factors causing barrier to entry?

Answer 3

1. ABSOLUTE COST ADVANTAGES = average costs are below any new entrant at any level of output which can be due to superior technology, control of key inputs, efficient production methods, or economies of scope
2. SWITCHING COSTS TO AN ALTERNATIVE SUPPLIER = such as searching, contractual, learning, product uncertainty and compatibility costs
3. NETWORK EXTERNALITIES = the benefits to consumers of having a network of other people using the same product or service
4. PRODUCT DIFFERENTIATION AND BRAND LOYALTY = a product that a customer identifies with
5. LEGAL RESTRICTIONS = patents and copyrights
6. MERGERS AND TAKEOVERS = of new entrants by a monopoly
7. AGGRESSIVE TACTICS = such as sustaining losses for a long period of time through price wars or massive advertisment campaigns by a monopoly to deter competition

Question 4

What effect does natural monopoly have on long-run average costs (LRAC)?

Answer 4

They would be lower if an industry were under monopoly than if it were shared between two or more competitors.

This means that the LRAC in the market are higher than long run marginal costs, as a result of high fixed costs.

This results in COMPETITION NOT BEING POSSIBLE as under a competitive environment firms would make a loss (and therefore leave the market)

Question 5

What happens to industries with a case of natural monopoly?

Answer 5

Historically the chosen option was often to NATIONALISE the industry (e.g. utilities, railways)

However, in more recent decades we have seen a movement away from nationalism in attempts to improve efficiency i.e. PRIVATISATION.

Generally, a monopoly firm is able to obtain ‘SUPERNORMAL’ profits in both the short & long run

Question 6

What is a ‘deadweight loss’?

Answer 6

Where a monopoly can charge at higher prices while producing lower quantities to supply the market

Deadweight loss to consumers = higher price
Deadweight loss to producers = lower quantity produced

Question 7

What are the benefits of monopoly?

Answer 7

• ability to benefit from economies of scale
• reinvest profits into R&D or other modes of increasing knowledge and innovation

Question 8

What is a monopolistic competitive market?

Answer 8

• There are several to many buyers and sellers providing DIFFERENTIATED PRODUCTS
• There are no barriers to entry in this market, but the differentiated products allows firms to have some control in the pricing decision, i.e. they are PRICE MAKERS
• They face a downward sloping demand curve which is more elastic than that of a monopoly market
• In the short-run firms in this market can earn ‘SUPERNORMAL PROFITS’ but due to no barriers of entry, when other firms see that there is supernormal profit to be made, they enter into the market and this results in a reduction in demand of goods from the existing firms thus reducing profits until they are NORMAL PROFITS IN THE LONG-RUN
• Appear to underutilise their capacity in the long-run by not producing at the minimum LRAC

Question 9

What is an Oligopoly market?

Answer 9

• A situation where there are a few firms dominating the market
• These firms are interdependent, thus the decision made by one firm can cause other firms to react
• The market has similarities to the monopoly market by having barriers to entry
• The interdependence of firms makes it more profitable for forms to collude with each other to prevent competition among each other, and can thus set prices or quantity production quotas (limit supply)
  
  • When firms make a formal agreement to collude with one another, they form a CARTEL (illegal in UK & US)