Market Structures and Monopoly

Question 1

Monopoly definition

Answer 1

A Monopoly market exists when there is a large and dominant firm within a market that has monopoly power. The Firm can influence or even set the market price for a good and the quantity supplied.

AR curve is downward sloping and relatively steep, inelastic as there are limited subsitutes.

Question 2

Pure Monopoly

Answer 2

This is when one firm has 100% of the given market share, this is rare.

Question 3

Characteristics of a Monopoly

Answer 3

• Lack of subsitutes for consumers
• Barriers to entry
• Price setting ability, brand loyalty, lack of subsitutes and therefore downward sloping AR.
• Supernormal profits in both the long and short run.

Question 4

Charateristics of a monopoly - Barriers to entry

Answer 4

Structural
- High start up costs, fixed costs.
- Incumbent firms may be large and possess economies of scale, therefore they have a costs advantage.
- Legal barriers (permission)

Behavrioural
- Brand Loyalty
- Intimidation, agressive pricing strategies, limit pricing, predatory pricing. EVAL CMA

Other
Knowledge of the market, and infomation gaps

Question 5

Natural Monopoly

Answer 5

A natural monopoly occurs when there are very high fixed costs and powerful economies of scale of conducting business in a certain industry. This may mean that a company could be the only provider of a product or service in an industry ot location.

Question 6

6 Disadvantages of a monoploy market

Answer 6

1. Higher prices than in more competitive markets
2. X-Innificiency
3. Taking advantage of their buying power
4. Potential for internal diseconomies of scale
5. Lack of incentives
6. lack of choice and variety for consumers

Question 7

Disadvantages and EVAL - Higher prices than in a more competitive market

Answer 7

• This results in a welfare loss and a fall in consumer surplus.
• Firms are not producing at the level of QAE, Ppm is greater than PAE and QPM is lower than QAE.
• Firms are incentivised to maximise profits and dont take into account the interest of consumers.

EVAL
- Depends on regulatory barriers set by the government or other agencies. Is there a price cap?
- Objectives of the monopoly, are they adopting a long growth strategy, adopting lower prices in order to gain more market share and brand loyalty.
- Levels of regulation in the market, CMA? or thames water and OFWAT.
- How significant are the barriers to entry?

Question 8

Disadvantages and EVAL - X-inefficiency

Answer 8

This could occur when firms costs raise because of a lack of competitive pressures. This can cause organisational slack. This can be caused by uneccesary spending on products. This can be felt by the consumers and prices could rise.
The principle agent problem is also a example of this
DIAGRAM

The principal-agent problem is a situation where an agent is expected to act in the best interest of a principal. But, the agent has different incentives to the principal, leading to a conflict of interests.

EVAL
- Owners can help limit the principle agent probelm with oversight or placing bonuses and incentives in the contract.
- Economies of scale, average costs will be lower and therefore outweighs issues that are caused my x-inefficiency.
- Small market, if its a small market they may not suffer from the principle agent problem.

Question 9

Disadvantages and EVAL - Taking advantage of their buying power

Answer 9

Purchasing economies of scale, monopoly firms that are large in size and buy in bulk in order to reduce costs, this negatively effects producers down the supply chain who are selling their product now at lower prices.

EVAL
Bilateral Monopoly, if the seller to monopoly is itself a dominant firm.

Question 10

Disadvantages and EVAL - Potential for internal diseconomies of scale

Answer 10

• Firms in a monopoly could suffer possible diseconomies of scale such as communication issues and a fall in productivity and workers becoming deincentivised if they cant see their own work.
• Costs for firms could rise.

EVAL
- Impact on profits, revenue is likely to offset any diseconomies of scale. So firms profits may still rise.
- If diseconomies of scale are a issue in the market is is unlikely a firm will operate past the point MES.
For example in a natural monopoly.

Question 11

Disadvantages and EVAL - Lack of incentives

Answer 11

• Lack of competitive measures could result in firms not producing effectivelt and not producing the best quality goods.
• This could result in X-Inefficiency and a fall in dynamic efficiency, which could mean lower costs in the future.
• Lower quality and less diverse selection of goods for consumers

EVAL
- Shareholder activism, removal of the principle agent problem.
- Contestability, there could be threat of future competitive measures, forced to innovate.

Question 12

Disadvantages and EVAL - Lack of choice and variety for consumers

Answer 12

• No subsitutes for consumers
• Quantity is set below the QAE level, fall in welfare and consumer surplus.
• Cant best match consumer prefferences, less utility and therefore they lose wefare.

EVAL
- Large profits can cause firms to diversify their products and create greater quality and choice for consumers.
- Contestability? Want to cultivate brand loyalty?
- Buisness objectives
- They could expand into other markets

Question 13

Potential advantages of a Monopoly

Answer 13

• They can take advantage of potential economies of scale.
• Dynamic gains through reaserch and development
• Domestic monopoly v global competition
• The ability to become a monopoly in the future creates a incentive to seriously compete with rivals and innovate.

Question 14

Potential advantages of a Monopoly - They can take advantage of potential economies of scale.

Answer 14

• Bulk buying and managerial economies of scale will reduce costs for firms and increase their profits, rewarding shareholders.
• This could be felt by consumers as the price level could fall, increasing welfare and consumer surplus.
  DIAGRAM

EVAL
- You can be a dominant firm in a small market, therefore not suffer from Economies of scale.
- The larger the firm, and the less competitive measures means that firms are more likely to suffer from X-inefficiency.

Question 15

Potential advantages of a Monopoly - Dynamic gains through reaserch and development

Answer 15

• High profits could lead to reaserch and development, innovation and dynamic efficiency.
• This could result in greater future profits for the firm and lower costs, this could be felt by consumers as lower prices.
• Possibly wider choice and greater quality products.

EVAL
- Lack of incentives in a Monopoly to invest the supernormal profits.
- Instead the shareholders may just recieved greater wages and dividens.

Question 16

Potential advantages of a Monopoly - Domestic monopoly vs global competition

Answer 16

• Domestic monoplies that operate with high profit margins will not be under threat from TNCs and foreign exporters. They will be more competiive internationaly allowing the industry to undergo dynamic efficiency, innovation, cut costs and grow.

Question 17

Price discrimination definition

Answer 17

Price discrimination is the practise of charging a different price for the same good or services, there are three types of price discrimination, first second and third degree.

It requires at least some price setting ability (to avoid being undercut by other firms) so you need some ‘Monopoly power’.

Question 18

1st Degree price dicrimination

Answer 18

This is a hypothetical scenario, and would occur when a firm can change a different price for every unit consumed.

Question 19

Why isnt 1st degree price descrimination

Answer 19

Information gaps (producers dont know how much the individual is willing to pay and consumers are unlikely to be willing to provide this info.
Legality?
Possibility of arbitrage? Resale for profit.

Question 20

What is 2nd degree price discrimination

Answer 20

This means chagning different price for different quantaties such as quantity discounts for bulk purschases, this allows consumers to select the quantity that best suits their preference and could increase the quantity bough by consumers and increasing firms welfare.

Question 21

3rd degree price discrimination

Answer 21

This means charging a differeent price to different consumer groups, for example rail and tube travelers can be subdivided into commuter and casual traveller. Splitting the market into peak and off peak use invery common and occurs with gas and electircity.

• Firms must have monopoly power.
• They must be able to identify the different market - segments/groups.
• Different segments (consumer groups) must have different PEDs for the product. More PED groups should be charged higher prices.
• Markets must be spereate, seepage between markets must be avoided (In order to prevent arbitrage).

Question 22

Benefits of price discrimination

Answer 22

• Always going to benefit the firm (except if there is extreme arbitrage)
• Can be beneficial for consumers.

Some groups benefit from cheaper prices. Price discrimination means that firms have an incentive to cut prices for groups of consumers who are sensitive to prices (elastic demand). For example, firms often offer a 10% reduction to students. Students typically have lower income so their demand is more elastic. This means they benefit from lower prices. These groups are often poorer than the average consumer. The downside is that some consumers will face higher prices.

Avoid Congestion. Price discrimination is one way to manage demand. If there were no price discrimination rush hour trains would be more overcrowded. Price discrimination gives an incentive for some people to go later in the day. This means that those who have to travel at rush hour benefit from less congestion.

Low-income consumers may be able to benefit from cheaper prices. One form of indirect price discrimination is to offer lower prices to consumers who collect coupons. This imposes a cost on consumers (time to collect). So if consumers are time-rich and money poor, they can take advantage of lower prices.

Investment. Price discrimination helps a firm to become more profitable. This may enable the firm to invest in increased capacity. For example, an airline which maximises profits from price discrimination can invest in updating its aircraft to the latest technology.

Question 23

Costs of Price discrimination

Answer 23

• Some groups now pay a higher price.
• Fall in consumer surplus
• Potentially unfair

Question 24

Why does a Natural Monoploy occur

Answer 24

The most efficient number of firms in the industry is one, high fixed costs and economies of scale means its impractical to have more than one firm produce the good.

Question 25

Regulation of natural monopolies

Answer 25

Natural monopolies are uncontestable and firms have no real competition, therefore without government intervention they coould abuse their market power and set higher prices.
Therefore OFWAT and OFGEM can regulte water and energy markets and keep prices low.