Monopolies

Question 1

A Monopoly is a market containing a Single Seller

Answer 1

1. In economics, a monopoly (or ‘pure monopoly’) is a market with only one firm in it (i.e. one firm is in the industry). In other words, a single firm has 100% market share. (in law its 25% more = monopoly).
2. Even in markets with more than one seller, firms have monopoly power if they can influence the price of a particular good of their own - i.e. they can act as price makers.
3. Monopoly power may come about as a result of:
   - Barriers to entry preventing new competition entering a market to compete away large profits
   - Advertising and product differentiation - a firm may be able to act as a price maker if consumers think of its products as more desirable than those produced by other firms (e.g. because of a strong brand).
   - Few competitors in the market - if a market is dominated by a small number of firms, these are likely to have some price-making power. They’ll also find it easier to differentiate their products.
4. Even though firms with monopoly power are price makers, consumers can still choose whether or not to buy their products. So demand will still depend on the price - as always, the higher the price, the lower the demand will be.

Question 2

A Monopolist makes Supernormal profits - even in the Long Run

Answer 2

This diagram shows how a firm behaves in a monopoly market LOOK ON PAGE 64

1. Assuming that hte firm wants to maximise profits, its level of output will be where MC = MR - shown by the red dot.
2. If the firms produces a quantity, Qm, the demand or (AR) curve shows the price the firm can set - Pm.
3. At this output the average cost (AC) of producing each unit is ACm.
4. The difference between ACm and Pm is the supernormal (excess) profit per unit. So the total supernormal profit is shown by the red area.
5. In a monopoly market, the barriers to entry are total, so no new firms enter the market, and this supernormal profit is not competed away.
6. This means the situation remains as it is - this is the long run equilibrium position for a monopolist.

Question 3

Monopolies aren’t Productively or Allocative Efficient

Answer 3

1. The top diagram on page 64 shows that MC isn’t equal to AC at teh long run equilbrium position for a monopoly. This means that a monopoly isn’t productively efficient.
2. The same diagram shows that the price charged by the firm is greater than MC. This means that a monopoly market is not allocatively eficient. Producers are being ‘over-rewarded’ for the products they’re providing.
3. Because of the restricted supply, the product will also be underconsumed - consumers aren’t getting as much of the product as they want.
4. The red area shows how some of the consumer surplus (see p.29) that would have existed at the market equilibrium price Pc is transferred to the producer.
5. There’s a deadweight welfare loss too. The grey area shows potential revenue that the producer isn’t earning on the quantity Qm to Qc of the product that consumers would have been prepared to pay for (but which isn’t produced).

Question 4

Monopolies have further Drawbacks

Answer 4

• There’s no need for a monopoly to innovate or to respond to changing consumer preferences in order to make a profit, so they may become complacent.
• Similarly, there’s no need to increase efficiency, so x-efficiency can remain high.
• Consumer choice is restricted, since there are no alternative products
• Monopsonist power may alos be used to exploit suppliers.

Question 5

Natural Monopolies have A Lot of Monopoly Power

Answer 5

Some industries => natural monopoly - this can mean they have a great deal of monopoly power.

• Industries where there are high fixed costs and/or there are large economies of scale => natural monopolies.
• If there was more than one firm in the industry, then they would have the same high fixed costs. This would lead to higher costs per customer than could be obtained by a single firm.
• In this case, a monopoly might be more efficient than having lots of firms competing. E.g. the supply of water is a natural monopoly - it makes no sense for competing firms to lay separate pipes.
  1. A natural monopoly will have continuous economies of scale - i.e. LRAC always fall as output increases (meaning MC is always below AC). A profit maximising natural monopoly will restrict output to where MC = MR (at Qm) LOOK AT DIAGRAM ON PG 65
  2. A government might be reluctant to break up a natural monopoly as this could reduce efficiency. However, it might want to provide subsidies to a natural monopoly so that it increases output to the point where demand (AR) = supply (MC) - this is Qs. This will reduce prices to Ps (from Pm).

Question 6

Monopolies have some Potential Benefits

Answer 6

1. A monopolist’s large size allows it to gain an advantage from economies of scale. If diseconomies of scale are avoided, this means it can keep average costs (and perhaps prices) low. A monopolists will produce more than any individual producer in a perfectly competitive market would.
2. The security a monopolist has in the market (as well as supernormal profits) means it can take a long-term view and invest in developing and improvide products for the future - dynamic efficiency.
3. Increased financial security also means that a monopolist can provide stable employment for its workers.
4. Interllectual property rights IPRs allow a form of legal limited monopoly that can actually be in consumers’ interests because they’ll benefit from better quality, innovative products.
   - There are various types of IPRs, such as copyright and patents. These allow a firm exclusive use of their innovative ideas (i.e. no one else is allowed to use them) for a limited time.
   - During this time, supernormal profits may be possible, but this is seen as the reward for innovation and creativity.
   - Without the protection of IPRs, firms would have little incentive to risk their resources investing in innovative products or processes - other firms would simply be able to copy those ideas (and immediately start to compete away any supernormal profits).

Question 7

A Monopsony is a market with a Single Buyer

Answer 7

1. A monopsony = situation when a single buyer dominates the market.
2. A monopsonist can act as a price maker, and drive down prices. E.g. supermarkets are somtimes accused of acting as monopsonists when buying from their suppliers. Some ppl claim supermarkets unfairly use their market power to force suppliers to sell their products at a price that means those suppliers make a loss.
3. This could be seen as a monopsonist exploiting its suppliers. But it could be in the interests of consumers if the supermarkets pass on those low prices (by charging low prices to their customers).
4. If a firm is a single buyer of labour in the market, it can exploit its power and lower the wages of its employees.