Monopolies and oligopolies Flashcards

Question

costs of a monopoly (FOR A FIRM)

Answer 1

1. Risk of investigation by competition authorities - Monopoly power may attract scrutiny and investigation by regulatory bodies such as the CMA - penalties and legal challenges can impose significant costs to the firm and harm its reputation, potentially reducing profitability 2. Deos - if a firm grows too large, it may face diseconomies of scale, such as higher managerial/coordination costs - these inefficiencies can erode cost advantages and negatively impact profitability 3. Complacency and inefficiency - lack of competitive pressure may lead to complacency, leading to X inefficiency and organisational slack - resulting in higher costs and lower productivity, reducing the potential benefits of monopoly power over time

Answer 2

1. Economies of scale and lower prices - monopolies achieving eos can reduce production costs, potentially lowering prices for consumers - lower costs also allow firms to produce at a larger scale, meeting consumer demand more 2. innovation through r&d - supernormal profits allow monopolies to invest in research and development, creating higher quality products or entirely new goods over time - consumers benefit from access to innovative and improved products over time 3. International competition - a domestic monopoly may face competition from foreign firms, incentivising it to maintain efficiency and competitive pricing - this ensures consumers still gain access to better prices and quality

Answer 3

1. Allocative inefficiency and higher prices - monopolies set prices above marginal cost, leading to higher prices for consumers and reduced allocative efficiency - consumers end up paying more than the optimal price for goods and services, reducing their overall welfare 2. deadweight loss - monopolies create DWL by reducing consumer and producer surplus, as fewer goods are produced and consumed than in a competitive market - this represents a loss of societal welfare and economic efficiency 3. no guarantee of reinvestment - monopolies, facing no competition, may not reinvest profits into improving products or processes - consumers may experience stagnant quality and limited choices, as the firm lacks incentive to innovate or enhance services 4. Lack of incentive to improve products - with no threat from competitors, monopolies may not prioritise product development or customer satisfaction - consumers may face outdated products or substandard service qualities

Answer 4

1. monopsony power over suppliers - a monopoly with monopsony power may exploit suppliers by forcing lower prices, which can reduce suppliers revenues and stifle innovation or production at earlier stages of the supply chain - this can have knock on effects of the broader economy, such as reduced investment and job losses in upstream industries

Answer 5

- occurs when it is most efficient for one firm to supply the entire market, due to high fixed costs and significant eos - own 100% market share

Answer 6

- national grid - tfl - thames water

Answer 7

- large fixed costs, result in a downward-sloping long-run average cost (LRAC) curve, where increasing output reduces average costs. - effective for one provider to serve the market. Allowing multiple firms to build duplicate tracks would create wasteful duplication, driving up costs and increasing fares for consumers. - A single operator can achieve economies of scale, such as bulk purchasing of equipment or better use of management expertise, further lowering average costs. - govt subsidises any losses

Answer 8

- wasted products - productive and allocative efficiency

Answer 9

if it is regulated

Answer 10

- no allocative efficiency or productive - firm sets price where costs = mr, this restricts output and increases price - as they provide essentials, this is unsustainable in the long run, so governments enforce regulations

Answer 11

- prices are lowered to where P = MC - increased output - however AC is greater than AR, so there’s a huge loss - usually a subsidy is given that is the same value of the loss - allows them to make normal profits in LR

Answer 12

- significant economies of scale - minimum efficient scale is very high - productively efficient for one firm to operate in the industry - pricing for allocative efficiency leads to losses - case for government ownership or subsidy, or right regulation

Answer 13

where a firm charges different prices to different consumers for an identical good with no differences in costs of production

Answer 14

- firm needs price making ability, so need some kind of monopoly power - need to have information to separate the market into different PED, eg identify consumers with inelastic PED so they can charge higher prices - prevent reselling (market seepage)

Answer 15

when a firm is able to segment the market into different ped. so there’ll be one group of consumers with inelastic PED and one with elastic PED - a firm will recognise that based on things like age, income, time differences, and will therefore charge different prices to different groups - eg rail company

Answer 16

Dynamic Efficiency - PD enhances firm profitability, enabling greater investment in R&D. - Supernormal profits generated from higher-paying consumer groups can fund innovation, product development, and technology improvements. Maximizes Producer Surplus - Firms capture more consumer surplus by charging different prices to different consumer groups based on their willingness to pay. - Increases revenue and profitability, allowing firms to sustain operations and potentially reinvest in R&D or other activities Enables Economies of Scale - Higher revenues from price discrimination allow firms to produce at a larger scale, reducing average costs. - Consumers may benefit from lower prices in the long run due to cost savings passed on by firms. Cross-Subsidization of Goods/Services - Profits from high-paying consumers can be used to subsidize lower prices for price-sensitive groups or fund unprofitable services. - Expands access to products and services, such as student discounts or discounted medicines in developing countries Increases Market Efficiency - Firms are able to serve a broader range of customers by tailoring prices to different demand levels. - Ensures that some consumers, who otherwise would not have been able to purchase, can still access goods or services, improving allocative efficiency and accesibility, and market share

Answer 17

📉 Consumer Harm (Exploitation) 🔗 Price discrimination can exploit consumers by charging them higher prices than they would pay under uniform pricing 🔗 Some consumers, especially those with inelastic demand, end up paying more than others for the same product 🔗 This leads to inequality in how consumers are treated, as some may feel unfairly charged for the same product or service 🔗 As a result, consumer welfare can decrease, especially for vulnerable groups ⚖️ Inefficiency in the Market 🔗 Price discrimination can lead to allocative inefficiency, where resources are not distributed in the most efficient way 🔗 When firms price differently based on consumer willingness to pay, it may result in overpricing for some groups and underpricing for others 🔗 This can cause misallocation of resources, where some consumers who value the product highly may be priced out, while others who value it less may get a cheaper deal 🔗 In the long term, this may reduce overall market efficiency, as it disrupts the balance between supply and demand 🏆 Barriers to Entry for Competitors 🔗 Price discrimination can give established firms an unfair competitive advantage by allowing them to charge different prices to different groups 🔗 New entrants may struggle to compete, as they would have to offer uniform pricing, which could limit their ability to attract customers 🔗 This may lead to less competition in the market, potentially stifling innovation and preventing consumers from benefiting from lower prices or better products 🔗 As a result, barriers to entry increase, and monopoly power can become entrenched 💸 Administrative Costs 🔗 Implementing price discrimination often requires additional administrative costs to segment the market and track consumer behavior 🔗 Firms need to gather data, develop pricing strategies for different consumer groups, and potentially adjust prices in real-time 🔗 These costs can be significant, especially for small firms, and might not be worth it if the gains from discrimination are small 🔗 In some cases, these administrative efforts can actually reduce overall profitability in the long run 🔄 Consumer Confusion and Backlash 🔗 Consumers may become confused or frustrated when they discover they are paying different prices for the same product 🔗 This can lead to a negative perception of the business and may result in consumer backlash, especially if the price discrimination seems unfair or arbitrary 🔗 Negative reviews and social media campaigns can tarnish a company's reputation 🔗 Over time, this backlash can damage brand loyalty and reduce demand among certain consumer groups

Answer 18

1️⃣ Increased Access to Goods and Services → More Consumers Benefit Firms can offer lower prices to more price-sensitive consumers (e.g., students, pensioners) through third-degree price discrimination. 🔽 This allows low-income consumers to afford essential goods and services they otherwise couldn’t (e.g., cheaper train tickets for students). 🔽 As a result, market participation increases, ensuring more people can access necessary goods and services, which enhances overall consumer welfare. 2️⃣ Higher Revenue for Firms → More Investment in Innovation and Quality By charging different prices to different consumer groups, firms can increase total revenue and profits beyond what they would earn with a single price. 🔽 This extra revenue can be reinvested into R&D, product quality improvements, and better customer service. 🔽 Consumers ultimately benefit from better products, improved technology, and enhanced service offerings, making their purchases more valuable. 3️⃣ More Efficient Use of Capacity → Reduced Congestion and Shortages Price discrimination allows firms to manage demand more effectively by charging different prices at different times (e.g., peak vs. off-peak pricing in transport). 🔽 This helps reduce overcrowding during peak hours and encourages consumers to shift their consumption to less busy periods. 🔽 Consumers benefit from reduced congestion, better service quality, and improved availability, especially in industries like travel, entertainment, and utilities. 4️⃣ Cross-Subsidisation → Lower Prices for Essential Services Higher prices paid by less price-sensitive consumers can be used to subsidise lower prices for others (e.g., in healthcare, public transport, or education). 🔽 This enables firms to maintain services for those who need them most while still remaining profitable. 🔽 As a result, vulnerable groups (e.g., the elderly, disabled, or students) gain access to affordable services that improve their quality of life. 5️⃣ Market Expansion → Increased Consumer Choice Price discrimination allows firms to serve different consumer groups that would otherwise be priced out of the market. 🔽 This can make certain markets more viable and sustainable, encouraging firms to expand their offerings. 🔽 As a result, consumers benefit from greater choice, more competition, and potentially lower prices in the long run due to economies of scale.

Answer 19

1️⃣ High Fixed Costs → Significant Economies of Scale Certain industries (e.g., utilities, railways) require massive upfront investment in infrastructure (e.g., power grids, rail networks). 🔽 As firms produce more output, average costs (AC) continue to fall because fixed costs are spread over a larger quantity of goods/services. 🔽 This creates significant economies of scale, meaning a single large firm can operate at a lower cost per unit than multiple smaller firms. 2️⃣ Duplication of Infrastructure Would Be Inefficient If multiple firms tried to compete in a natural monopoly sector (e.g., building multiple electricity grids in one city), each firm would have to set up its own expensive infrastructure. 🔽 This would result in wasteful duplication and drive up total industry costs, leading to higher prices for consumers. 🔽 Thus, allowing a single firm to dominate ensures that resources are used efficiently, keeping costs lower. 3️⃣ Declining Long-Run Average Cost (LRAC) → Single Firm Can Always Undercut Competitors Due to high fixed costs and economies of scale, a single firm can always produce at a lower cost per unit than any new entrant. 🔽 If a new firm tries to enter, it lacks the same cost advantages and must charge higher prices to remain profitable. 🔽 As a result, the incumbent firm can price out competitors, making competition unsustainable in the long run. 4️⃣ Essential Service Provision → Monopoly Prevents Market Failure Many natural monopolies exist in essential sectors (e.g., water supply, electricity, rail transport), where reliability and universal access are crucial. 🔽 If multiple firms operated in these markets, some areas might be underserved (e.g., rural areas with low profitability). 🔽 A single regulated monopoly ensures continuous service provision, avoiding market failure due to under-provision of essential services. 5️⃣ Contestability Is Limited → High Barriers to Entry Natural monopolies often involve huge sunk costs (e.g., power plants, water pipelines), making entry extremely difficult for new firms. 🔽 Even if a competitor enters, it cannot recover these sunk costs if forced to exit, discouraging investment. 🔽 This means the market remains inherently uncompetitive, reinforcing the idea that it is more efficient for a single firm to dominate.

Answer 20

1️⃣ Economies of Scale May Be Exhausted at a Lower Output Level While natural monopolies benefit from economies of scale, there may be a point where average costs (AC) stop falling beyond a certain output level. 🔽 If this occurs before the entire market is supplied, then multiple firms could coexist at similar cost levels rather than a single firm being necessary. 🔽 This suggests the market does not need just one firm to be efficient, meaning it is not truly a natural monopoly. 2️⃣ Technological Advancements Can Reduce Barriers to Entry In industries like telecommunications and energy, advancements in technology have lowered fixed costs (e.g., decentralized energy production, wireless networks). 🔽 This allows smaller firms to enter and compete, reducing the dominance of a single firm. 🔽 If barriers to entry can be overcome, then the industry should not be classified as a natural monopoly. 3️⃣ Competition Can Drive Innovation and Efficiency Monopolies, even natural ones, often lack competitive pressure, leading to productive inefficiency (higher costs due to wasteful spending). 🔽 If competition is introduced, firms have a greater incentive to innovate, cut costs, and improve service quality. 🔽 This means that allowing multiple firms could increase efficiency rather than relying on a single dominant firm. 4️⃣ Price Discrimination and Consumer Exploitation Risks Natural monopolies often use their power to engage in price discrimination, charging higher prices to different consumers based on willingness to pay. 🔽 This leads to allocative inefficiency because some consumers may be priced out of essential goods or services. 🔽 If competition were introduced, firms would be forced to lower prices, improving consumer welfare. 5️⃣ Potential for Regulation to Mimic Competitive Benefits Even if a market has some characteristics of a natural monopoly, government regulation (e.g., price caps, service requirements) can force firms to act competitively. 🔽 If an industry can be effectively regulated, then maintaining a monopoly is unnecessary to ensure efficiency and fairness. 🔽 This suggests that markets should not be automatically classified as natural monopolies without considering the role of regulation.

Answer 21

🔹 1️⃣ Limit Pricing (Discouraging Market Entry) An incumbent firm sets prices low (just above average cost) to make it unprofitable for new firms to enter the market. This protects market share and reduces long-term competition. Existing firms benefit from lower competition, maintaining a dominant position. Consumers might enjoy lower prices initially, but could face higher prices in the long run due to reduced competition. 📌 Example: Amazon uses limit pricing by keeping profit margins low, making it difficult for new retailers to compete. 🔹 2️⃣ Predatory Pricing (Driving Out Competitors) A firm temporarily sets prices below cost to force competitors out of the market. Once rivals exit or become weak, the firm raises prices to recoup losses. This eliminates competition, leading to higher long-term profits. Consumers benefit from short-term low prices, but in the long run, they may face monopoly pricing. 📌 Example: Uber vs. Local Taxi Firms – Uber used very low fares to drive traditional taxis out of business, then later increased prices. 🔹 3️⃣ Price Matching (Maintaining Market Share) Firms promise to match competitors' prices, reducing the incentive for customers to switch. This prevents price wars, while still keeping prices low for consumers. Consumers feel reassured that they are getting the best deal. Firms retain market share while maintaining brand loyalty. 📌 Example: John Lewis’ ‘Never Knowingly Undersold’ policy guaranteed to match competitors' prices, keeping customers loyal. 🔹 4️⃣ Price Discrimination (Maximizing Revenue) Firms charge different prices to different consumer groups based on willingness to pay. This allows businesses to maximize revenue and profits by capturing more consumer surplus. Consumers with lower willingness to pay (e.g., students) can access goods at cheaper rates. Helps firms cover fixed costs and reinvest in innovation and quality improvements. 📌 Example: Airlines charge different fares for economy, business, and first-class passengers based on demand elasticity.

Answer 22

🔹 1️⃣ Advertising (Brand Loyalty & Market Power) Firms invest heavily in advertising to increase brand recognition and customer loyalty. This helps create perceived product differentiation, even if the actual product is similar to competitors'. Consumers become less price-sensitive, allowing firms to charge premium prices without losing demand. The firm gains market power, reducing the risk of competitors stealing market share. 📌 Example: Coca-Cola vs. Pepsi – Coca-Cola’s strong brand image through advertising helps maintain high demand, despite similar pricing. 🔹 2️⃣ Product Design & Packaging (Perceived Quality & Differentiation) Firms invest in unique product designs and packaging to differentiate themselves from competitors. Aesthetic appeal and functionality enhance perceived value, making consumers willing to pay more. Differentiation helps firms reduce price elasticity of demand, allowing for higher profit margins. Strong branding through packaging can create repeat purchases and brand loyalty. 📌 Example: Apple’s sleek product design & eco-friendly packaging create a premium feel, justifying higher prices. 🔹 3️⃣ Customer Service (Loyalty & Competitive Edge) Firms invest in after-sales support, warranties, and personal customer interactions. High-quality customer service reduces consumer uncertainty, making them more likely to choose a trusted brand. This leads to repeat purchases and positive word-of-mouth marketing, lowering customer acquisition costs. Firms can charge higher prices without losing demand, as consumers value service over just cost. 📌 Example: John Lewis’ excellent customer service and free returns policy encourage loyalty and premium pricing. 🔹 4️⃣ Provision of Complementary Products or Services (Enhanced Value Proposition) Firms bundle products or offer additional services to enhance the overall customer experience. This makes switching to competitors more difficult, increasing customer retention. Bundling complementary products increases consumer surplus, leading to higher perceived value. Firms generate additional revenue streams beyond the core product. 📌 Example: Microsoft Office comes bundled with Word, Excel, and PowerPoint, making it more attractive than buying alternatives separately.

Answer 23

📊 Depends on the Elasticity of Demand Across Consumer Groups Price discrimination is only profitable if different consumer groups have different price elasticities of demand ➡️ If the firm misjudges elasticity and sets prices too high for elastic consumers, sales could fall ➡️ This would reduce total revenue, especially if marginal cost is low ➡️ ⏩ So profits may fall unless the firm segments the market accurately 💡 Depends on the Cost of Separating Markets To price discriminate, firms must prevent resale and identify different groups ➡️ This may require data collection, legal controls, or different versions of a product, increasing costs ➡️ If these costs are too high, they may outweigh the extra revenue ➡️ ⏩ Profitability only rises if administrative costs are low 📉 Depends on the Nature of Competition In highly competitive markets, rivals may undercut discriminatory prices ➡️ This can erode market share or force the firm to lower prices ➡️ This reduces the ability to sustain price differences across segments ➡️ ⏩ So price discrimination may not lead to higher profits if competition is strong 🧾 Depends on Regulatory Intervention or Public Backlash Price discrimination, especially in essential goods (e.g. utilities, drugs), may face regulatory limits ➡️ Governments may cap prices or fine firms for perceived unfairness ➡️ Firms might also face consumer backlash and brand damage ➡️ ⏩ This can reduce long-term demand or trigger intervention that harms profits