Monopoly

Question 1

What is monopoly and what percentage of market share does a firm need to have to be considered a monopoly?

Answer 1

• A monopoly exists when a single firm is the sole seller of a product in a market.
• Pure monopoly is rare, but a firm is considered to have monopoly power if it has more than 25% of the market.
• Tesco is an example of a legal monopoly with 28% market share in the UK grocery sector.
• Google is the closest example of a pure monopoly with 88% market share in internet search engines.

Question 2

How does a monopolist determine the output and price to maximise profit?

Answer 2

• Monopolists maximize profit at the point where marginal revenue (MR) equals marginal cost (MC).
• The demand curve facing a monopolist is the demand curve for the product.
• Monopoly firms can earn supernormal profits or loss in the long run because of high barriers to entry in the market.
• The short-run profit maximization output and price are determined by the intersection of the MR and MC curves.
• The area of supernormal profit is represented by the shaded area between the price (P1) and the average total cost (ATC) at the profit-maximising output (Q1).

Question 3

What is third degree price discrimination and what are the conditions required for price discrimination to be effective?

Answer 3

• Third degree price discrimination is when a monopolist charges different prices to different groups of consumers for the same product.
• Price discrimination is beneficial for monopolists as they can charge higher prices to consumers with inelastic demand while lowering prices for those with elastic demand.
• To practice price discrimination, the monopolist must be able to differentiate the buyers based on their willingness to pay and have the power to prevent resale between markets.
• The monopolist produces where marginal cost (MC) equals marginal revenue (MR) in each market served, and the combined output is represented by the Q3 output at the price P3.
• Price discrimination leads to higher profits for the monopolist as the combined shaded area (yellow) is greater than the area of the elastic (purple) or inelastic (orange) markets separately.

Question 4

What is a natural monopoly and what industries are likely to have natural monopolies?

Answer 4

• Natural monopolies happen when a single producer can supply the entire market more efficiently than multiple producers.
• Natural monopolies are mostly found in industries with high fixed costs like transportation, water, and electricity.
• The most significant characteristic of a natural monopoly is that the average total cost of output falls continuously as output expands.
• A natural monopolist produces where MC=MR to maximize profit and earn supernormal profits.
• A natural monopoly creates a trade-off between market efficiency and consumer welfare, and raises issues on competition policy.

Question 5

How do different stakeholders benefit or suffer from the presence of a monopolist in the market?

Answer 5

• Monopolist firms can make large profits, but they can be affected by X-inefficiencies or lack of incentives to invest.
• Monopolists can benefit from economies of scale, lowering costs and increasing profit.
• Employees of monopolist firms may receive higher wages and salaries than workers in competitive markets.
• Suppliers may suffer if the monopolist abuses its power as a monopsonist and drives down the price of their goods.
• Consumers can benefit from the lower prices and cross-subsidization but may also see reduced quality and choice in products compared to a competitive market.

Question 6

Why is monopoly considered to be inefficient and what are the potential benefits and drawbacks of a monopoly for businesses and consumers?

Answer 6

• Monopoly is productively inefficient because it does not produce where MC=ATC.
• It is also not allocative efficient since the price is higher than in perfect competition.
• The shift from perfect competition to monopoly results in consumer surplus, producer surplus, and deadweight loss.
• A monopolist can be dynamically efficient if it invests in research and development to create new and better products.
• The effects of a monopoly on efficiency rely on the industry: some argue it can be beneficial in the short-run and harmful in the long-run.