Monopoly

Question 1

Characteristics of Monopoly

Answer 1

• One seller in the market that dominates
• Inelastic good - with few close substitutes, a unique product
• Price maker - can set the price or output but not both
• Very high barriers to entry or exit in the market
• Industry often coincides with the firm (the firm is technically the industry)

Examples:

• Microsoft (Windows)
• Only supermarket in a small town

Question 2

Monopolies are able to restrict entry of new firms into the market by…

Answer 2

• Reducing prices in the short run to a level where potential competitors cannot match = predatory pricing
• Taking out patents or legal rights to manufacturing techniques and processes.
• Without these methods, making certain products would be impossible, requiring significant investments in new techniques.
• Controlling the supplies of the necessary raw materials to the exclusion of potential competitors

Question 3

Sometimes it is difficult to enter a monopoly because…

Answer 3

Government protection - some monopolies are legal monopolies protected by the government even in market economies
e.g. telecommunications

• Limited market - this makes it difficult for a number of firms to make normal profit - natural monopoly
• Large capital equipment

Question 4

Profit Maximization point

Answer 4

MR = MC as MC is rising

Question 5

Barriers to Entry

Answer 5

Startup costs:

• Capital costs
• Sunk costs - costs that cannot be recovered

Scale economies - large economies of scale where a new firm would need to produce large levels of output to reach minimum cost

Legal barriers:

• Patents and Govt. licences
• Internation Trade restrictions like tariff/quotas

Anti competitive behavior/Restrictive Practices:

• Marketing barriers
• Brand loyalty
• Price wars

Question 6

Marginal revenue

Answer 6

Additional to revenue from selling an additional unit

Question 7

Average revenue

Answer 7

Revenue earnt per unit

Question 8

Marginal cost

Answer 8

additional to cost from producing an additional unit

Question 9

Average cost

Answer 9

Cost per unit

Question 10

Long run (profit)

Answer 10

A monopoly is able to make abnormal profit in both the short run and long run

Assumptions:

• Barriers exist and therefore no new firms
• Demand and costs are constant

Question 11

Economies of scale

Answer 11

Cost advantages that firms gain as their size increases

Question 12

Examples of Economies of Scale

Answer 12

• Specialization (Managerial economies)
• Division of labor (Managerial economies)
• Bulk buying (Purchasing economies)
• Financial economies (raising capital)
• Transport economies (bulk order delivery costs)
• Large machines (Technical economies)
• Promotional economies

Question 13

Advantages of monopoly comparing to perfect compertition

Answer 13

Economies of scale - pushes MC curve down, therefore higher output and lower price is possible

Higher levels of investment in research and development - should lead to better products and more choice

Question 14

Disadvantages of monopoly comparing to perfect competition (consumer POV)

Answer 14

• Monopolies may restrict output and charge a higher price
• Higher profits are unfair for competing firms and low income earners. The scale of this problem depends on the size and power of the monopoly

Question 15

Allocative efficiency

Answer 15

AR = MC = P

Question 16

Natural monopoly

Answer 16

• Occurs because market is so limited
• High fixed/sunk costs
• One firm
• Often run and regulated by the government
• Massive economies of scale
• Efficient to only have one firm in the industry

NOTE: A second firm would move the demand curve so neither can survive

Question 17

Advantages of Monopoly

Answer 17

• Because of their size and expertise, they can be the most efficient and take advantage of economies of scale
• Able to divert some of the abnormal profits to research and development, hence innovation
• Avoid wasteful duplication involving large capital outlays

Question 18

Disadvantages of Monopoly

Answer 18

• No competition can lead to inefficient service
• No incentive to research new products or innovate and create more advanced technology
• Risk in terms of output
• No freedom of choice
• Higher prices
• Restricted production
• No incentive to pursue the least cost method of production (not techinically efficient)
• Not allocatively efficient

Question 19

What can the government do?

Answer 19

• (Anti-trust) Legislation and regulation
• Government ownership (rare) - “nationalisation”
• Fines
• Regulatory bodies

Question 20

(Anti-trust) Legislation and regulation

Answer 20

• Prevent mergers or takeovers
• Laws against price fixing (this is more for oligopolies)
• Laws to prevent firms demanding certain prices or preventing firms from refusing to sell to only certain retailers
• Promoting competition (e.g. by removing bureaucratic/legal barriers)

Question 21

Regulatory bodies

Answer 21

• Ability to set price controls (price capping)
• Ability to impose fines
• Insist on average price levels (‘fair rates of return”)
• Make firms ‘unbundle’ their products (e.g. Microsoft Office instead of Word, Excel, Powerpoint, Access as single products)
• Break up monopolies (rare) or require to sell assets
• Set standards of quality of service

Question 22

Demand curve

Answer 22

Inelastic - because goods has no substitutes, only one firm in the market

Question 23

Abnormal Profit diagram

Answer 23

Question 24

Monopoly diagram

Answer 24

Question 25

Loss diagram (RARE)

Answer 25

Can make loss if firm produce good with little demand = no profit