Monopoly

Question 1

Characteristics of a monopoly

Answer 1

In a monopoly there is a single seller that dominates the market for a specific good or service.
The characteristics include:
- single seller
- High barriers to entry
- Price makers
-Profit maximisers

Question 2

What type of demand curve does a monopoly have?

Answer 2

The demand curve is equal to AR and is downward sloping because the monopoly is the sole seller in the market. They can sell more products by reducing prices, or they charge higher prices by restricting output.

Question 3

Why do monopolies make SNP’s in the long run?

Answer 3

There is high barriers to entry so their profits are not eroded by new entrants and can persist into the long run,

Question 4

What is a monopoly power?

Answer 4

A firm with 25% market share, whereas a monopoly is one with 100% market share, Monopoly powers still exhibit characteristics of a monopoly.

Question 5

Monopoly diagram and efficiencies

Answer 5

The monopoly diagram is a SNP diagram.

They are not allocatively efficient as they produce at MR=MC and to be allocatively efficient they would have to produce at AR=P=MC

They are dynamically efficient because they have SNP’s which can be used to invest into R&D. However they are unlikely to be dynamically efficient due to a lack of competition so they are unlikely to invest into R&D,

They are not productively efficient as they do not operate at the lowest point of AC where MC=AC. and instead they produce at MC=MR.

They are likely to be X-inefficient because they have no incentive to reduce AC due to a lack of competition.

Question 6

What is third degree price discrimination?

Answer 6

Third-degree price discrimination is a pricing strategy used by firms to maximise profits by charging different prices to different groups of consumers for the SAME product or service, based on their willingness or ability to pay.

Question 7

What are the conditions for third degree price discrimination?

Answer 7

• The firm must have distinct groups of customers with different price elasticities of demand.
• There must not be any reselling of the product/service (in theory)
• The firm must have significant market power to be able to vary the price, so they must be price makers.

Question 8

What is the effect of third price discrimination on the inelastic portion of the market?

Answer 8

The monopolist charges higher prices for the inelastic portion of the market because these consumers can bear high costs without a significant drop in quantity demanded. The monopoly makes most revenue from its inelastic consumer base due to charging higher prices for them.

Question 9

What is the effect of third price discrimination on the elastic portion of the market?

Answer 9

The elastic portion consists of people who are more sensitive to price changes like students.
The monopolist charges lower prices for these elastic consumers to stimulate demand. When prices fall, there is a larger proportion of quantity demanded.

Question 10

What are the effects of third price discrimination on consumers?

Answer 10

Benefits:
Consumers all get the price they are willing to pay
- Inelastic consumers benefit from reduced overcrowding because when they access the good/service the elastic portion are not present
- Elastic consumers benefit from greater consumer surpluses

Disadvantages:
- Inelastic consumers can experience high prices, reducing their consumer surplus
- Consumers can experience inequity if they are paying different prices and this can lead to reduced loyalty towards the firm

Question 11

What is the effect of third price discrimination on producers?

Answer 11

Disadvantages:
- It is difficult to calculate PED and know what price to charge who

Benefits:
- Firms are able to maximise revenue and profits

Question 12

What are natural monopolies?

Answer 12

A natural monopoly is one in which the LRAC falls continuously over a large range of output, so it is the most productively efficient for a SINGLE firm to be in the market for a specific good or service

Question 13

What are the characteristics of natural monopolies ?

Answer 13

• High fixed costs (natural monopolies exist in industries where upfront investment is required and this is very expensive so high fixed costs)
• Declining marginal costs ( After the initial investment, the cost of producing an additional unit is low because of the huge quantity of output to spread the costs over)
• Declining average costs due ti spreading over fixed costs over output

Question 14

Why does the AC fall continuously for natural monopolies?

Answer 14

Natural monopolies have high fixed costs, but if there is a single seller in the market, then these fixed costs can be spread over a huge quantity of output and therefore AC is constantly falling.

Question 15

What does the natural monopoly graph look like?

Answer 15

Draw AC and MC falling. Draw AR and MR as normal.

Question 16

What are the effects of natural monopolies ?

Answer 16

Advantages:
- Benefit from economies of scale
- Increased efficiency (A single firm is more efficient than multiple firms and this reduces waste)

Disadvantages:
- Due to a lack of competition there may not be an incentive to increase quality of the good/service
- Due to the natural monopoly having significant price setting power, this may lead to high prices being charged, and consumers being exploited, especially if the good/service has an inelastic PED.
- They have no incentive to cut costs and this may lead to X-inefficiency

Question 17

What are the advantages of a monopoly?

Answer 17

• Dynamic efficiency : Monopolies make SNP’s and they can use these to invest in R&D and find innovative new products for consumers increasing choice, or they can even use their SNP’s to invest and find ways to reduce costs and therefore these low costs could be passed onto consumers through lower prices.
• Monopolies can benefit from economies of scale which causes their AC to be reduced, and therefore consumers can benefit from lower prices, and this also improves their productive efficiency.

Question 18

Disadvantages of monopolys?

Answer 18

• Allocative inefficiency : they produce as MC=MR instead of AR=MC
• X-inefficiency due to lack of competition and reduce incentive to lower AC, so these higher costs can get passed to consumers
• Even though they make SNP’s they are unlikely to invest into R&D due to a lack of competition
• Due to high price setting power they may exploit consumers leading to reduced consumer surplus and reduced living standards
• They may not be providing high quality goods/service due to a lack of incentive to have quality control.