Monopoly

Question 1

Factors of a monopoly

Answer 1

• A pure monopoly occurs when there is only one firm in the industry.
• In the UK, a firm is said to have monopoly power if it has more than 25% of the market share.
• A monopoly will have barriers to entry.

Question 2

Explain the monopoly diagram

Answer 2

• A monopolist maximises profit, where MR = MC.
• Therefore, it sets price = P1 and quantity = Q1.
• Firm makes supernormal profit = (AR-AC) ×Q
• If the market was competitive, output would be Q2 and price P2 (normal profit).

Question 3

Disadvantages of a monopoly

Answer 3

• Allocative inefficiency, because in monopoly, P > MC.
• Productive inefficient, because output is not at lowest point on AC curve.
• X-inefficient,because a monopolist has fewer incentives to cut costs;therefore AC curve is higher than it could be.
• Less choice for consumers.
• Quality of product could be worse, because there are fewer incentives for a monopolist to develop new products
• Monopsony power. A monopoly may also have monopsony power,in employing workers and buying products. This means the firm can pay workers lower wages, and supermarkets can pay farmers lower prices.

Question 4

Advantages of monopoly

Answer 4

1. Economies of scale. If the industry has high fixed costs and economies of scale, then a large monopolist can bring benefits of lower average costs, which lead to lower prices for consumers.

ECONOMIES OF SCALE DIAGRAM

2. Research and development. A monopolist can use its supernormal profits, to invest in developing new products which may require high investment. This is very important for industries, such as the pharmaceutical industry where, without high profits, they would be unable to develop new drugs.
3. International competition. A domestic monopoly may be necessary to compete internationally. For example, Corus is the only steel producer in the UK, but it faces competition from overseas competitors.
4. Monopolies may be efficient. A firm may gain monopoly power, because it is efficient and innovative
   e. g. Google and Apple. A monopoly isn’t necessarily inefficient; the opposite may be true.

Question 5

What are barriers to entry?

Answer 5

1. High fixed costs. This enables the incumbent firm to benefit from economies of scale. If a new firm entered the market, it would have higher average costs and struggle to compete.
2. Vertical integration. This occurs when a firm has control over raw materials and other supplies necessary for the good. For example, a new
   airline may not be able to get landing slots at popular airports like Heathrow.
3. Legal monopoly. For example, a patent on an invention.
   4.Advertising. If a firm engages in advertising, then consumers may develop very strong brand loyalty to a particular firm, making it difficult for others to enter.
4. Being the first firm in the industry.
   For example, Microsoft was the first firm and therefore
   people usually buy Microsoft Office to obtain compatibility with everyone else.
   6.Predatory pricing.If an incumbent firm cuts price when a new firm enters the market, it may be able to force the new firm out of business and retain its monopoly power.
5. Geographical barriers. Some monopolies are based on geographical barriers, such as having access to diamond mines,or even local monopolies, like motorway service stations.
   8.Barriers to exit. If a firm has high costs to leave a market it may deter entry. For example, if you have to spend a lot on research and development, you can’t get this back when you leave industry.