Monopoly and monopoly power

Question 1

What is a monopoly

Answer 1

when there’s only one firm in the market

Question 2

Define pure monopoly

Answer 2

a firm with 100% market share - only one firm (rare because at some point other firms will enter)

Question 3

What is considered a legal monopoly by firms and what does this means

Answer 3

when its market share is over 25% (when a firm owns more than 25% of the market).
- means the firm has monopoly power

Question 4

What three assumptions do economists make when they model monopolies

Answer 4

1. They assume there is only one firm in the industry with 100% control over the market - to simplify the model
2. We assume the firm is a profit maximiser (when MC = MR)
3. We assume there are high barriers to entry
   (otherwise other firms will enter the market and the monopoly will no longer be a monopoly)

Question 5

State 4 factors which monopoly power is influenced by

Answer 5

• barriers to entry
• The number of competitors in the market
• advertising
• the degree of product differentiation

Question 6

Factors affecting monopoly power: barriers to entry

Answer 6

The higher the barriers to entry, the easier it is for firms to maintain monopoly power

Question 7

Factors affecting monopoly power: there are 4 barriers to entry, state them

Answer 7

• legal barriers
• sunk costs
• economies of scale
• brand loyalty

Question 8

Type of barrier to entry: state what legal barriers include and state what this allows for firms

Answer 8

Legal barriers include patents, trademarks and copyright which allow firms to legally prevent other firms from stealing ideas of incumbent firm (a firm already in the market) and entering the market.

Question 9

Type of barrier to entry: state what sunk costs are and why this may deter new firms from entering the market

Answer 9

Sunk costs is the money that cannot be recovered when a firm leaves the market
- deter new firms from entering as they know that if they fail, they won’t be able to recover any of their sunk costs (cost of failure is high)

Question 10

Type of barrier to entry: state how economies of scale is a barrier to entry (small firm vs big firms)

Answer 10

Big firms use internal economies of scale to reduce their long run average costs (LRAC).
- smaller firms cannot compete with their lower prices

Question 11

Type of barrier to entry: how is brand loyalty a barrier to entry

Answer 11

Strong branding from incumbent firms makes it impossible for new firms to make any sales - there is customer loyalty

Question 12

factors which monopoly power: The number of competitors

Answer 12

If there are many competitors, competition is high = less market share.
If there are not many competitors, competition is low = greater market share

Question 13

factors which monopoly power: state how Advertising may affect monopoly power

Answer 13

Advertising can increase consumer loyalty, making demand price inelastic, and creating a barrier to entry

Question 14

factors which monopoly power: state how The degree of product differentiation affects monopoly power

Answer 14

The more the product can be differentiated, through quality, pricing and branding, the easier it is to gain market share. This is because the more unique the product seems, the fewer competitors the firm faces.

Question 15

Where will a monopoly profit maximise in the short run and long run and state hwy this is good

Answer 15

Where MC=MR
- Monopolies can earn significant supernormal profits

Question 16

Why is a monopoly profit maximising bad

Answer 16

They are not being productively efficient, where MC=AC
- they are bing productively inefficient, producing at a higher cost and lower quantity
+
They are not being allocatively efficient, where MC=AR
- there are producing at high costs and lower quantities

Question 17

What is X inefficiency

Answer 17

when a firm is producing above its average cost curve for agivenlevel of output.

Question 18

State how a monopoly is x inefficient

Answer 18

They have high profits and barriers to entry to keep out competitors and so tend to get lazy and inefficient, letting costs increase above their average cost curve

Question 19

What is dynamic efficiency, state where does this occurs and what firms need to have dynamic effeminacy

Answer 19

dynamic efficiency is how changing technology improved output potential over time
- occurs when AR > ATC.
- firms need supernormal profit to invest in R&D

Question 20

State how monopolies are usually dynamically efficient and why this actually may not be a good thing

Answer 20

Monopolies will be dynamically efficient because they are making supernormal profit.
- BUT, there is no guarantee the supernormal profit will be invested in R&D. To increase dynamic efficiency, it depends on the CEO.

Question 21

What is a natural monopoly

Answer 21

when it’s naturallymost efficientif only one firm is in the market.

Question 22

If monopolies are so inefficient, why does the government support and own monopolies

Answer 22

Because of natural monopolies

Question 23

Why might a monopoly be a natural monopoly (state example to support e.g. TFL )

Answer 23

1. High sunk costs E.G. TFL, Oyster card tech development and training staff - which have been estimated as high as £129bn. It would be inefficient if a second transport firm entered the market and duplicated this £129bn cost, so it’s most efficient to have just one firm, TFL, in the market.
2. Huge internal economies of scale e.g. TFL could use technical economies to invest in specialist technology like the oyster card system and self-service ticket stations to replace staff, and reduce wage costs + To fully exploit these economies of scale and get to its MES, TFL needs to increase its sales massively - which it can only do if it’s the only seller in the market.

Question 24

What is a natural monopolies long run marginal cost curve like

Answer 24

the LRMC is below a firms LRAC

Question 25

State advantage of a monopoly

Answer 25

• profit maximisation
• dynamically efficient
• natural monopoly

Question 26

State disadvantages of a monopoly

Answer 26

• productively inefficient
• allocatively inefficient
• x inefficient