Monopoly and monopoly power Flashcards
What is the monopoly model, and how is it represented diagrammatically?
A monopoly is a market structure where a single firm dominates the entire market (25% plus market share), offering a unique product or service with no close substitutes. This firm has significant control over the market price and output. In a monopoly, the firm faces a downward-sloping demand curve, indicating that to sell more units, the firm must lower the price. The marginal revenue (MR) curve lies below the demand curve because each additional unit sold reduces the price of all previous units. Profit maximization occurs where MR equals marginal cost (MC). The price is then determined by the demand curve at this output level. The area between the price and average cost (AC) at the monopolist’s output level represents supernormal profit.
What factors influence a firm’s monopoly power?
1)Barriers to Entry: High barriers prevent new firms from entering the market, such as significant capital requirements (huge fixed costs), control over essential resources, or government regulations.
2)Number of Competitors: A lack of competition allows a single firm to dominate the market.
3)Advertising: Extensive advertising can create brand loyalty, reducing consumer willingness to switch to alternatives.
4Degree of Product Differentiation: Unique products with no close substitutes enable a firm to set higher prices.
Advantages of Monopolies
1)Economies of Scale: Large-scale production can lead to lower average costs, potentially benefiting consumers with lower prices
2) Dynamic efficiency: Supernormal profits can fund research and development, leading to technological advancements.
3) Natural monopoly’s (single firm can supply the entire market demand at a lower cost than multiple firms)
4) Cross subsidisation (profits from one product or service are used to offset losses or lower prices of another)
What is cross subsidisation?
(Occurs in a monopoly) Cross-subsidization occurs when a firm charges higher prices to one group of consumers to subsidize lower prices for another group, aiming to achieve broader market coverage or promote social objectives
Disadvantages of Monopolies
1)Consumer Surplus deadweight loss : Monopolies may set higher prices and produce less than in competitive markets, leading to allocative inefficiency
2)Allocative Inefficiency: Price exceeds marginal cost (P > MC), resulting in a deadweight welfare loss
3)Productive Inefficiency: Without competition, monopolies may lack the incentive to minimize costs, leading to productive inefficiency
4)Potential for Exploitation: Monopolies might exploit consumers by offering substandard products or services due to lack of competition
5) X-inefficiency—higher average costs than necessary—due to a lack of competitive pressure, leading to reduced incentives for cost control and efficiency improvements
What is the difference between a monopoly and a natural monopoly?
A monopoly is a market structure where a single firm dominates the entire market, offering a unique product or service with no close substitutes, resulting in significant control over price and output. A natural monopoly occurs when a single firm can produce and offer a product or service at a lower cost than multiple firms, often due to high fixed costs and significant economies of scale, making it inefficient for multiple firms to operate in the market
E.g oil has monopoly’s but public utility’s such as water distribution are natural monopoly’s
What are the key characteristics of natural monopolies?
1)High Fixed Costs: Significant initial investment is required, such as infrastructure for utilities
2)Enormous potential for EOS: As production increases, average costs decrease, benefiting from economies of scale
3)Single-Firm Efficiency: One firm can supply the entire market demand more efficiently than multiple firms (competition would result in wasteful duplication of resources)
Evaluation points for Monopoly?
1) Dynamic efficiency may not actually occur since there is no guarantee of profits being reinvested (Could go to-shareholders via dividends or even pay off debts)
2) Economies of Scale: The extent to which the firm benefits from cost reductions due to increased production can affect pricing and output decisions.
3) Firm Objectives: The company’s goals, such as profit maximization or market share expansion, can determine its pricing and investment strategies.
4) Price Discrimination: The ability to charge different prices to different consumer groups can impact consumer surplus and overall market efficiency.
5) Competition: The level of competitive pressure can influence the monopoly’s behavior regarding pricing, quality, and innovation
6) Natural Monopoly: Whether the industry is a natural monopoly can justify the existence of a single provider due to high fixed costs and significant economies of scale.
7) Type of Good or Service: The nature of the product—whether it’s a necessity or luxury—can affect consumer demand and the ethical considerations of monopoly pricing.
8) Regulation: Government policies and regulations can constrain or enable monopolistic behavior, influencing pricing, output, and investment decisions.
