Monopoly (Market Structure) Flashcards
Describe the 5 characteristics of a Monopolist Market Structure
1) The firm is the industry – there is only one very large firm producing the product in the market
2) The Firm sells a unique good w/ no close substitutes
3) There are high barriers to entry (stops new firms from entering the industry allowing the firm to remain a monopoly)
4) Firms are profit maximisers (so firms will produce were MC = MR)
5) The firm has a high degree of monopoly power
What are the 4 main barriers to entry in a Monopoly market structure
1) Economies of scale
As a firm Increases in size, its average cost may decrease over time
Large economies of scale can create a barrier to entry because:
large firms can charge their product at lower prices than smaller firms, causing the smaller firm to face enormous start-up costs that it may not be able to sustain. Would eventually be unable to compete (incentivizing them to leave the market)
2) Branding
- Nike, Apple, etc. Brands create consumer loyalty and discourage switching to perceived inferior substitutes (creates bias and consumers will consider successfully branded products superior to others)
3) Legal Technicalities:
government can establish laws that protect monopoly power, enabling a monopolist having the legal reservation to produce a product. For example, legal monopolies exist in state-guaranteed industries (eg: postal service) Other legal barriers included the need for Patents (Rights given to a firm to be the sole producer of a product) or licenses (e.g radio stations, medical institutions) for a firm to enter a market that acts as a barrier to entry
4) Control of Essential Resources
A firm may control all of the F.o.P.s needed for firm production, preventing other firms from entering the market. The go-to example is DeBeers in South Africa, a firm that controlled all of the known diamond minds in South Africa for over a century
Why is the range of what can be considered a Monopoly not static?
The definition of a “monopoly” is ambiguous defending on how you define the industry. A coffee shop may have a temporary monopoly if no other coffee shops exist in the neighbourhood. Degrees of monopoly can thus exist ((local monopoly, TOTAL monopoly etc). The strength of a monopoly power possessed by a firm will really depend upon how many competing substitutes are available.
Define a local Monopoly
One single firm producing within the industry of a given geographical context (even if high competition else where)
Define Monopoly power
The ability a firm has to influence levels (price setting power)
Distinguish a pure monopoly from a natural monopoly
A Pure Monopoly – when only one firm provides all output for the market and no other close substitutes are available *is actually also rare in the real world)
(think of it as just a normal monopoly)
A Natural Monopoly — one firm that has economies of scale so large that it supply to an entire market (can meet the entire markets demand)
Give 3 characteristics of a Natural Monopoly
1) High capital to set up – Because of high start-up costs, the natural monopoly
can meet the entire market’s demand
2) Make rational sense for only one to supply to the entire market. More firms in the market would be inefficient, unnecessary and wasteful (Think hydroelectric dams – many highdroelectric dams would be inefficient (Kariba can supply to the whole country)
3) Natural monopoly demand curve intersect LRAC curve at a point where average costs are still falling - economies of scale does not appear to diminish in the foreseeable future. A Natural Monopoly has enemorous potential for economies of scale
4) Could result in allocative efficiency and productive efficiency as long as the natural monopolist is regulated
why is the distinction between short-run & long run is not important in a Monopoly market structure?
In monopoly, firms can make any profit in the long run especially abnormal profit due to high barriers to entry. Since no competition exists, whenever MC = MR, the firm will make excess profit. HOWEVER, if there is LITTLE/NO demand for a product, a monopolist can make losses rather than abnormal profit.
Give 3 Examples of Natural Monopolies (utilities)
1) Water suppliers (Lusaka water & sanitation Company – local monopoly)
2) Electricity suppliers (Zesco)
ZESCO is a state-owned power company in Zambia. It is Zambia’s largest power company producing about 80% of the electricity consumed in the country.
It receive financial support from government
- natural monopolies have extreme economies of scale. the most economically efficient way to produce the good to the whole society at low prices in the context of a monopoly market structure
3) Rallway construction company
(TAZARA Railway –binational railway owned by the two governments of Tanzania and Zambia – linked the railway that travels through Zambia and Tanzania)
State 3 advantages of a Monopoly Market Structure
Explain both with reference to examples
1) Can take advantage of economies of scale which could potentially lead to lower prices
- – cant occur in perfect competition
2) Opportunities for Research and development for product development and technological innovation
- – Due to lack of competition and the ability to make abnormal profit in the long run, a monopolist has the opportunity to profit from innovative activities
3) A Monopolist can achieve X (dynamic) efficiency
- X inefficiency is defined as producing at a higher AC than necessary. Because they can achieve economies of scale and make supernormal profit in the long run, a Monopolist can invest in R&D that can work in the interests of consumers as well as the monopolist in the long run
State 5 disadvantages of a Monopoly Market Structure
Explain both with reference to examples
1) Possibly less innovation
— Counterargument to the idea that this market structure provides the opportunity to profit from innovative activities.
Processes can become slow, innovation can lag, firm leaders can become corrupt and reward themselves with bonuses, and other largess, etc.
— Lack of competition may lead to little to no innovation at all
(Behavioural economics)
2) Lack of competition gives rise to high prices
- – Given no substitutes are available, a Monopolist may exploit its circumstance and charge high prices to maximize profit
3) Negative impact on the distribution of income
- - there is a redistribution of income away from consumers who pay the high prices to owners of monopoly
- - Results in the rich getting richer & the poor getting poorer
4) Monopoly Market structure cannot achieve allocative efficiency (create welfare loss)
5) A Monopoly Market structure cannot achieve productive efficiency
- - Monopolist is never operating at the minimum AC, its somewhere to the left — there are voluntarily forgoing economies of scale by not producing at the minimum point of AC — thus, not productively efficient
Why is it worth studying a Monopoly Market Structure?
helps economists study the affects - including benefits! - of monopoly power
Describe through a diagram how a Monopolist (making abnormal profits) acts in the short run and what will eventually happen in the long run
In short-run, a Monopolist can make abnormal profit or have its average revenue greater than its average cost illustrated by the vertical difference between AR and AC on the diagram. Given that this firm is profit maximiser producing were MR = MC at Q1, the total level profit made by this firm is the vertical difference between AR (price) & AC multiplied by Q1. In the long run, the Monopolist will continue to make abnormal profit due to high barriers to entry into the industry.
How to draw a Monopolist diagram (steps)
1) Draw the long run AC curve
2) Draw the long run MC curve
3) Draw downward sloping demand curve (Average revenue curve)
4) Draw downard sloping MR curve
5) label quantity (output) at the point where LRMC = MR
6) Extend output line where LRMC = MR up until its intersections with the demand curve to find the price
7) Vertical difference between AR (demand curve) and LRAC determines the type of profit being made
6) Extend output line where D = LRMC up until the intersection between the demand curve & extend at price line at the intersection between LRMC & the demand curve
Draw a natural Monopoly diagram and explains how it can achieve allocative efficiency
The natural monopolist is a profit maximiser so they are going to produce where marginal revenue equal marginal cost (LRMC = MR) at Q1 as is shown on the diagram. When average revenue greater than its average cost illustrated by the vertical difference between AR and LRAC on the diagram. Given that this firm is profit maximiser producing were MR = LRMC at Q1, the total level profit made by this firm is the vertical difference between AR (price) & LRAC multiplied by Q1. Consequently, the outcome of this occurrence would led to very high prices and a low quantity of output. Compared to allocative efficiency were price equals marginal cost, price is much lower and quantity is much higher than if firms were operating at a competitive outcome. Difference now compared to a normal monopoly, natural monopolies operating at profit maximising point is deemed not good enough by regulators as it would led to excess demand that can’t be satisfied due to no other firms in the industry. Due to the essential nature of these goods and services for the function of society, regulators would regulate the natural monopolist to allocative efficiency level were D(AR or price) = LRMC at Q2. This would lead to a big reduction in price & a big increase in quantity as a result of this regulation. Assuming firms desire to profit maximisers, there is no incentitivzed for a firm to be in the industry and produce were D(AR or price) = LRMC as average cost is high than average revenue. To incentivise firms to produce, subsidies are given by the regulator (usually equal to the loss per unit or ab) to make sure the loss is covered. Even though this leads to society desirable outcomes, there is very little incentive for a private natural monopolist and its explain why there are state run natural monopolies
