Week 6 - Monopoly Markets and Competition

Question 1

What are the characteristics of a monopoly (theoretical)?

Answer 1

• Single firm (no competition).
• Unique product (no close substitutes).
• Very high barriers to entry.
• Motivated by profit maximisation (produce at MR=MC).
• Cost curves same as pure competition.

Question 2

What are the definitions of a monopoly?

Answer 2

Narrow definition
- A firm is a monopoly if it can ignore the actions of all other firms.
- This means that other firms in the market must not be producing close substitutes. For example, the government water authority can ignore the price of bottled water.
- This means that other firms in the market are not close enough substitutes to compete away economic profits in the long run.

Question 3

What are the reasons for high entry barriers for a monopoly?

Answer 3

o Government blocks the entry of more than one firm into a market.
o One firm has control of a key raw material necessary to produce a good.
o There are important network externalities in supplying the good or service.
o Economies of scale are so large that one firm has a natural monopoly.

Question 4

How can the government block entry into a market?

Answer 4

1. By granting a patent or copyright to an individual or firm, which gives the exclusive right to produce a product or service for a period of time.
2. By granting a firm a public franchise, which makes it the exclusive legal provider of a good or service.

Question 5

How does a monopoly choose price?

Answer 5

Price maker (can set own price).

Question 6

What are the characteristics of a monopoly’s demand curve?

Answer 6

Monopoly’s demand curve is the same as the demand curve for the product (downward sloping).
 If it raises price, it will lose some customers.
 If it decreases price, it will be able to sell more.

Question 7

How does a monopoly choose output?

Answer 7

• Like every other firm, a monopoly maximises profit at the output when marginal revenue equals marginal cost (MR=MC).
• Profit maximising output (PMO) MR = MC

Question 8

What are the characteristics of monopolistic competition?

Answer 8

o Many firms compete.
o Each firm produces a differentiated product. (A differentiated product has close substitutes, but it does not have perfect substitutes).
o Firms are free to enter and exit.
o Firms have some control on the price (price maker). (When the price of one firm’s product rises, the quantity demanded of that firm’s product decreases.

Question 9

What does relatively easy entry into the market cause for economic profit?

Answer 9

Relatively easy entry into the market causes the disappearance of economic profits in the long run.
- Exception: a firm can maintain economic profits in the long run if a firm finds
o New ways of differentiating its product
o New ways of lowering the cost of producing its product