3.4.5 Monopoly Flashcards
Monopolies
Pure monopoly exists where one firm is the sole seller of a product in a market. One of the closest examples to a pure monopoly is Google, who have 88% of the market.
- Market structure where a single seller/producer assumes a dominant position in an industry or a sector. Monopolies are discouraged in free-market economies as they stifle competition and limit substitutes for consumers.
However, in the real world, pure monopoly rarely exists but a firm can be legally considered as having monopoly power if it has more than 25% of the market. The model assumes there is only one firm in the industry, they short run profit maximise and there are high barriers to entry. Tesco is a legal monopoly as it has 28% of the market. Some local monopolies exist, such as Stagecoach in Cambridge.
Characteristics of monopoly
Profit maximiser
Price maker
High barriers to entry
Single seller
Price discrimination
Profit maximising equilibrium
The demand curve for a monopolist will be the demand curve for the product (since the monopoly firm is the industry itself). It will be downward sloping, since even though the firm is a monopolist, people can still choose whether to buy the good or not. Profit maximising is at MC=MR, so this is the output they will produce at. They produce Q1 at price P1 and make supernormal profits. Since there is a monopoly, the firm may be able to earn supernormal profits or a loss in the long run as there is no freedom of entry and exit to the market.
Third degree price discrimination
When monopolists charge different prices to different people for the same good or service.
- There are different examples of where this can occur: different times of the day, for example peak and off-peak train times; different prices in different places, such as between London and smaller towns; and between different incomes, for example discounts for elderly people.
Price discrimination diagram
The diagram shows the seperate markets for separate groups: those with inelastic demand and those with elastic demand. If the example was about travelling up to London, the workers would be the inelastic market since they have little choice other than to pay the increased price as they have to go to London to work, whilst shoppers are the elastic market since they can decide to shop elsewhere.
Price discrimination conditions
In order for price discrimination to occur:
- the firm must be able to clearly separate the market into groups of buyers
- the customers must have different elasticities of demand
- firms must be able to control supply and prevent buyers from the expensive market from buying in the cheaper market.
Costs and benefits of third degree price discrimination
Benefits
- Firms benefit since they are able to increase their profits. This can go into research
and development, improving dynamic efficiency
- Those in the elastic market gain as they are able to pay a lower price than they otherwise would; they benefit from cross subsidisation. These consumers may have been unable to access the good if it were not for the price discrimination and so this
may increase equality.
Cost
- Consumers lose some of their consumer surplus to the producers and some consumers have to pay a higher price.
Other types of price discrimination (first degree vs second degree)
First degree: where the firm can charge different prices for every unit of the good and so can eliminate all consumer surplus
Second degree: charging a different price for different quantities such as discounts for bulk-purchases
Costs and benefits of monopoly to: FIRMS
● Monopolists have the potential to make huge profits for their shareholders through
profit maximisation.
● The existence of supernormal profits means firms will have finance for investments
and will be able to build up reserves to overcome short term difficulties.
● Firms with monopoly power will be able to compete against large overseas
organisations.
● Large firms will be able to maximise economies of scale, reducing costs and
increasing profit further.
- Eval: However, firms may not always choose to profit maximise because of X-inefficiencies, sales or revenue maximising, profit satisficing or contestability
leading to limit pricing. In the long run, the lack of competition may mean that firms
become complacent and so they may not make maximum profits.
Costs and benefits of monopoly to: CONSUMERS
● With a natural monopoly, consumers tend to be better off than if there was
competition.
● When firms enjoy economies of scale , they will be more efficient and customers will enjoy a higher consumer surplus.
● Monopolists may produce an increased range of goods or services due to cross
subsidisation.
● The use of price discrimination will allow for survival of a product or service , and
benefits some customers (those in the cheap market) whilst is negative for others.
For example, it is said that economy class flights are funded by business class flights
● Consumers may pay higher prices and see a poorer quality service , due to a lack of competition.
Eval: There is less choice for consumers, since there is only one firm producing the good.
Costs and benefits of monopoly to: EMPLOYEES
● Monopolists produce at lower outputs, so will employ fewer workers.
Eval: However, the inefficiency of the monopoly may mean employees receive higher wages, particularly directors and senior managers. Profit satisficing or sales/revenue
maximising may mean output is higher and so more employees are employed.
Costs and benefits of monopoly to: SUPPLIERS
● For suppliers, the impact of a monopolist will depend on the extent to which the
monopolist is also a monopsonist .
- If the monopolist buys all or most of the suppliers’ goods (so is a monopsonist), it will reduce the suppliers’ profits as the
monopolist will decrease prices.
Natural monopoly
In these industries, the economies of scale are so large that even a single producer is not able to fully exploit all of them.
- These are decreasing cost industries.
- There are no pure natural monopolies in real life, but some examples include the National Grid, Royal Mail and National Rail.
Natural monopoly characteristics
- It would be pointless to encourage competition since it would raise average costs for the industry. If any new firm enters the market, they will be easily priced out as their costs will be so much higher. This raises questions for competition policy and nationalisation.
- Natural monopolies tend to be found in industries with very high fixed costs, such as railways. In order to run one train you would need to invest billions in track, tunnels, bridges and stations whilst running extra trains represents a much smaller relative increase in costs, meaning average costs will decrease drastically.
- These firms are neither allocative nor productively efficient as there is no minimum on the AC curve and at allocative efficiency there would be a loss.
Efficiency (monopoly)
- A monopoly is productively inefficient, since they don’t produce at MC=AC. They
are also not allocative efficient as P>MC. - Since a monopolist is likely to make supernormal profits, they will be dynamically
efficient. However, if there is no competition, they may have no incentive to invest.
