3.4.5 Monopoly

Question 1

Characteristics of a monopoly

Answer 1

• large firms - only one firm in a pure monopoly
• high barriers to entry
• product differentiation
• profit maximiser
• price maker

Question 2

What makes a firm a monopoly?

Answer 2

Has over 25% of the market

Question 3

Monopoly diagram analysis

Answer 3

• AR + MR downwards sloping —> inelastic PED due to lack of substitutes
• allocatively inefficient = PM is above MC=AR
• productively inefficient = PM above minimum point of ATC
• X-inefficiency as ATC is not minimised

Question 4

Why is a monopoly x-inefficient?

Answer 4

• organisational slack = average costs not minimised due to lack of competition, meaning firms are not incentivised to be efficient
• due to lack of competition prices can increase as PED is inelastic
• prices can exploit customers, lead to a fall in consumer surplus (certainly compared to more competitive markets)

Question 5

Sales + revenue maximisation

Question 6

Advantages of monopolies

Answer 6

• produce on a large scale = can benefit from economies of scale —> as output increases, LRATC fall + costs per unit fall —> large scale production may be required to reach minimum efficiency scale (lowest output at which LRATC is minimised) = unattainable for perf comp
• can but not always make supernormal profit due to high barriers to entry —> if they invest back into new products e.g. pharmaceutical = innovation = dynamic efficiency, possible also allocative efficiency through producing what consumers want through innovation
• absence of wasteful competition = familiarity with products, e.g. apple, Microsoft (trusted brands) —> customers enjoy the convenience + familiarity with one brand

Question 7

Examples of internal economies to scale

Answer 7

• financial = larger firms are more able to obtain cheaper loans than smaller firms as they are considered more credit worthy = less risk
• technical = larger firms are able to afford more advanced machinery + so are more productive due to technology
• purchasing = larger firms tend to buy more in bulk + this means they pay a cheaper price per unit
• risk bearing = larger firms tend to be able to operate in different markets + sell different products = spreads the risk from just selling one product in one market
• managerial = larger firms tend to employ specialist managers where as in smaller firms the owner tends to run all areas of the business

Question 8

Examples of external economies of scale

Answer 8

• skilled workforce
• good infrastructure
• good area for business
• well provided for by suppliers

Question 9

How can monopolies begin to experience diseconomies of scale?

Answer 9

• control, communication + coordination
• as firms get bigger = harder for mangers to control so quality + productivity drops unless employees are self-motivated
• management may find it hard to communicate with employees + coordinate activities = work becomes duplicated = waste

Question 10

Disadvantages of monopolies

Answer 10

• a monopolist can act as a monopsonist = one buyer of a product —> e.g. Tesco can use this power to drive down suppliers prices, farmers want their products on their shelf = accept a lower price
• can also act as one buyer in the labour market + force wages down —> although national minimum wage acts to limit this + workers with broader skills may move elsewhere

Question 11

What is price discrimination?

Answer 11

• when a firm charges a different price to a different group of customers for an identical good or service
• this for reasons not associated with the costs of production
• charging a higher price for a first class train ticket is NOT price discrimination = this is explained through different costs involved

Question 12

Examples of price discrimination

Answer 12

• cinemas, threatres, hairdressers cutting prices to attract additional audiences e.g. student discounts
• cheaper train, bus, flight tickets for off-peak travel times/ off-season holidays = tickets are generally more expensive during school holidays

Question 13

Conditions required for price discrimination

Answer 13

• monopoly power = firms must have price setting power (not seen in perf comp)
• different price elasticity of demand for the product = allows firm to extract consumer surplus by varying price = additional revenue + profit as customers are prepared to pay more a good/service if PED is inelastic e.g. peak time
• separation of the market = firms must be able to split the market into subgroups + prevents the product being resold between groups e.g. adult using child ticket = high costs for inspectors

Question 14

What is the aim of price discrimination

Answer 14

to increase total revenue and/or profits of the supplier

Question 15

Diagrams for price discrimination

Answer 15

Market A = inelastic market = greater profit
Market B = elastic market = smaller profit
Market without price discrimination

Question 16

What are the ways firms can discriminate?

Answer 16

• time = charge different prices at different times of the day/week e.g. peak/ off peak
• place = according to location of buyer e.g. petrol is often more expensive at motorway service stations, prices may be different in international markets
• income/ages = charge higher prices to those on higher incomes e.g. hairdressers charging lower prices to pensioners + students —> BUT some OAPs + students may be better off than some adults

Question 17

Advantages of price discrimination

Answer 17

• potential for cross subsidy of acitivires that bring social benefits = high priced market allows for low prices (loss making) in other markets (market B) charging much lower prices e.g. lower priced rail or bus service in rural areas
• brings new consumers into the market who would otherwise be excluded by ‘normal’ higher prices - customers in more elastic (lower price) markets benefit from cheaper price than without price discrimination
• making better use of sparse capacity - e.g. hairdressers can manage demand by offering cheaper prices to OAPs + students at certain time of the week
• higher profits can be reinvested to improve quality of service e.g. improve trains
• use of monopoly profit for research = stimulates innovation/dynamic efficiency
• improves cash flow in peak periods which can help survival in downturns for essential services e.g. bus travel

Question 18

Disadvantages of price discrimination

Answer 18

• exploits consumer in higher priced market - majority of consumers will pay more than marginal cost e.g. holidays during school holidays excessively expensive = not all consumers on high income
• reduction of consumer surplus in market A turned into higher producer surplus/supernormal profit
• possible use of discrimination as a limit pricing tactic = barrier to entry = less choice
• increased inequality as OAPs or students may have higher incomes but are charged a lower price
• depends on how profits are used e.g. reinvested vs dividends to shareholders/bonuses to executives

Question 19

Adv of a monopoly to a firm

Answer 19

• supernormal profit allows for reinvestment in technology + product innovation
• increased market share = large scale = economies of scale = lowering average costs
• higher prices than perf comp = increased producer surplus
• price discrimination increases revenue

Question 20

Disadvantages of a monopoly to a firm

Answer 20

• lack of competition = reduced incentive to be efficient
• monopolies can lead to a misallocation of resources as P>MC = price is above the opportunity cost of providing the goods

Question 21

Adv + disadv of a monopoly to employees

Answer 21

• supernormal profits can result in higher wages
• BUT having only one supplier (monopsony) can limit opportunity to change employers

Question 22

Adv of monopoly to consumers

Answer 22

• innovation fuels by supernormal profit may result in better quality product
• price discrimination could benefit certain groups of consumers
• prices may fall if firms pass on their cost savings (due to economies of scale) in the form of lower product prices

Question 23

Disadv of a monopoly to consumers

Answer 23

• lack of competition = higher prices as there are no substitutes
• X-inefficiency = organisation slack due to lack of competition may result in a lower incentive to be innovative
• price discrimination can exploit consumers that are in the inelastic market
• consumer surplus decreases as monopolies charge higher prices

Question 24

Adv + disadv of a monopoly to suppliers

Answer 24

• increased sales volume for some suppliers as they are able to supply products that are distributed nationally or internationally
• BUT monopsony power may mean a firm e.g. Tesco dictates the price they pay suppliers

Question 25

What is a natural monopoly?

Answer 25

- occurs when the most efficient number of firms in the industry is one - only room in the market for one firm to fully exploit economies of scale - the LRATC curve falls continuously over a large range of output

Question 26

Characteristics of a natural monopoly

Answer 26

- high capital start up costs e.g. high fixed costs - the minimum efficiency scale is minimised at a very high level of output = more efficient with only one firm - high levels of output is needed to fully benefit from economies of scale - high fixed costs + sunk costs but low marginal costs - creates significant barriers to entry = allows the natural monopoly

Question 27

Advantages of natural monopoly

Answer 27

- one firm in a market is able to produce a greater output due to fully exploiting economies of scale, therefore costs per unit is significantly lower - where as 3 firms in a market would be producing much less output due to them not having full access to economies of scale leading to high AC (can be displayed through diagram) - more productively efficient for there to be one dominant provider of infrastructure e.g. a railways network - private monopolies are able to achieve dynamic efficiency by investing in new technology

Question 28

Disadvantages of a natural monopoly

Answer 28

- natural monopoly unlikely to set an allocatively efficient output —> MC is below ATC across the range of output, so if firms set a price = MC, a loss would be made = this is because the MC is low - the firm may exploit the monopoly power by raising prices + making huge supernormal profit

Question 29

Should natural monopolies be under state control?

Answer 29

- natural monopolies are more productively efficient as a provider of a national infrastructure e.g. rail network - natural monopolies require enormous capital investment spending to maintain + improve the networks - private monopolies are free from political interference + therefore are able to achieve dynamic efficiency in new technology