Unit 3: Monopoly

Question 1

What is a Monopoly?

Answer 1

A situation in which the market is dominated by one seller/producer.

(By law, it occurs when 1 firm has a market share of at least 25%)

Question 2

What are the Assumptions/ Characteristics of a Monopoly?

Answer 2

Only one firm in the industry/country;
High barriers to entry, preventing new firms from entering the market
Short-run profit maximiser
Price Makers

Question 3

What does a Monopoly look like in the Short Run?

Answer 3

It makes supernormal profit, because high barriers prevent new businesses from entering the market

Question 4

What does a Monopoly look like in the Long Run?

Answer 4

It makes supernormal profit, because high barriers prevent new businesses from entering the market

Question 5

What factors influence Monopoly Power?

Answer 5

Barriers to Entry
Number of Competitors
Advertising
Degree of Product Differentiation

Question 6

What barriers to entry are there in a monopoly?

Answer 6

Patents
Limit pricing
Cost advantages
Advertising + Marketing
Research + Development expenditure
Sunk Costs
International Trade restrictions

Question 7

How does advertising affect monopoly power?

Answer 7

Advertising can increase consumer loyalty, making demand price inelastic, and creating a barrier to entry

Question 8

How does the degree of product differentiation affect monopoly power?

Answer 8

The more the product can be differentiated (through quality, pricing and branding), the easier it is to gain market share.

this is because the more unique the product seems, the fewer competitor the firm faces (a bit like a niche product)

Question 9

What are the advantages to a monopoly?

Answer 9

1. Abnormal profit means:
   ● finance for investment to maintain competitive edge
   ● reserves to overcome short-term difficulties and provide funds for research and development / invention and innovation
2. Cross-subsidisation (using profits from one sector to finance losses in another sector) may lead to an Increased Range of goods or services available to the consumer.
3. Price discrimination may raise total revenue to a point that allows survival of a product or service. It is often said that economy-class flights are funded by those flying business and first class.
4. Monopolists can take advantage of Economies of Scale, which means that average costs may still be lower than the most efficient average of a small competitive firm
5. Monopolies could generate Export Revenue (e.g. Microsoft generates a lot of it for the US)
6. High profits could be a source of government revenue through taxation

Question 10

What are the disadvantages to a monopoly?

Answer 10

1. Abnormal profit means:
   ● less incentive to be efficient and to develop new products
   ● efforts are directed to protect market dominance.
2. Monopolists avoid undesirable duplication of services and therefore a misallocation of resources
3. Monopoly power means higher prices and lower output for domestic consumers.
4. Monopolies may waste resources by undertaking cross-subsidisation, (using profits from one sector to finance losses in another sector).
5. Monopolists may undertake price discrimination to raise producer surplus and reduce consumer surplus.
6. Monopolies lead to a misallocation of resources by setting prices above marginal cost, so that price is above the opportunity cost of providing the good.
7. Monopolists do not produce at the most efficient point of output (i.e. at the lowest point of the average cost curve).

Question 11

What is a Natural Monopoly?

Answer 11

A natural monopoly is an industry where sunk costs are so high that average costs are always falling

Therefore, only one supplier can fully exploit the economies of scale in the market

Question 12

What is meant by ‘Barriers to Entry’?

Answer 12

Barriers to entry are designed to block potential entrants from entering a market profitably.

They seek to protect the monopoly power of incumbent (existing) firms in an industry, and therefore maintain supernormal (monopoly) profits in the long run.

Barriers to entry have the effect of making a market less contestable.

Question 13

What do Patents do?

Answer 13

Patents involve giving the firm the legal protection to produce a patented product for a number of years.

Question 14

What is meant by ‘Cost Advantages’ as a barrier to entry?

Answer 14

Lower costs, perhaps through experience of being in the market for some time, allows the existing monopolist to cut prices and win price wars

Question 15

What does a Natural Monopoly Diagram look like?

Answer 15

Price maker AR and MR curve
Downwards AC curve
Downwards MC curve