Micro 21- Monopoly

Question 1

What is a pure monopoly?

Answer 1

A pure monopoly/monopolist is defined as a sole seller in a given industry - it has a market share of 100%

Question 2

What is a monopolist?

Answer 2

A monopolist is a firm that dominates a market by gaining over 25% of the market share

Question 3

What are the characteristics of a monopoly market structure?

Answer 3

• There is only one firm. A monopoly firm is the same as the industry as it is the only firm in the market
• There are very high barriers to entry which prevent new firms from entering the market
• The business is a price maker with a downward sloping demand (AR) curve as it is the only firm in the industry and is a short run profit maximiser

Question 4

What are some of the reasons as to why a monopoly may form?

Answer 4

• If a firm has exclusive ownership of a scarce resource
• Governments may grant a firm monopoly status
• Producers may have patents over designs or copyright over ideas, characters, images, sounds or names giving them exclusive rights to sell a good or service such as a song writer having a monopoly over their own material
• A monopoly could be created following the merger of two or more firms. Given that this will reduce competition, such mergers are subject to close regulation and may be prevented if the two firms gain a combined market share of 25% or more

Question 5

What is the main objective of a monopolist?

Answer 5

• A monopolist is assumed to adopt the objective of profit maximisation. As with all market structures, profits are maximised when MR=MC
• Due to the high barriers to entry and exit, monopolies can maintain supernormal profits in the long run
• The level of supernormal profit made depends on the level of competition in the market which for a pure monopoly is zero

Question 6

Are monopolists price makers or price takers?

Answer 6

Monopolists have the power to be price makers. By setting the price in the market the monopolist sells whatever quantity consumers are willing to buy at that price

Question 7

For a monopolist, when are supernormal profits possible?

Answer 7

For a monopolist, supernormal profits are possible in both the short run and the long run

Question 8

For firms in a perfectly competitive market, when are supernormal profits possible?

Answer 8

For firms in a perfectly competitive market, supernormal profits are possible in the short run but not in the long run

Question 9

What is a natural monopoly?

Answer 9

A natural monopoly refers to a firm that can theoretically gain continuous economies of scale and so it is thus inefficient for more than one firm to supply this market.

Question 10

What type of minimum efficient scale is there is a natural monopoly?

Answer 10

Economies of scale are so large meaning a very high minimum efficient scale relative to market demand. This is usually because of extremely high fixed costs of distribution such as large scale infrastructure required to ensure supply. These industries are often referred to as natural monopolies because economies of scale are so large new entrants would find it impossible to match the costs and prices of the established firm

Question 11

What is third degree price discrimination?

Answer 11

Third degree price discrimination is the most frequently found form of price discrimination and involves charging different prices for the same product in different segments of the market. It occurs when a business charges charges different groups of customer different prices for the same product

Question 12

What are the three main ways in which a monopolist may choose to price discriminate?

Answer 12

1- Time - Charging a different price at different times of the day, week or year
2- Place - Different pricing according to the location of the buyer
3- Income - Charging high income earners a higher price and low income earners a lower price

Question 13

What three conditions must be met for price discrimination to be possible?

Answer 13

1- Market power - price discrimination can only take place when the firm has the ability to vary the price such as a monopoly. The firm must be able to separate the market and thus having a significant market share makes it easier to do this
2- There must be different groups of consumers with different price elasticity of demand figures. The firm must be able to distinguish between different customers willingness to pay and identify who is in which group without incurring excessive costs
3- It should be difficult/impossible for consumers to resell the product known as arbitrage. The firm must be able to prevent buyers in the high priced market from buying in the low priced market - the product should be non-transferrable

Question 14

How are prices set in third degree price discrimation?

Answer 14

The key is that third degree price discrimination is linked directly to consumer’s willingness and ability to pay for a good or service. It means that the prices charged may bear little or no relation to the cost of production

Question 15

What is the assumption underlying third degree price discrimination?

Answer 15

The assumption is that there are two markets, one with price inelastic demand and the other with price elastic demand

Question 16

Draw three costs and revenues diagrams to show third degree price discrimination

Answer 16

See page 9 in pack 21

Question 17

In a third degree price discrimination diagram what is the first diagram representing and labelled?

Answer 17

Sub-market A with price inelastic demand

Question 18

In a third degree price discrimination diagram what is the second diagram representing and labelled?

Answer 18

Sub-market B with price elastic demand

Question 19

In a third degree price discrimination diagram what is the third diagram representing and labelled?

Answer 19

Total firm with no price discrimination

Question 20

Explain how to draw a third degree price discrimination diagram?

Answer 20

• Draw three sets of costs and revenues axes in a row
• On the third diagram representing no price discrimination draw a diagram showing the firm making supernormal profit
• On the other two diagrams representing sub market A and B do not draw a MC and AC curve
• Draw relatively flat MR and AR curves on the second diagram for sub market B showing price elastic demand
• Draw relatively steep MR and AR curves on the first diagram representing sub market A showing price inelastic demand
• Extrapolate C1 from the third diagram onto the other two and label these levels on the axes ACb and ACa (average costs of sub markets A and B)
• Extrapolate the level at which MR=MC on the third diagram onto the other two diagrams and label these MCb and MCa (marginal costs of sub markets A and B)
• Label the quantities on diagrams on diagrams A and B and label them Qa and Qb where MR=MC
• Label the areas of SNP on diagrams A and B
• To show that profits are higher with price discrimination than without it write SNPA+SNPB > SNPC

Question 21

What is the general idea of price discrimination?

Answer 21

Profits are higher with price discrimination than without it

Question 22

What are some examples of price discrimation?

Answer 22

• Peak and off-peak pricing
• Airlines charge different prices depending on the season and the day of the week
• Advanced bookings of trains
• Student discounts

Question 23

What are some of the benefits to firms of price discrimination?

Answer 23

Firms benefit from price discrimination because it increases their profits. They can increase their producer surplus at the expense of consumer surplus

Question 24

What are some of the drawbacks to firms of price discrimination?

Answer 24

Some costs may be involved when price discriminating for example in monitoring that those from lower price sub-markets are not reselling/transferring output to higher price sub-markets. However, increases in revenue are likely to offset this

Question 25

What are some of the benefits to consumers of price discrimination?

Answer 25

• It can help avoid congestion/manage demand for example on trains
• Extra supernormal profit could be used to make the firm more dynamically efficient in the long run
• Some sub-markets benefit as they can pay less for example those with price elastic demand. These are often consumers in lower income groups. Drugs companies might justify selling their products at inflated prices in developed countries so they can sell the same drugs cheaper to patients in developing countries
• Some consumers that previously would not have purchased the product can now purchase at the lower price
• In some cases without price discrimination the monopolist would not supply at all as it would make a loss. However, by price discriminating it may be able to raise revenues so that AC at least equals AR and production could occur and consumers can benefit from the good or service

Question 26

What are some of the drawbacks to consumers of price discrimination?

Answer 26

• Consumers categorised in more price elastic subgroups may not always be poorer. Students benefitting from student discount may come from wealthy families. Adults paying full price for a train fare may be out of work or in low paid jobs
• Low prices for the sub-market with price elastic demand can act as a barrier to entry for prospective entrants reducing market contestability and consumer choice
• Consumers tend to lose out as their consumer surplus is reduced and translated into producer surplus
• Some subgroups now must pay higher prices for goods and services. This is allocatively inefficient as price is likely to be much higher than marginal cost

Question 27

What are the benefits of the monopoly market structure to firms?

Answer 27

• Supernormal profits can be made in the short term and the long term]
• Monopolies can exist because they are successful

Question 28

What are the drawbacks of the monopoly market structure to firms?

Answer 28

• Their market power may attract the attention of competition authorities
• Maintaining monopoly power can require time, effort and expense

Question 29

What are the benefits of the monopoly market structure to consumers?

Answer 29

• Supernormal profit is likely to exist. This can be used to finance investment and improve dynamic efficiency. This can lead to allocative and productive efficiency long term
• Price discrimination may raise total revenue to a point that allows survival of a good or service
• A monopoly may still be efficient and not abuse market power if the market is contestable - the monopolist fears new entrants so does not want to make large supernormal profits to attract entrepreneurs
• Monopolists avoid undesirable duplication of services and roles which can increase efficiency and avoid unnecessary costs. This is particularly the case in instances of natural monopoly
• Cross-subsidisation may lead to an increased range of goods or services available to the consumer

Question 30

What are the drawbacks of the monopoly market structure to consumers?

Answer 30

• There is reduced incentive to be efficient due to high supernormal profits being made. So though supernormal profit provide the funds needed to improve products or processes, firms may not do so as there is no competition, reducing the need to be productively and allocatively efficient
• Higher prices and lower output is seen compared to other market structures reducing consumer surplus. Consumer surplus is particularly reduced if firms engage in price discrimination
• As the monopoly is the sole seller of the product, there is no consumer choice. This is likely to continue long term due to barriers to entry
• Barriers to entry such as patents prevent new firms entering the market. This may stop potential rivals developing better versions of the monopoly’s products, hindering the achievement of allocative efficiency
• Monopolies may waste resources by undertaking cross-subsidisation - using profits from one sector to finance losses in another sector and employing more labour. This may be particularly evident in the public sector

Question 31

What are the benefits of the monopoly market structure to employees?

Answer 31

• Supernormal profits are likely to mean cash reserves in case of financial difficulty which should give stability and job security

Question 32

What are the drawbacks of the monopoly market structure to employees?

Answer 32

• A monopolist may also have monopsony power when it comes to buying labour. This might therefore mean that lower wages can be paid to staff in this profession as they lack an alternative firm who would need their services. The more specialist the job role, the more likely this is to be the case

Question 33

What are the benefits of the monopoly market structure to suppliers?

Answer 33

• Stability and high demand for the monopolist’s products is likely to mean high and stable demand from the monopolist for its raw materials. Dealing with one or a few large customers is likely to mean less administration compared to selling to many smaller firms
• Monopolists are often less cost conscious due to high levels of supernormal profit and less need to be productively efficient. Therefore they may be less inclined to negotiate hard on the price of goods/services they buy

Question 34

What are the drawbacks of the monopoly market structure to suppliers?

Answer 34

• A monopoly obviously has a high degree of market power. They may have a high degree of monopsony power for some goods as well. This means they could force suppliers to charge low prices if they are a supplier’s only/largest customer. The more specialist the raw material, the more this will be the case. This would mean a lower producer surplus for the supplier