Monopoly

Question 1

Assumptions of a Monopoly

Answer 1

1. A single seller of the good
- firm = industry
- a single firm has complete market power annd market share

2. No substitutes for the good
- one firm sells the good
- cant buy anything similar to this good
- can increase prices however high they want as consumers buy from them regardless

3. High barriers to entry and exit
- no other firm can enter the market
- high start up costs, high brand loyalty

4. Profit maximisers
- produce where MR = MC

Question 2

Causes of Monopoly Power

Answer 2

1. Legal
- the gov may grant a patent to firms so that they are the only firm selling that good

2. Growth and Takeover
- when a firm gets really big and it’s sales get very high which pushes other firms out of the market, take full market share
- When a large firm buys a smaller firm from the Stock Exchange they can become a monopoly

Question 3

Revenue curves

Answer 3

• Downwards sloping
• The only way for a monopoly firm to increase sales is to decrease price
• monopolies are price makers and if they decide to increase price this will result in sales decreasing

Question 4

Why is the MR Curve twice as steep?

Answer 4

• in order to sell an additional unit of output the firm not only need to decrease the price of the additional unit but all previous units of output

Question 5

Market equilibrium

Answer 5

• output takes place where MR = MC
• once the output level has been found we find the price by going up to the corresponding point on the demand curve
• shows the price consumers are willing to pay

Question 6

Efficiency implications

Answer 6

1. Productive inefficiency
- not producing goods and services efficiently as not producing on the MES

2. Allocative inefficiency
- price is not equal to marginal costs as firms have a lot of market power so charge higher prices and exploit consumers
- increase price in excess of what it costs to produce these goods

3. Dynamic efficiency
- can be dynamically efficient as these firms make a lot of supernormal profits so can invest into R&D
- may not as they are the only firm in the industry so won’t have any incentive to invest and improve as they know consumers will buy from them anyways

4. X-inefficiency
- not x-efficient as only firm in the industry, firm may get complacent

Question 7

Implications for consumer welfare

Answer 7

1. High Price
- these firms have a lot of market power and our price makers or can charge really high prices and exploit consumers
- know that they are the only firm that sell the good

2. Low Choice
- only one firm in the industry to buy goods from
- there are no substitutes for consumers to buy so there is no variety between products

3. Low/High Quality
- have enough supernormal profits so invest into research and development to improve quality of goods
- however don’t have the incentive to improve as they know they are the only firm consumers can buy from anyways

Question 8

Natural Monopoly

Answer 8

An industry where theres such huge economies of scale to be had, that only one firm is financially viable

Question 9

Efficiency Implications

Answer 9

1. Productive inefficiency
- not producing goods and services efficiently as not producing on the MES

2. Allocative inefficiency
- price is not equal to marginal costs as firms have a lot of market power so charge higher prices and exploit consumers
- increase price in excess of what it costs to produce these goods

Question 10

Why are natural monopolies sometimes naturalised?

Answer 10

• these industries are all necesities (e.g oil, gas etc)
• when left unregulated, they will increase prices by huge amounts to massively exploit consumers as they will buy regardless as necessity

Question 11

What is the problem with nationalising monopolies?

Answer 11

• can create inefficiencies when gov runs these industries as they are not profit maximisers and are welfare maximisers
• even if they are making an economic loss, they know they’ll remain in the industry so will start to slack

Question 12

What do the government have to provide natural monopolies when they are nationalised?

Answer 12

• gov regulates their price
• firm makes an economic loss and will be incentivised to leave the industry
• gov provides the firms with a subsidy the exact same size of the loss

Question 13

Advantages of a natural monopoly

Answer 13

1. Avoids a wasteful duplication of resources
- dont need two firms selling the same natural resources
- if there was two firms, prices would be higher
- have a natural monopoly means that large costs are passed out and spread over a greater output so prices are much lower than they would actually be

2. Lower prices
- gove regulates the price so consumers are not exploited
- good for consumers as can afford to buy necessities

3. Allocative efficiency
- price is now equal to marginal cost and so the regulated price is a more allocatively efficient price
- the gov will provide a subsidy to cover the costs
- still a privatey run firm so will chose to contuinue being x-efficient

Question 14

Disadvantages of a natural monopoly

Answer 14

1. High prices
- profit maximising firm and so deliberately choose to restrict output and increase prices
- know they have complete market power and nowhere else for consumers to buy from

2. Inefficiency
- start to slack as they know that even if they’re making economic lost they will remain in the industry
- no incentive to improve
- they know that the government will provide them with a subsidy to cover the cost
- x inefficiency as there is no incentive to improve as they know that no matter how much they invest they will always make normal profit

3. Information failure
- government does not know the firm’s LRAC
- a firm can be incentivized to lie about the average costs
- may start to slack as they know the gov is going to cover the economic loss

Question 15

Price Discrimination

Answer 15

When different consumers are charged exactly what they are willing and able to pay
- no consumer surplus as there is no difference between what they are willing to pay and what they actually pay

Question 16

What happens to the demand curve when firms price discriminate?

Answer 16

becomes MR curve

Question 17

What happens to consumer surplus?

Answer 17

• there is no consumer surplus so there is no dead weight loss
• each person is paying what they are willing to pay
• there is no consumer that doesn’t have access to the good
• becomes supernormal profit redirected to the firm

Question 18

What efficiency is reached?

Answer 18

There is an allocative efficient level of output as those able and willing to buy the good have access

Question 19

Conditions of price discrimination

Answer 19

1. Firm must have market power
- If there were two firms (one that does discriminate and one that doesn’t) price discrimination won’t work
- this is because people who are willing to pay at the firm that discriminates are going to buy from the non-discriminating firm if they are cheaper

2. Firm must have information on consumers that are willing to pay
- the firm needs to know the PED for different groups of people
- information is needed so firms know how high or low to set prices

3. Consumers must have limited ability to resell the products
- price discrimination is meaningless if the product can be resold

Question 20

When does partial price discrimination occur?

Answer 20

When the market can be split into different groups and you can charge these different groups different prices

Question 21

Disadvantages of Monopoly power

Answer 21

1. High prices
- use their market power by charging consumers very high prices as know that they are the only firm selling the good and can’t buy from anywhere else and don’t have a lot of substitutes
- higher prices, lower choice, lower quality
- no productive, allocative and dynamic efficiency

2. No incentive to improve
- no that consumers will always buy from them as they have a lot of market power and they are the only firm in the industry
- have no incentive to be dynamically efficient

3. Price discrimination is very unlikely
- partial discrimination is more likely as they will always be some dead weight loss

4. Inefficiency
- the government work to regulate prices it would mean that the Monopoly is making an economic loss
- this means that the government have to provide a subsidy the size of the economic loss
- this is not good as they know that there will be no reward for regulating their prices and so will have no incentive to be efficient
- know that they would never make any super normal profit as prices will be very low

5. Profit maximising
- profit maximizing firm so they deliberately choose to have higher prices and restrict output despite being able to set lower

Question 22

Advantages of Monopoly Power

Answer 22

1. Benefit from economies of scale
- monopolies benefit and rely on huge economies of scale but perfect competition doesn’t
- this means they have lower prices and have a higher output
- even though they exploit consumers and have a large area of dead weight loss, it is preferred over perfect competition as prices are lower as low income households can benefit

2. Supernormal Profit
- can invest in R&D which improves the quality of their goods

3. Monopolies price discriminate
- with a monopoly that discriminates there is no dead weight loss as all people pay what they want
- dead weight loss becomes producer surplus, so it is not worse off as there has just been an allocation of resources

4. Regulated monopolies
- the government would set the price where it is allocatively efficient
- consumers will benefit from lower prices

5. Avoids are waste for duplication of resources
- monopolies have a high cost and so would it make sense to have more than one firm in the industry
- if there was multiple firms overall output per firm were decreased and this will cause prices to increase even more as less profit is made
- one firm in the industry means that they are closer to allocative efficiency than if there were multiple firms