Monopoly

Question 1

Monopoly

Answer 1

a form of market structure in which there is only one seller of a good or service

Question 2

Perfect/ first degree price discrimination

Answer 2

a situation arising in a market whereby a monopoly firm is able to charge each consumer a different price

Question 3

Arbitrage

Answer 3

a process by which prices in two market segments will be equalised as a result of purchase and resale by market participants

Question 4

Dynamic efficiency

Answer 4

lowering the position of the AC curve over time by improving production processes,

reinvestment of SNP into innovation, SNP in LR

Question 5

X-inefficiency

Answer 5

production with no waste, productiob on AC curve

Question 6

Second-degree price discrimination

Answer 6

lower prices are charged when larger quantities are bought

Question 7

Third-degree price discrimination

Answer 7

a firm charges different prices for the same product to different market segments

Question 8

What are the 5 assumptions of monopoly

Answer 8

1. The firm aims to maximise profits
2. There is a single seller of a good
3. There are no substitutes for the good
4. The market has barriers to entry
5. There is imperfect knowledge

Question 9

Why is there a single seller of a good in monopoly

Answer 9

1. no competition
2. So the firm is a price maker because this gives it market power

Question 10

Why are there no substitutes for the good in monopoly

Answer 10

1. The product is ‘heterogeneous’
2. Advertising and strong branding build brand loyalty
3. So the firm is a price maker because this gives it market power

Question 11

Why does the market have barriers to entry in monopoly

Answer 11

1. Insulates firm from competition in the long run
2. So the firm is a price maker in the long run because this gives it market power in the long run

Question 12

Why is there imperfect knowledge in monopoly

Answer 12

1. Monopolist may have patents or unique knowledge leading to more advanced production techniques
2. So the firm is a price maker because this gives it market power

Question 13

Examples of monopoly

Answer 13

Google
Microsoft Windows
Facebook

Question 14

Analysis monopoly making long run SNP

Answer 14

As seen in the preceding diagram, the monopoly profit maximises, so produces at MC=MR, leading to Q0 production at a unit cost of AC0 and a price of P0. P0-AC0 is the supernormal profit per unit, so the shaded rectangle Q0x(P0-AC0) is the total SNP.

Because barriers to entry are very high, new firms are unable to enter the market, so the SNP is made by the firm is not competed away in the short or the long run. Therefore, this shows both the short run and the long run equilibrium for a monopolist.

Because production is not at the bottom of the AC curve, the monopoly is not productively efficient. Furthermore, because production is not at P=MC the monopoly is not allocatively efficient.

Question 15

Advantages of monopoly

Answer 15

1. Could be dynamically efficient

Higher profit levels than a more competitive firm means more scope to invest SNP into R&D. It may choose to develop advanced technology or train workers if it knows this will keep barriers to entry high.

2. Benefits from economies of scale

Being the sole supplier means scope for benefiting from economies of scale and achieving a lower average cost than a competitive firm could. Even with a high profit per unit, the price charged could be lower than in a more competitive market. Especially the case if a natural monopoly and fixed costs are so high economies of scale are never fully exploited.

Question 16

Disadvantages of monopoly

Answer 16

1. Economically inefficient

Productive and allocative inefficiency mean that quantity supplied to consumers is restricted, reducing utility, and at a higher price, further reducing consumer utility – an inefficient use of scarce resources

2. Could be x-inefficient

Lack of competition reduces incentive to reduce excessive stock levels or overstaffing, leading to higher prices for consumers and lower utility

3. Could be dynamically inefficient / lack of consumer choice

Lack of competition may mean that it does not reinvest profits to improve the quality of its products and, even though they are unhappy with the quality, consumers have to buy them anyway as there are no substitutes available

Question 17

Judgement of monopoly being better than a more competitive market

Answer 17

1. Depends on objectives – a state owned monopoly might seek allocative efficiency and be mandated to consider social costs and benefits
2. If a monopoly is threatened with competition it can be forced to be dynamically efficient and still benefit from economies of scale, which a firm in a more competitive market is less able to do

Question 18

Judgement of monopoly being worse than a more competitive market

Answer 18

1. If, due to lack of competition (actual or threatened), a monopoly is complacent, it will suffer from x-inefficiency, innovate little, and be forced to charge high prices. Consumers, therefore, will have the downsides of reduced choice and higher prices without the benefits of a higher quality product

Question 19

Price discrimination

Answer 19

when a seller charges different prices to different customers for the exact same product

Question 20

What are the 3 conditions of price discrimination

Answer 20

1. The seller must be a price-maker (have market power)
2. The seller must be able to identify different groups of customers with different PED
3. The consumers must not be able to easily resell the product in to a different market segment, or in a different market, for a higher price (arbitrage)

Question 21

Examples of price discrimination

Answer 21

Houses
Insurance
Train fares
Cinema tickets

Question 22

Analysis monopoly with first degree price discrimination

Answer 22

all consumer surplus becomes extra SNP because the monopolist charges each consumer the maximum amount that they will pay. This assumes that the monopolist has perfect knowledge of the consumers’ preferences, and that this knowledge cost less to acquire than the extra SNP.

Question 23

Analysis monopoly with third degree price discrimination

Answer 23

monopolist charging lower prices to a market segment like children or students. A higher price P1 is charged to certain customers, like older adults, but children and students only pay P0. This leads to some consumer surplus extracted from adults becoming extra SNP.

Question 24

Advantages of monopolist price discrimination

Answer 24

1. Lower prices for some consumers

Consumers that receive lower prices are able to use the same high quality good or service at a lower price – they may not have been able to afford the higher price paid by other users

2. Increases viability of good/service

A single price may not lead to any supernormal profit, and would therefore prevent the good or service from being provided at all

Question 25

Disadvantages of monopolist price discriminating

Answer 25

1. Higher prices for some customers

Consumers that are forced to pay higher prices have less to spend on other goods or services and so may have lower utility than if the market were competitive

Question 26

Judgement of price discrimination

Answer 26

Depends on whether price discrimination by a monopolist benefits or harms a consumer depends on the nature of the good or service; a product with positive externalities of consumption and price discrimination leads to benefits as more consumers can afford the product.