monopoly

Question 1

What is a monopoly

Answer 1

• Single dominant firm in the market
• Price makers
• High barriers to entry
• Unique product
• Aim to profit maximise - set price at MC=MR
• Absence of competition

Question 2

Disadvantage - higher consumer prices - price discrimination

Answer 2

• Produce where MC=MR - diagram
• Restricts output and raises prices to maximise profits
• Creates a welfare loss represented by triangle
• Loss of allocative efficiency - when price=marginal cost - social welfare is at optimum
• Demand for good is inelastic as they are the sole seller so able to exploit consumers easily
• Third degree price discrimination - different consumers are charged different prices depending on their demand elasticity

Question 3

Disadvantage - higher average costs

Answer 3

• Higher average costs due to X-inefficiency
• Do not face competitive pressures
• Operate with organisational slack - employ workers who are not being deployed to full capacity
• Less incentive to lower costs of production
• Higher average costs lead to even higher prices paid by consumer

Question 4

Benefits of monopoly - dynamic efficiency

Answer 4

• Dynamic efficiency - ability of firm to improve productivity over time
• Re-invest supernormal profits (show on diagram)
• Leads to innovation - better quality product
• Take form of process innovation - investing in significantly improved production processes - e.g. investing in automation
• Improves long-term growth potential
• A monopoly that does not innovate may lose its market dominance and the barriers to entry may weaken

Question 5

Natural monopoly argument

Answer 5

• May be efficient for some firms to operate as a monopoly - effectively exploit economies of scale - operating closer to the minimum efficient scale thann a market with many firms
• Industries with high fixed costs e.g. water or transport
• These firms have to invest large sums before they earn any revenue
• Economies of scale
• The LRAC curve is steeply declining so average costs fall as output increases
• One firm can serve entire market at lower cost
• Firm may potentially pass on cost savings in form of lower prices

Question 6

Monopoly judgement

Answer 6

• Benefits are large for natural monopolies
• Other markets, consumer exploitation may be high
• A domestic monopoly may still face international competition from foreign companies
• Also success is dependent on management - prevents inertia in large monopolies
• Also dependent on industry - doctors and nurses do not need to face competition to provide a good service
• Gov regulation can reduce the excesses of some monopolies - eg price regulation

Question 7

Evaluating dynamic efficiency

Answer 7

• Firms may not allocate its supernormal profits to reinvestment
• May go to dividends and shareholders
• Quality of product may remain the same
• Firms do not see lower costs from innovation

Question 8

Evaluation of natural monopoly and EoS

Answer 8

• Potential for diseconomies of scale
• Managerial, lack of coordination - leading to slower decision making and overall productivity
• Higher LRAC could be passed onto consumers