Monopoly

Monopoly

1. A monopoly is where one firm has more than 25% of market share. A monopolist can take the market demand curve as its own demand curve.

   • A pure monopolist is the sole supplier in an industry.
     • Natural Monopoly: where the largest supplier in an industry has an overwhelming cost advantage over other competitors.

2. Assumptions

   • High barriers to entry
   • Profit maximiser: can maintain SNP in long run
   • Price maker
   • Unique product: no close substitutes

3. Barriers to entry

   • Cost Barriers: if a monopoly experiences substantial EoS, a company would have to be large in order to compete. It is therefore difficult for smaller firms to compete, especially as new firms entering the market would be driven out by monopolies charging a price below the cost of the new entrant.
   • Legal Barriers: some monopolies are protected by law, which a national government might argue is in the public interest, e.g. the mail service monopoly which ensures a single-price stamp will guarantee delivery to addresses anywhere in the country (by cross-subsidising cheap local deliveries with loss-making remote deliveries.
   • Natural Barriers: for example uneven distribution of natural resources, e.g. oil concentrated in certain countries assists in creation of oil monopolies.
   • Vertical Integration: when a firm has control over the raw materials needed to produce the good
   • Trade Barriers: have the effect of protecting monopolies by acting as a barrier to the entry of international competition in protected domestic markets.

4. Diagram

   • The monopolist reduces output in order to push up price. The price charged is always in the upper half of the demand curve.
   • A monopolist might make a loss if its average costs are above average revenue, however it will still minimise its losses by producing at the level of output where MC=MR.
   • Unlike PC, any profits earned in short run will still be earned in long run. If the firm wants to increase sales, it must lower the price and vice versa - they cannot set both price and quantity.

5. Price Discrimination

   • Due to the lack of competition, the monopolist can charge a higher price than in a more competitive market, causing a loss of consumer surplus and increased producer surplus at a higher price, causing a loss of economic welfare.
     • Discrimination depends on time (peak/off-peak), location and income.
   • The motive is to increase profit by reducing consumer surplus.
   • To discriminate effectively...
     • (1) The elasticity of demand must be different in the different markets. (2) The monopolist must be able to separate their buyers into different groups so those paying a lower price can't resell to those paying higher. (3) The firm must be a price maker.
   • Types
     • 1st Degree: a firm charges people different prices, the max they will pay - reducing or completely erasing consumer surplus and is therefore most profitable for a monopolist.
     • 2nd Degree: occurs when the monopolist price discriminates according to the volume of purchase by a particular customer.
     • 3rd Degree: a monopolist will split up its customers into 2 or more separate groups and charge them a different amount.

6. Drawbacks

   • Inefficiency
     • Allocatively inefficient because the price is greater than MC.
     • Productively inefficient as it is not the lowest point on the AC curve.
     • X inefficient because a monopolist doesn't have incentives to cut costs & therefore the AC curve is higher than it should be.
   • Less choice for consumers, and monopoly charges a higher price than a competitive market, reducing consumer surplus and economic welfare.
   • Quality of product will be worse because there is less incentive to develop new products.

7. Benefits

   • If the industry has high fixed costs and economies of scale, then a large monopolist can bring benefits of lower average costs.
   • A monopolist can use its SNP to invest in developing new products which may require high investment, creating dynamic efficiency.
   • A domestic monopoly may be necessary to compete internationally.
   • A firm may actually gain monopoly power because it is efficient and innovative, e.g. Google