4.1.5.4 Monopoly & Monopoly Power

What are the characteristics of a monopolist firm?

• demand curve = average revenue curve

• Aims to profit maximise

• Makes supernormal profits ( AR > AC)

• Is a price maker i.e. it sets the price in the market

• Barriers to entry stop other firms entering the industry

What are barriers to entry & what do they include?

• stop firms from entering the market

• High costs to enter the market, especially high capital costs

• Economies of scale experienced by large firms e.g. bulk buying

• Intellectual property rights/legal barriers – patents, trademark & copyright restrict other firms from producing a good or service

• Unfair competition e.g. predatory pricing attempting to force competitors out of a market e.g. selling products below cost price for a time period

• Government regulation restricting firms from entering a market e.g. giving sole rights to one supplier

What does the concentration ratio tell us?

• number of firms that dominate the market.

• For example - A 3 firm concentration ratio means the total market share of the top three firms in that market

What’s the importance of advertising?

• create awareness and deter new entrants into the market

• a form of product differentiation

• Increase fixed costs and therefore increase the scale of production at which a firm needs to operate profitability

• Effective advertising will lead to an increase in the level of profit for a monopolist

What does product differentiation include?

• Quality features that competitors’ products do not have

• Functional and design features that competitors’ products do not have

• Imperfect information where consumers are more aware of one firm’s products over those of the competition

• Advertising creating perceived differences in the mind of the consumer

• Location, where the product can only be bought geographically through one supplier

What do EOS mean for monopolies?

• monopolies can force down unit costs becoming more productively efficient

• lower costs can be passed on to the benefit of society

• have large research and development budgets allowing for the development of new products that can benefit society

• creates dynamic efficiency as innovation leads to better processes lowering the LRAC curve further

• Better quality products can be developed as monopolies can invest without the threat of competitors

• leads to product invention and product innovation

Why is a pure monopoly highly regulated by the government?

• there’s no competition

• Consumer exploitation might occur if the industry was left to its own devices.

What are the disadvantages of monopoly?

• Removes competition due to barriers to entry

• Makes supernormal profits in the long run by charging higher prices than would occur under competitive markets

• This leads to the consumer being exploited

• Is productively inefficient as it does not produce at the lowest point on its LRAC curve

• Is allocatively inefficient as it does not produce at the point where P = MC

• Is x-inefficient as no competition means less incentive to control costs

• Can reduce choice and quality as there is no competition

For a monopoly what does the demand curve look like?

What’s a quantity setter? How can this happen?

• choosing how much to sell

• monopolist can act as a quantity setter

• the demand curve will dictate the (maximum) price that can be charged

• Better would be to use advertising to shift the demand curve to the right.

DRAW A MARKET DEMAND CURVE SHOWING THE EFFECT ON PRICE OF PRODUCING A LOWER OUTPUT

• The monopolist prices its product at P.

• At this point output is Q.

• By reducing output to Q1 the monopolist is able to increase price to P1.