3.4.5 Monopoly

What are the characteristics of a monopoly? (5)

• Holds more than 25% of the market share

• Price maker

• Impenetrable barriers to entry

• Profit maximisation → monopolies can earn SNP

• Imperfect information → asymmetric info

What are the barriers to entry in a monopoly + explain them? (5)

• Predatory pricing → putting price below the cost of production of new entrants so they can’t profit

• High sunk costs → unrecoverable, so they deter new entrants

• Brand loyalty

• Set-up costs

• Number of competitors → lower number = higher barriers to entry

What type of profit do monopolies get, when do they get it + draw a diagram showing it

• SNP

• Both in the short run + the long run

What is third-degree price discrimination + give an example?

• When the monopolist decides to charge different groups of consumers different prices, for the same good or service

• E.g., peak/off-peak tickets or Adult + Child tickets, any student discount – Unidays, student beans

What are the necessary conditions for price discrimination?

• The firm is a price maker

• Seperate markets → firm can identify and seperate markets

• Different elasticities of demand 

• Low admin costs for the price discrimination 

• Prevention of arbitrage

• Same costs of production for both markets

Draw the 3 diagrams involved in price discrimination

Explain cross-subsidisation in terms of third-degree price discrimination

Different PED between groups → firm charges higher prices to inelastic group → earns supernormal profit → uses this to lower prices for elastic group → cross-subsidisation occurs → lower prices for consumers with more elastic demand

What are the costs + benefits of third-degree price discrimination to consumers?

• Benefits

  • Those in the elastic market have lower prices → benefit from cross-subsidisation

• Costs

  • A fall in consumer surplus + those in the inelastic market have to pay a higher price

  • Some groups might not be inelastic because they are wealthier but because it is a necessity, e.g., peak time train travel → Unfair 

What are the costs + benefits of third-degree price discrimination to producers?

• Benefits

  • Increase profits for firms which can be reinvested to increase dynamic efficiency

• Costs

  • Administration costs

  • Arbitrage

  • If it is used as a predatory pricing method, the firm could face investigation

What are the costs + benefits of monopolies to firms?

• Cost

  • Firms may not always profit maximise + due to a lack of incentive to invest, as there is no competition → can lead to inefficiencies

• Benefit

  • Due to high SNP, monopolists can increase dynamic efficiency

  • Since monopolies are large, they can exploit EoS + this means lower production costs

  • Firms with monopoly power will be able to ​compete against large overseas organisations

What are the costs + benefits of monopolies to consumers?

• Cost

  • With a ​natural monopoly​, consumers tend to be better off than if there was competition

• Benefit

  • Due to EoS, firms will be more efficient + so consumers will enjoy a higher consumer surplus

  • Dynamic efficiency → higher quality goods

What are the costs + benefits of monopolies to employees

• Cost

  • Monopolists produce at lower outputs, so will ​employ fewer workers

• Benefit

  • However, the ​inefficiency of the monopoly may mean employees receive higher wages, particularly directors and senior managers

What are the costs + benefits of monopolies to suppliers

For suppliers, the impact of a monopolist will depend on the extent to which the monopolist is also a monopsonist → If the monopsonist buys all or most of the suppliers’ goods (so is a monopsonist), it will reduce the suppliers’ profits as the monopolist will decrease prices

What is a natural monopoly?

An industry in which the most efficient number of firms is 1 due to fixed costs being a high proportion of total costs so having more than one firm produce a good is inefficient

Explain a natural monopoly in terms of profits + provide an example

It is more effective to have one firm making SNP and charging a lower price than having multiple firms making normal profits but charging a higher price

Explain monopolies in terms of efficiencies (4)

• Monopolies aren’t productively efficient because they don’t produce at MC=AC

• They are also not allocatively efficient as P>MC

• Since a monopolist is likely to make supernormal profits, they will be dynamically efficient. However, if there is no competition, they may have no incentive to invest

• Monopolists may suffer from X-inefficiency because of the lack of competition

What is 'creative destruction' + what does it lead to? (2)

• Creative destruction is the process where innovation replaces old products, firms, or industries with new ones → allows for resources to be reallocated to more efficient uses

• Leads to economic growth, innovation, and efficiency but causes job losses and business failure in the short run