3.4.5 Monopoly

PURE MONOPOLY- DEFINITION

• one firm is sole seller of a product in a market

MONOPOLY- CHARACTERISTICS

• high barriers to entry- incumbent firms less likely to face new competition as barriers are high (e.g. loyalty, high start up costs, high sunk costs, EoS, limit pricing, ads)- allows them to increase prices as no substitutes

MONOPOLY POWER

• a firm can be legally considered to have monopoly power if it has >25% of market share

• firm has price making power for their product

MONOPOLY- PROFIT MAX EQUILIBRIUM

• monopolist earns SNP in both SR and LR (bc high barriers)

• since firm is sole supplier in market, firm’s cost and revenue curve is the same as the industry’s cost and revenue curve

• firms are price makers in a monopoly

• P>MC in diagram, due to profit max, so there is allocative inefficiency

THIRD DEGREE PRICE DISCRIMINATION- DEFINITION

• charge diff prices to diff people for the same good or service, in diff markets

THIRD DEGREE PRICE DISCRIMINATION- CONDITIONS

• separate market into groups of buyers- must have diff elasticities of demand (low price for elastic, high price for inelastic)

• be able to control supply and prevent buyers from expensive market from buying from cheaper market

THIRD-DEGREE PRICE DISCRIMINATION DIAGRAM

• same costs for industry as whole (so AC equal)

• total SNP higher with price discrimination compared to original profit (right diagram)

IMPACTS OF PRICE DISCRIMINATION- GROUPS OF PEOPLE

• consumers

• producers

BENEFITS OF PRICE DISCRIMINATION ON CONSUMERS

• net welfare gain as a result of cross subsidisation, if they receive lower prices for having price elastic demand

• those previously excluded by high prices, may now be able to benefit from g or s - increase equality

COSTS OF PRICE DISCRIMINATION ON CONSUMERS

• usually results in loss of consumer surplus

• since P>MC theres a loss of allocative efficiency

• strengthens monopoly power → increases barriers → may result in higher prices in LR

BENEFITS OF PRICE DISCRIMINATION ON PRODUCERS

• make better use of spare capacities

• higher SNP → stimulate investment (dynamic efficient)

• if more profits are made in one market, a diff market which makes a loss could be cross-subsidised → limit job losses

COSTS OF PRICE DISCRIMINATION ON PRODUCERS

• if used as a predatory pricing method- firm could face investigation by CMA

• might cost firm to divide market, which limits benefits they could gain

COSTS AND BENEFITS OF MONOPOLY ON…

• firms

• consumers

• employees

• suppliers

BENEFITS OF MONOPOLY ON FIRMS

• high SNP through profit max- can set high prices which will benefit owners (shareholders) as they can gain high return on investment, can increase investment (innovation and R&D) to maintain monopoly power and improve dynamic efficiency and overcome short term difficulties

• gain economies of scale- lower LRAC → increase profits + can limit price to increase barriers to entry

• can compete internationally- can lower price and achieve non-price competitiveness

COSTS OF MONOPOLY ON FIRMS

• greater regulation- as they gain greater monopoly power, regulators (CMA) may intervene to protect consumers

• diseconomies of scale- explain yourself

• LR lack of competition- may mean that firms become complacent and so they may not make maximum profits

BENEFITS OF MONOPOLIES ON CONSUMERS

• benefit from innovation and R&D- improved g and s through product innovation or maybe lower prices due to more efficient production methods

• lower prices through EoS- particularly seen in natural monopolies, where having monopoly prevents duplication of effort and max EoS

• consumers benefit from cross-subsidisation- firms funds loss from one product by raising price of another → widening range of products (increase choice) available for consumers and increase consumer welfare

COSTS OF MONOPOLIES ON CONSUMERS

• higher prices- no competition → high price and low output → allocative inefficiency → decrease consumer surplus (low costs of EoS may not be passed to consumers)

• lack of choice and poor quality- SNP may not be invested into R&D → less innovation → less choice + lack of incentive to improve quality due to no competiiton

BENEFITS OF MONOPOLIES ON EMPLOYEES

• high levels of employment and job security- firm has high profits and lack of competition to remain in business in LR + may expand operations which allow increase employment

• higher wages- more SNP → can reward successful employees as there is increase in demand for workers

COSTS OF MONOPOLIES ON EMPLOYEES

• few employment opportunities- lower overall output in that industry due to lack of competition→ less derived demand for labour

BENEFITS OF MONOPOLIES ON SUPPLIERS

• higher sales and profit- can have a reliable buyer → LT relationship → also provide security for employees in supplier company

COSTS OF MONOPOLIES ON SUPPLIERS

• exploitation- may have monopsony power → suffer from lower prices → lower profits (maybe even loss)

EFFICIENCY OF MONOPOLY

• allocative inefficient- as P>MC so they will be profit max → deadweight loss

• productively inefficient- not minimising costs (AC not = MC)

• dynamically efficient- invest into R&D due to high SNP

• X-inefficient- lack of competitive pressure → increase AC

NATURAL MONOPOLY

• situation where, due to EoS of a particular industry, industry is best served by single supplier

NATURAL MONOPOLY DIAGRAM

• occurs in an industry where LRAC falls over a wide range of output levels such that there may be only room for one supplier to exploit all internal EoS, so achieve productive efficiency

• e.g. gas network, electricity grid, railway infrastructure