L7-8: Monopoly, Monopolistic Competition and Oligopoly

What is a ‘monopoly’ ? (Definition, Key Idea and Example)

• Definition: A market structure characterized by a single seller supplying a unique product to the entire market, protected by high barriers to entry that prevent competitors from entering.

• Key Idea: As it supplies the entire market, it faces the industry’s downward-sloping demand curve, meaning it must lower its price to sell a higher quantity. The firm has the market power to act as a ‘price maker’ rather than ‘price taker’.

• Example - Shor, R. (2005). A review of the political and economic forces shaping today’s diamond industry: As recently as 1993, the De Beers Central Selling Organisation (CSO) controlled about 80% by value of the approximately $5.5 billion world market.

Where is the ‘profit maximising’ quantity of output for monopolies ?

• ∆r / ∆y = ∆c / ∆y = MR = MC

• If MC > MR, decrease output as cost savings outweigh additional revenue

• If MR > MC, increase output as additional revenue outweighs cost increase

What is the equation for ‘Marginal Revenue’ for a Monopoly’ ?

• ∆r / ∆y = p + (∆p / ∆y) x p

• When a firm increases output by one unit the firm receives the market price (p) for the brand-new unit sold (positive) and then must lower the price for all previous units already being sold (negative).

Where would the ‘profit maximising quantity’ be found using ‘average curves’ ?

• Where MR = MC.

• Barriers to entry prevent new firms entering the industry, allowing for supernormal profits in the long-run.

What is ‘Pareto Optimality’ ? (Definition, Key Idea and Example)

• Definition: An economic state where resources are allocated in such a way that it is impossible to make any one person better off without making at least one person worse off.

• Key Idea: It represents a point of maximum economic efficiency where there is no waste and all mutually beneficial trades have already been made.

• Example - Radford, R.A. (1945). The economic organisation of a P.O.W. camp: When Red Cross prisoners voluntarily traded their unwanted items, it was a Pareto improvement as both parties became better off without harming anyone else. Using cigarettes as a universal currency allowed free trade until all win-win opportunities were exhausted.

how is ‘allocative inefficiency’ a disadvantage of monopoly (Definition, Key Idea and Example)

• Definition: A market failure that occurs when the value consumers place on a good or service does not equal the marginal cost of producing it, meaning resources are not distributed in a way that maximises societal welfare.

• Key Idea: In an allocatively inefficient market, goods are not produced up to the point where P = MC, such as under monopoly where prices are set higher than marginal cost.

• Example - Shor, R. (2005). A review of the political and economic forces shaping today’s diamond industry: The CSO would act as a market buffer by stockpiling diamonds or reducing their purchases from certain producers (effectively forcing them to stock at the mine sites).

how is ‘x-inefficiency’ a disadvantage of monopoly (Definition, Key Idea and Example)

• Definition: An organisational inefficiency that occurs when a firm fails to minimise its production costs and operate on its lowest possible cost curve, often due to lack of competitive pressure.

• Key Idea: A monopolist facing no market competition lacks the competitive drive to run efficiently, resulting in internal inefficiency via corporate slack, administrative bloat, or wasted resources.

• Example - Florio, M. (2003). Does privatisation matter ? The long-term performance of the British Telecom over 40 years: “Operating profits were stable before and after privatisation and privatisation (1984) had little discernible effect on productivity trends before 1991, when the introduction of more competition and new regulatory pressures led to large gains.”

how is ‘inequitable distribution of income’ a disadvantage of monopoly (Definition, Key Idea and Example)

• Definition: How a single-firm market structure transfers wealth from consumers to monopolists, widening the gap between high-income owners of capital and lower-income households.

• Key Idea: Monopolies are able to charge artificially high prices (P > MC) and earn supernormal profits. Because ownership of these powerful firms is concentrated in the hands of a few shareholders or owners, these monopoly profits flow upward.

• Example - Schmitz, J. A. (2021). Because of Monopolies, Income Inequality Significantly Understates Economic Inequality: “The U.S. oral health care industry is not competitive. Dental-monopolies are instrumental in passing laws that block the practice of mid-level professionals. As a consequence of monopoly sabotage, many low-income and middle-income Americans have very poor oral health. One measure of poor health is untreated cavities. Over the period 2011 and 2012, and among those aged 45-64, the fraction of individuals with untreated caries was 51.6% for those at or below the poverty level. For those whose income was four times or greater than the poverty level, the fraction was 11.7%.”

How is perfect competition ‘allocatively efficient’ ? (Definition, Key Idea and Example)

• Definition: A market state where resources are distributed in a way that perfectly maximises combined consumer and producer surplus, occurring precisely where P = MC

• Key Idea: Thousands of price-taking firms and well-informed consumers interact so that no-one has market power. Price (P) reflects the marginal benefit to society, while marginal cost (MC) represents the opportunity cost of the scarce resources used. As individual firms maximise profit by expanding output until P = MC, society produces neither too much nor too little of a good.

• Example - Tomek, W. G., & Kaiser, H. M. (2014). Agricultural Product Prices: In the Global Wheat and Corn Commodity Markets, thousands of independent farmers act as price-takers facing a horizontal demand curve. As no single farm possesses market power, each producer expands output until their marginal cost equals the global market-clearing price (P = MC), eliminating deadweight loss.

How is monopoly ‘allocatively inefficient’ ? (Definition, Key Idea and Example)

• Definition: A firm with market power restricts output and charges a price above the marginal cost of production (P > MC), resulting in a deadweight loss to society where the value consumers place on an extra unit exceeds the cost of making it.

• Key Idea: A monopolist faces a downward-sloping demand curve and has the power to set prices. To maximise profit, it restricts output to the point where MR = MC, which forces P > MC. This artificial scarcity means society under-allocates resources to this good, destroying potential consumer and producer surplus and creating a permanent deadweight loss.

• Example - Shor, R. (2005). A review of the political and economic forces shaping today’s diamond industry: The CSO would act as a market buffer by stockpiling diamonds or reducing their purchases from certain producers (effectively forcing them to stock at the mine sites).

How does ‘allocative efficiency’ change when transitioning from monopoly to perfect competition ?

What is a ‘Natural Monopoly’ ? (Definition, Key Idea and Example)

• Definition: A specific market structure in which high fixed costs and substantial economies of scale mean that a single firm can supply the entire market demand at a lower average cost than two or more competing firms.

• Key Idea: In industries requiring massive upfront infrastructure investments, building parallel competing networks is economically wasteful. As the single firm expands output, its long-run average total cost falls over the range of demand. If multiple firms tried to compete, they would duplicate massive fixed costs, resulting in higher average costs for consumers.

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How can a Natural Monopoly be regulated using ‘Marginal cost pricing’ ? (Definition, Key Idea and Example)

• Definition: The government forces the monopolist to set its price equal to the marginal cost of production (P = MC)

• Key Idea: If a regulator strictly enforces marginal cost pricing (P = MC), the firm's price will fall below its average total cost at that output level. The firm runs at a persistent economic loss, making it financially unsustainable without government subsidies to cover the shortfall.

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How can a Natural Monopoly be regulated using ‘Average cost pricing’ ? (Definition, Key Idea and Example)

• Definition: A regulatory approach for a natural monopoly where the government sets the firm's price equal to its average total cost (P = ATC), allowing the firm to cover all its operating and capital expenses while earning zero normal profit.

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How can a Natural Monopoly be regulated using ‘Rate-of-return regulation’ ? (Definition, Key Idea and Example)

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how are ‘unknown cost and demand functions’ an issue when regulating natural monopolies ? (Definition, Key Idea and Example)

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how is ‘regulatory capture’ an issue when regulating natural monopolies ? (Definition, Key Idea and Example)

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how are ‘subsidies’ an issue when regulating natural monopolies ? (Definition, Key Idea and Example)

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How can a Natural Monopoly be regulated using ‘price-cap regulation (CPI-X)’ ? (Definition, Key Idea and Example)

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How can a Natural Monopoly be regulated using ‘Structural Measures’ ? (Definition, Key Idea and Example)

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How can a Natural Monopoly be regulated using ‘Franchise Bidding’ ? (Definition, Key Idea and Example)

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How does a monopoly use ‘1st Degree Price discrimination’ ? (Definition, Key Idea and Example)

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How does a monopoly use ‘2nd Degree Price discrimination’ ? (Definition, Key Idea and Example)

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How does a monopoly use ‘3rd Degree Price discrimination’ ? (Definition, Key Idea and Example)

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How can a Monopoly be regulated using ‘Antitrust policy law’ ? (Definition, Key Idea and Example)

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How can a Natural Monopoly be regulated using ‘public regulation’ ? (Definition, Key Idea and Example)

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How can a Natural Monopoly be regulated using ‘Public ownership’ ? (Definition, Key Idea and Example)

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What is ‘Monopolistic Competition’ ? (Definition, Key Idea and Example)

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How does monopolistic competition occur in the ‘short-run’ ?

How does monopolistic competition occur in the ‘long-run’ ?

how is ‘allocative inefficiency’ a disadvantage of monopolistic competition (Definition, Key Idea and Example)

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how is ‘productive inefficiency’ a disadvantage of monopolistic competition (Definition, Key Idea and Example)

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how is ‘product differentiation’ an advantage of monopolistic competition (Definition, Key Idea and Example)

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how is ‘greater consumer tailoring’ an advantage of monopolistic competition (Definition, Key Idea and Example)

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what is ‘Hotelling’s Paradox’ in regards to product differentiation within monopolistic competition (Definition, Key Idea and Example)

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How does ‘price competition’ break ‘Hotelling’s Paradox’ in regards to product differentiation within monopolistic competition (Definition, Key Idea and Example)

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How does a ‘multi-dimensional product space’ break ‘Hotelling’s Paradox’ in regards to product differentiation within monopolistic competition (Definition, Key Idea and Example)

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How do ‘location-changing costs and new entrants’ break ‘Hotelling’s Paradox’ in regards to product differentiation within monopolistic competition (Definition, Key Idea and Example)

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What is ‘Oligopoly’ ? (Definition, Key Idea and Example)

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What is a ‘Nash Equilibrium’ ? (Definition, Key Idea and Example)

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What is ‘Collusive behaviour’ in an oligopoly ? (Definition, Key Idea and Example)

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What is ‘Non-collusive behaviour’ in an oligopoly ? (Definition, Key Idea and Example)

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What is the ‘Cournot Model of Non-cooperative Oligopoly’ ? (Definition, Key Idea and Example)

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What is the ‘Cournot-Nash Equilibrium’ ? (Definition, Key Idea and Example)

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What is the ‘The Stackelberg Game’ ? (Definition, Key Idea and Example)

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What is a ‘Cartel’ in the context of an oligopoly ? (Definition, Key Idea and Example)

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How does the ‘free-rider problem’ make cartels unstable in the context of an oligopoly ? (Definition, Key Idea and Example)

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How does the ‘Grim trigger’ punishment make cartels more stable in the context of an oligopoly ? (Definition, Key Idea and Example)

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How do ‘Price war’ punishments make cartels more stable in the context of an oligopoly ? (Definition, Key Idea and Example)

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How does the ‘Output expansion’ punishment make cartels more stable in the context of an oligopoly ? (Definition, Key Idea and Example)

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How does ‘Targeted punishment’ make cartels more stable in the context of an oligopoly ? (Definition, Key Idea and Example)

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What does the ‘Market Concentration Overview’ look like ?