3.4.5 monopoly

pure monopoly

single seller of a product or service in a market,faces limited competition due to high barriers to entry

working monopoly

a firm with 25% or more total sales within a market

close example to pure monopoly

google who has 88% of market

legal monopoly example

tesco 28%

regional monopoly

when only one company can supply an essential produt or service in a region because of significant barriers to entry for any competitor

example of regional monopoly

TFL

characteristics of monopoly

• barriers to enter

• few compeitors in market

• price makers

lgal monopoly

The UK Competition and Markets Authority defines a legal monopoly as any firm having more than 25% market share

objective of monopoly

profit maximise

monopoly in short run and long run with diagram

• makes supernormal profits even in long run

• level of output is at mc=mr

• if firm produces a quantity Qm the demand curve shows the price the firm can set -Pm

• at this output the AC of producing each unit is ACm

• difference between ACm and Pm is the supernormal profit per unit so total is red area

• in a monopoly market barriers to entry are total so no new firms enter the market and this supernormal profit is not competed away

• so situatuon remains as it is

price discrimination

occurs when a firm charges a different price for the same good/servise in order to maixmise revenue e.g cinema tickets kids and adults

third degree price discrimination

occurs when a firm charges different prices to different consumers for same good/service e.g rail fares are priced differently depending on time of travel

Markets are often sub-divided based on time, age, income and geographic location

conditions for 3rd degree price discrimination

• market power-ability to change prices

• varying consumer PED-some consumers must be willing to pay more and the firm must be able to identify these grops

• ability to prevent resale f tickets-It must be able to prevent consumers from buying in the low-price elastic sub-market and reselling in the higher price inelastic market.

first degree price discrimination

each individual customer is charged the maximum they would be willing to pay

second degree price discrimination

often used in wholesale markets where lower prices are charged to people who purchase large wuantities

third degree price discrimination diagram

• The diagram below illustrates the market for rail travel in the UK, where price inelastic demand is 'peak' hour demand and price elastic demand is any other time of the day, i.e. 'off-pea

• Each train route has an effective monopoly provider

• The overall firm is producing at the profit maximising level of output where MC=MR

  • This point is extrapolated to both sub-markets on the left by using the lower dotted line

  • The average cost is extrapolated across both sub-markets using the upper dotted line (C₁)

• A higher price for peak travel has been set at P_a and a lower price for off-peak travel has been set at P_b

• Following the revenue rule, total revenue increases in both markets

• The profit for sub-market A = (P_a-C₁) * Q₁

• The profit for sub-market B = (P_b-C₁) * Q₂

• The firm's total profit is the average selling price - the average costs

  • Total profit = (P_t-C₁) * Q₃

  • he firms' total profits are higher than if they had charged a single price to all customers  

costs and benefits of 3rd degree price discrimination to consumers

• Many price inelastic consumers will lose out as they pay higher prices, lowering consumer surplus

• Other price elastic consumers will benefit as they will be able to take advantage of the lower prices, increasing consumer surplus

• Some consumers will gain as a higher price decreases the quantity demanded and in some markets this canincrease consumer utility e.g. on train services; it helps limit over-crowding

costs and benefits of 3rd degree price discrimination to firms

• The total revenue of producers increases, leading to higher profits assuming there is no change in costs

• Firms increase their producer surplus at the expense of a decrease in consumer surplus

• Setting up and enforcing price discrimination can increase average costs. The costs of price discrimination must not outweigh the additional revenue gained

advantagrs of monopoly power to firm

• Supernormal profits generate finance for continued investment in technology and product innovation

• Market power enables the firm to increase its global competitiveness

• Economies of scale can increase, thereby lowering the average cost

• Producer surplus increases

• Price discrimination can increase total revenue

disadvantagrs of monopoly power to firm

• Due to a lack of competition, there is a reduced incentive to be efficient

• Cross subsidisation can create inefficiencies

• Monopolies lead to a misallocation of resources as P > MC. The price is above the opportunity cost of providing the product

• Due to a lack of competition, innovation sometimes lacks effectiveness

advantages of monopoly power to employees

• Supernormal profits often result in higher wages and greater job security

disadvantages of monopoly power to employees

• Having only one supplier in the industry limits the opportunity to change employers

advantages of monopoly power to consumers

• Product innovation due to the firm's supernormal profits may result in a better-quality product

• Cross subsidisation can lower prices on some products that the firm provides

• Prices may fall If firms pass on their cost savings (due to economies of scale) in the form of lower product prices

disadvantages of monopoly power to consumers

• A lack of competition is likely to result in higher prices as no substitute goods are available

• A lack of competition may result in no product innovation and worse product quality over time

• May experience worse customer service as the incentive to improve it is limited

• Cross subsidisation is likely to increase prices on some products offered by the firm, e.g. First class air ticket prices are used by some airlines to subsidise lower economy ticket prices

• Consumer surplus decreases

advantages of monopoly power to suppliers

• Increased sales volume for some suppliers as they are able to supply products that are distributed nationally or internationally with a secure contract

disadvantages of monopoly power to suppliers

• There is less competition for their products and a monopoly often has the power to dictate what price they will pay to suppliers (monopsony power)

• This price may not be profitable in the long run

natural monopoly

occurs when a single firm can produce a particular product or service at a lower average cost than multiple firms could e.g.national grid,network rail,thames water

why can natrual monopoly happen

• This is often due to associated infrastructure issues e.g. delivery of utility services like water, where it does not make sense to have multiple pipelines

• It can also be due to the significant cost that is generated when entering or exiting the industry, e.g. the sunk costs

• It can also be due to the ability of economies of scale to lower prices for consumers, e.g. it makes sense to have one firm building five nuclear power stations as opposed to five firms, as average costs will be lower with one firm constructing

• Even one firm in the industry cannot achieve an output at the lowest average cost where AC=MC, productive efficiency. More competition would simply increase average costs, further increasing prices for consumers

• industries usually have high fixed costs and karge economies of scale

regulation of natural monopoly

Government to ensure that consumers are not charged higher monopoly prices

exxamples of gov regulation

ofgem,ofwhat

examiner trick for evluating monopolies

When evaluating monopolies, demonstrate critical thinking by acknowledging the positives as well as the negatives. For example, Amazon has partly become a monopoly by being very good at what it does, with consumers benefiting from lower prices and a greater choice. However, its power means that it can also exploit the suppliers on its platform

examiner trick for evluating natural monopolies

When evaluating natural monopolies, consider the government failure that may occur with the regulation and the imposition of maximum prices. There is a lot of disagreement about the level of profits that natural monopolies should be allowed to make. It is a normative issue

natural monopoly digram

A natural monopoly will have continuous economies of scale — i.e. LRAC always falls as output increases (meaning MC is always below AC — see p.39). A profit maximising natural monopoly will restrict output to where MC = MR (at Qm).

A government might be reluctant to break up a natural monopoly as this could reduce efficiency. However, it might want to provide subsidies to the natural monopoly so that it increases output to the point where demand (AR) = supply (MC) — this is Qs. This will reduce prices to Ps (from Pm).

issues with natural monopoly

• gov failure - issues with regulation and max prices

• lack of dynamic efficiency

• heavily subsidised by gov - opportunity cost

thames water natural monopoly example

• debt of 22 billiom

• regulatory pnalties

• infrastructure

• serve 15 million cstomers

• fined 122.7 million by ofwat for sewage spills and improper dividend payouts and has faced criticism for its handling of leaks and outdated infrastructrue

• potential investor kkr pulled out of 4bn reserve deal as risky

• government couldpotentially takeover - nationiolisation

efficiency in monopoly

• not productively efficient since they dont produce at mc=ac

• not allocative efficient as P>MC

• since likly to make supernormal profits they will be dynamically efficient however if there is no competition they may have no incentive to invest