5.6 Monopoly

Pure monopoly

where a single firm supplies 100% of a market

monopoly power

the ability of a firm to control the market price and output of a product

what influences monopoly power

barriers to enrty

number of competitors

advertising

degree of product differentiation

how does barriers to entry influence monopoly power

when there are high barriers to entry → incumbent firms are protected from competition → allowing them to maintain high prices without the threat of new entrents

example of high barriers to entry influencing monopoly power

patents for drugs

Sovaldi an antiviral drug for hepititis C retails for £50,000 for a 12 week treatment

Example of degree of product differentiation influencing monopoly power

Apple’s distinct design and ecosystem give it pricing power over similar smartphones

How does advertising effect the degree of monopoly power

Advertising → strengthens brand loyalty → more inelastic PED and raising barriers to entry

Example of how advertising effects monopoly power

Coca-Cola

40% global soft drinks

Spends $4 billion on advertising

CMA definition of a monopoly

Any firm with more that 25% of industry sales

how may a monopoly change its pricing descions if faced with the treat of new entrents

A monopoly will lower its prices using limit pricing, such that they make low or normal profits, so new firms no longer have an incentive to join the market

profit max output

MC=MR

productively efficient output

MC=ATC

allocatively efficient output

P = MC = AR

revenue max ouput

MR = 0

sales max output

AR = ATC

limit pricing output

setting a price lower than the profit max output

competetive market output

MC = AR

predetory pricing output

lower than cost, after ATC = AR

predetory pricing

when a firm temporarily sustains losses to drive competition out of the market (illegal)

what is the difference between limit and predetory pricing

Limit pricing involves setting prices low enough to deter entry over a long period of time while making profits, while predatory pricing involves temporarily lowering prices below costs to eliminate competitors.

Natural monopoly

high fixed costs High output to spread fixed costs

Large output to max out on econs of scale

Advantages of monopolies

• can be dynamically efficient → investment and innovation

• natural monopoly → better as a monopoly

• economies of scale

• if contestable may use limit pricing

• a domestic monopoly can be internationally competetive

disadvantages of monopolies

• not statically effieicnt

• deadweight loss

• prices higher and output lower than in a competetive market

• may be x inefficient

• diseconomies of scale

• divorce of ownership and control

• regressive effect of higher prices

Evaluation of monopolies

• is it a natural monopoly

• Strength of monopoly power

• Contestability - may use limit pricing

• Is there regulation

policies to control monopoly power

price caps

nationalisation

tax on monopoly profits

liberalisation of markets

Where would a price cap be set

At the competitive level where MC = AR

Advantages of a price cap

• allcoativelly efficient as price = MC so the market has achieved an optimal distribution of resources

• Social welfare is maximised by removing deadweight loss

• Increased consumer surplus

Cons of a price cap

• Producers leave the market → supply shortages

• Creates potential black markets where consumer rights are not protected and prices are even hire

• Risk of regulatory failure by setting the wrong rate → worsen shortages

• Risk of regulatory capture → cronyism

• Erode profits → risk of discouraging new entrants → lower contestability (similar to limit pricing)