5.4 and 5.5 - Monopoly and monopoly power

Define monopoly

One firm only in a market

Short and long run profit maximisation in monopoly on a diagram

(page 135) The equilibrium level is shown at point A where MC=MR which is the condition which must be met to maximise profit. However, in monopoly, point A does not show the profit maximising price, which is located at point B on the demand curve. P1 is the maximum price the monopolist can charge and succeed in selling output Q1.

Why does the diagram not distinguish between short run and long run profit maximisation?

This is because a monopoly is protected by barriers to entry, which prevent new firms entering the market to share in the abnormal profit made by the monopolist. Entry barriers enable the monopolist to preserve abnormal profits in the long run as well as in the short run. By contrast, in perfect competition abnormal profits are temporary, being restricted to the short run. A monopolist has the monopoly power to preserve profit by keeping competitors out.

What are the two types of entry barriers?

Natural barrier and artificial barriers

What are natural barriers?

Barriers to market entry caused by geography. For example, if one firm has control of a resource essential for a certain industry, other firms are unable to compete in the industry.

What are artificial barriers?

'Man-made' barriers to market entry e.g. patent protection

What are the possible advantages of monopoly?

- benefitting from economies of scale

- Dynamic efficiency

- Monopoly can use its abnormal profit to fund research and development which leads to development of new products and improved existing products

What are the possible disadvantages of monopoly?

- Can lead to productive inefficiency and allocative inefficiency

- A monopoly may profit satisfied rather than profit maximise and be content with satisfactory profits and an easy life