Monopoly

Assumptions of model

• only one firm, so firm is industry

• high barriers to entry

• may make abnormal profit in the long run due to barriers of entry

• firm is a short run profit maximiser

• single monopoly firm is able to choose to produce at any point along the market demand curve

• firm produces and sells a unique with no close subsitutes

How do monopoly firms gain market power?

• firm is a price maker as there are lack of consumer substitute goods

• market power arises whenever a firm faces a downward sloping demand curve

• a monopoly must be supplying goods which is quite alone in terms of percieved utility, & therefore cant be replaced

sources of monopoly power/barriers to entry

• economies of scale

• natural monopoly

• legal barriers

• brand loyalty

• aggressive tactics

• control of essential resources

economies of scale

• result in the downward sloping portion of a firm’s LRAC, resulting in lower costs as the firm increases its size

• create a barrier to entry

• larger firm can charge a lower price than smaller firms, & can force the smaller firms into a situation where they’ll not be able to cover its costs

• if the new entrants on a small scale try to enter the industry, they’ll be able to compete with the larger one

natural monopoly

• barriers to other firms entering the market are in built into the environment, infrastructure, or the nature of the good itself

• tend to occur when fixed costs are very high, giving potential economies of scale only to firms which can exploit sheer size to some extent and spread the fixed costs over large units of output

legal barriers

• intellectual property, patents, licenses, copyrights, tariffs, quotas, and other trade restrictions

• not all of the legal barriers lead to monopoly, but they have the ability to limit competition, contributing to some degree of monopoly power

brand loyalty

• involves creation by a firm of a unique image and name of a product

• can make it difficult for new firms to enter a market that is dominated by a successful brand

• used mostly by monopolistic competition and oligopoly

• has the effect of limiting the number of new competitor firms that enter a market

agressive tactics

• firms which are able will attempt to create barriers of entry in the aims of constructing a monopoly, like cartels, cutting its price, or takeover

• important for oligopolies

control of essential resources

• monopolies can arise from ownership or control of an essential resource

• a local monopoly is a single producer within a particular geographical area

profit and revenue max

• profit max: MC=MR

• revenue max: MR=0

• as a single price monopoly will lose revenue as well as gain revenue by lowering price, the MR curve will fall twice as fast as AR

• TR is maximised where output level MR=0, which is where PED=1

what do all market structures aim for?

profit maximiser level of output in short run, MC=MR

abnormal profit monopoly

• abnormal profit: ar > ac

• in monopoly, in SR, the firm may make abnormal profit. if this is the case and the firm has high barriers to entry, then they will continue to make abnormal profit in the LR.

• however, in order to eliminate the new entrants from the market, the monopoly firm can lower down the price and may make normal profit

normal profit in SR

• ac=ar

• firm breaks even at this point

• though monopolists typically earn supernormal profits, they may achieve only normal profit due to high operational costs, weak demand, or government price regulation, resulting in zero economic profit

loss is SR

• ac > ar

• could be due to massive overheads such as rent, specialized machinery, research and development, or licensing fees can push the average total cost too high.

natural monopoly (formation)

• it’s a market situation where there are considereable entry barriers (very high fixed costs or start up costs), and no single firm would be able to fully exploit these scale benefits

• A natural monopoly is a specific market structure where a single firm can supply a good or service to an entire market at a lower cost than two or more competing firms could

normal monopoly diagram analysis

• natural monopolist’s demand curve intersects its LRAC curve at a point where average costs are still falling

• at output level q 1, there are still economies of scale

• if firm produces past q 1, they will make a loss

• if it went past, the P which is given by the demand curve would be lower than LRAC

• P < AC means firm is making a loss

• if firm is to earn normal profit or abnormal profit, it must produce a quantity less than or equal to q 1, and charge a price greater than or equal to AC 1.

how is natural monopoly a barrier?

• because potential entrants realise that it would be extremely difficult to attain the low costs of the already existing firm

• high AC would mean having to charge a high price for the good, so that the new firm would be unable to compete with the existing firm

how can a natural monopoly stop being natural?

if changing technologies create conditons that allow new competitions to enter the indsutry and being production at a relatively low cost

criticism of monopoly

• welfare loss, allocative inefficiency, market failure

• higher price and lower output

• loss of consumer surplus to monopolist

• negative impacts on the distribution of income

• lack of competition may give rise to higher costs (poorly motivated labout, poor management, avoidance of risk)
  possibly less innovative

possible pros of monopoly

• economies of scale

• natural monopoly

• research & development for product development and technological innovation