Monopoly

Define the term ‘monopoly’

A market structure where there is one dominant firm in the market

What is the CMA’s threshold for a legal monopoly

Over 25% market share

What is the CMA’s threshold for a dominant firm

At least 40% of market share

Explain the why a monopoly acts as a price maker.

A monopoly is characterised by one seller in the market, meaning that there is no available substitute products for consumers. In turn, this suggests inelastic demand and so this gives the monopoly complete market power as some consumers are forced to accept a higher price. Therefore, monopolies operate as price makers as it can manipulate prices to change demand, allowing them to make supernormal profits in the short-run.

Explain how legal barriers, such as patents acts as a barrier to entry.

Patents prevent competitors from using the idea’s of incumbent firms, which in turn may prevent them from entering the industry. In turn, there is no long-run crowding out of supernormal profits as the monopolist is able to retain its market share.

Explain how sunk costs acts as a barrier to entry

Sunk costs refer to costs that cannot be recovered if the firm exits the market. This may increase the cost of failure, and so may deter new entrants from entering the market, given that if they fail they wont be able to recover its sunk costs. In turn, there is no long-run crowding out of supernormal profits as the monopolist is able to retain its market share.

Explain how ‘relative scale benefits’ acts as a barrier to entry

• Incumbent firms are able to benefit from internal economies of scale as they are able to produce to a much larger scale, relative to potential entrant competitors

• This means that the incumbent firm has more access to more significant internal economies of scale

• In turn, as the incumbent firm expands output at Q2, these scale economies can put downwards pressure on their LRAC from C1 to C2.

• Contrastingly, potential entrant competitor may only be able to produce at a level of output at Q1, if it successfully enters the market and since it had less access to these same internal scale economies it can only choose to produce at a higher SRAC of C1.

• This creates a cost asymmetry of (C2-C1), representing a lack of cost competitiveness

• Because the larger firm can achieve a lower LRAC, it may be the case that it can offer a lower price relative to the the potential entrant.

• As a result, this may erect a barrier to entry as these potential entrants may be unable to compete with the incumbents lower price, deterring them from entry.

• In turn, there is no long-run crowding out of supernormal profits as the monopolist is able to retain its market share.

Explain how ‘relative scale benefits’ acts as a barrier to entry

• Incumbent firms are able to benefit from internal economies of scale as they are able to produce to a much larger scale, relative to potential entrant competitors

• This means that the incumbent firm has more access to more significant internal economies of scale

• In turn, as the incumbent firm expands output at Q2, these scale economies can put downwards pressure on their LRAC from C1 to C2.

• Contrastingly, potential entrant competitor may only be able to produce at a level of output at Q1, if it successfully enters the market and since it had less access to these same internal scale economies it can only choose to produce at a higher SRAC of C1.

• This creates a cost asymmetry of (C2-C1), representing a lack of cost competitiveness

• Because the larger firm can achieve a lower LRAC, it may be the case that it can offer a lower price relative to the the potential entrant.

• As a result, this may erect a barrier to entry as these potential entrants may be unable to compete with the incumbents lower price, deterring them from entry.

• In turn, there is no long-run crowding out of supernormal profits as the monopolist is able to retain its market share.

Explain how anti-competitive practices acts as a barrier to entry

Vertical integration for instance, enables a firm to take control of scarce recourses, in which they may refuse entrant firms from using these scarce recourses. This may In turn, there is no long-run crowding out of supernormal profits as the monopolist is able to retain its market share.

Draw a basic monopoly diagram.

• One firm

• High barriers to entry

• Operates at the profit maximising level of output where MC=MR

Explain how monopolies lead to allocative inefficiency

• A monopoly operates as a single seller of goods or services in a market

• A monopoly is characterised by one seller in the market, meaning that there is no available substitute products for consumers.

• In turn, this suggests inelastic demand and so this gives the monopoly complete market power as some consumers are forced to accept a higher price.

• Therefore, monopolies operate as price makers and so sets a higher price of Pmax and restricts output to Qmax

• Assuming the monopolist is a profit maximiser, it will operate at the profit maximising level of output where MC=MR

• Able to make supernormal profits of (Pmax-C1) x Qmax

• This leads to an increase in producer surplus by charging higher prices of P1 at level of output it does produce at Q1 although it may loose producer surplus it could have earned from supplying the additional units of Qe

• Consumers who are willing to pay a higher price of P1 see a loss of consumer surplus of area P1AB, as well as pricing some consumers out of the market who were only only willing and able to pay the original price of Pe.

• There is now a condition of higher prices and restricted output relative to the allocatively efficient level of output where P=MC, meaning that consumers who have been priced out the market experience a loss of utility as they are no longer able to purchase the good alongside a lack of choice due to output being restricted at Qmax, leading to an increase in allocative inefficiency

• This leads to an area of deadweight loss of ABC as beneficial trades have been foregoned due to the degree of allocative inefficiency within the monopoly

Explain how monopolies lead to productive inefficiency

• Assuming the monopolist is a profit maximiser, it will operate at the profit maximising level of output where MC=MR

• Able to make supernormal profits of (Pmax-C1) x Qmax

• However, the productively efficient level of output is where AC=MC, where a firm is producing at its lowest possible average cost

• In turn, firms operating under a monopoly may create productively innefficent outcomes

• This may be driven by, firms voluntarily foregoing internal economies of scale since the firm is restricting output

• This results in an underutilisation of its factors of production, and so average costs are higher, which leads to a higher price of Pmax relative to the productively efficient price of Pprod

Explain how monopolies lead to X-inefficiency

• Assuming the monopolist is a profit maximiser, it will operate at the profit maximising level of output where MC=MR

• Able to make supernormal profits of (Pmax-C1) x Qmax

• However, it may be X-inefficient which is where a firm is operating above its average cost curve for a given level of output.

• This may be due to a lack of competition within a monopoly, which is primarily driven by high barriers to entry such as patents which prevent competitors from using the idea’s of incumbent firms, which in turn may prevent them from entering the industry. In turn, there is no long-run crowding out of supernormal profits as the monopolist is able to retain its market share.

• The absence of genuine market competition may lead to monopolists having less incentive to control its production costs which in turn may lead to productive slack occurring as a consequence.

Explain how monopolies lead to dynamic efficiency

• Assuming the monopolist is a profit maximiser, it will operate at the profit maximising level of output where MC=MR

• Able to make supernormal profits of (Pmax-C1) x Qmax

• In 2026, Apple made $112 billion in supernormal profit.

• Now that it has greater levels of retained earnings, it may be able to reinvest it’s long-run supernormal profit’s into R&D in order to speed up technological innovation

• In turn, this improves dynamic efficiency within the smartphone industry.

• This can be seen by Apple where, in Q4 of 2026 it introduced the IPhone Duo, which revolutionised the smartphone industry with its modern, sleek design and well integrated flip-phone interface.

• (Get sales revenue figures once released)

• Apple was therefore able to successfully differentiate itself from its competitors and hence experience improved revenue streams.

• This may positively impact consumers, as they are able to reap more satisfaction from technological innovation as they have access to a greater variety of products which may increase their marginal utility.

• This could lead to improvement’s in consumer welfare in the long-run

• Therefore, monopolies may be able to promote allocatively efficient outcomes alongside dynamic efficency which strengthens the case that monopolies may not always have adverse impacts on society.