Microeconomics
Topic 4 - Market structures
4.1 Monopoly
Explain:
• The characteristics of monopoly
• Dynamic efficiency
• X-inefficiency
Explain, with the aid of a diagram:
• Monopoly; supernormal profit in both short and long run
• A monopolist as a price maker
• Equilibrium price and output for a profit maximising monopolist
• Productive and allocative efficiency with a profit maximising monopolist
• Price discrimination by a firm with monopoly power
• Natural monopoly
Evaluate:
• Advantages and disadvantages of a monopoly
• Advantages and disadvantages of a natural monopoly
Monopoly
• A pure monopoly occurs when there is only one firm in the industry. In other
words, a single firm has 100% market share.
• In the UK, a firm is said to have monopoly power if it has more than 25%
of the market share.
• Even in markets with more than one seller, firms have monopoly power if they
can influence the price of a particular good on their own — i.e. they can act as
price makers.
Monopoly power may come about as a result of:
• Barriers to entry preventing new competition entering a market to
compete away large profits
• Advertising and product differentiation — a firm may be able to act as a
price maker if consumers think of its products as more desirable than those produced
by other firms (e.g. because of a strong brand).
• Few competitors in the market — if a market is dominated by a small
number of firms, these are likely to have some price-making power. They’ll also find
it easier to differentiate their products.
Even though firms with monopoly power are price makers, consumers can still choose
whether or not to buy their products. So demand will still depend on the price — as
always, the higher the price, the lower the demand will be
• Diagram of monopoly
, • A monopolist maximises profit, where MR = MC.
• Therefore, it sets price = P1 and quantity = Q1.
• Firm makes supernormal profit = (AR- AC) × Q
• If the market was competitive, output would be Q2 and price P2 (normal
profit).
Natural monopolies.
• Industries where there are high fixed costs and/or there are large economies of
scale lead to natural monopolies.
• If there was more than one firm in the industry, then they would all have the
same high fixed costs. This would lead to higher costs per customer than could
be obtained by a single firm.
• In this case, a monopoly might be more efficient than having lots of firms
competing. For example, the supply of water is a natural monopoly — it makes
no sense for competing firms to all lay separate pipes.
• 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).
• note ; Economies of scale may be so large that they outweigh everything else,
such as allocative and productive inefficiency.
, Advantages of monopolies Disadvantages of monopoly
Allocative inefficiency, because in
Economies of scale - If diseconomies of monopoly, at Q1, MC is not equal
scale are avoided, this means to AR
it can keep average costs (and perhaps ⁃ Producers are being ‘over-
prices) low. A monopolists will rewarded’ for the products
produce more than any individual they’re providing.
producer in a perfectly ⁃ Because of the restricted
competitive market would. supply, the product will
also be underconsumed
Research and development - A
monopolist can use its supernormal
Productive inefficient, because output
profits, to invest in developing new
is not at lowest point on AC curve.
products which may require high
investment. — this can lead to dynamic
efficiency
X-inefficient, because a monopolist has
International competition - A domestic fewer incentives to cut costs;
monopoly may be necessary to compete therefore AC curve is higher than it
internationally. For example, Corus is could be. & Quality of product could
the only steel producer in the UK, but it be worse, because there are fewer
faces competition from overseas incentives
competitors. for a monopolist to develop new
products.
Monopsonist power may also be used
to exploit suppliers.
Monopolies may be efficient - A firm
may gain monopoly power, because it is Monopsony power. A monopoly may
efficient and innovative e.g. Google and also have monopsony power, in
