3.4.5 Monopoly

Question 1

What is a Pure monopoly? (give an example)

Answer 1

One firm is the sole seller of a product in a market .
One of the closest examples to a pure monopoly is Google, who have 88% of the market.
(in the real world, pure monopoly rarely exists but a firm can be legally considered as having monopoly power)

Question 2

When would we legally consider a firm to have monopoly power?

Answer 2

If it has more than 25% of the market.

Question 3

What do we assume if there is only one firm in the industry?

Answer 3

They short run profit maximise and there are high barriers to entry.
(Tesco is a legal monopoly as it has 28% of the
market. Some local monopolies exist, such as Stagecoach in Cambridge.)

Question 4

What will the demand curve for the monoplist be and why?

Answer 4

The demand curve for the product (since the
monopoly firm is the industry itself). It will be downward sloping, since even though the firm is a monopolist, people can still choose whether to buy the good or not.

Question 5

Where will a monoplist chose to produce?

Answer 5

Profit maximising at MC=MR

Question 6

What kind of profit can the monoplist make in the long term?

Answer 6

Able to earn supernormal profits or a loss in the long run as there is no freedom of entry and exit to
the market.

Question 7

Draw a Cost, Revenue profit digram to show a monopolies supernormal profit.

Answer 7

Question 8

What is Third degree price discrimination?

Answer 8

When monopolists charge different prices to different people for the same good or service .

Question 9

Give examples of how a firm could price discriminate.

Answer 9

Different times of the day- peak and off-peak train times; different prices in different places, such as between London and smaller towns;
Different incomes, for example discounts for elderly people.

Question 10

What is needed in order for firms to price discriminate?

Answer 10

1) The firm must be able to clearly separate the market into groups of buyers;
2) the customers must have different elasticities of
demand;
3) Control supply and prevent buyers from the
expensive market from buying in the cheaper market.

Question 11

What is the digram forthe seperate markets for separate groups: those with inelastic demand and those with elastic demand.

Answer 11

Question 12

Explain this digram

Answer 12

• The diagram assumes the industry is a constant cost industry, in order to make it clearer.
• The firm produces where MC=MR in each market. -Therefore, in the inelastic market they produce at Q1P1 and make supernormal profit of the orange area; in the elastic market they produce at Q2P2 and make supernormal profit of the purple area; and in the combined market they produce at Q3P3 and make supernormal profit of the yellow area.
  -This shows that by price discriminating and having two separate markets, the inelastic market and the
  elastic market, rather than a combined market, the firm can make higher profits. The orange
  area plus the purple area is larger than the yellow area.

Question 13

What are the costs and benfits of price discrimination?

Answer 13

● Firms benefit since they are able to increase their profits. This can go into research and development, improving dynamic efficiency.
● Those in the elastic market gain as they are able to pay a lower price than they otherwise would; they benefit from cross subsidisation. These consumers may have been unable to access the good if it were not for the price discrimination and so this may increase equality . .
● Consumers lose some of their consumer surplus to the producers and some consumers have to pay a higher price.

Question 14

What is first degree price discrimination?

Answer 14

The firm can charge different prices for every unit of the good and so can eliminate all consumer surplus;

Question 15

What is second degree price discimation?!?!

Answer 15

Second-degree price discrimination is charging a different price for different quantities such as discounts for bulk purchases.

Question 16

What are natural monopolies?

Answer 16

These industries, the economies of scale are so large that even a single producer is not able to fully
exploit all of them . These are decreasing cost industries.
-There are no pure natural monopolies in real life, but some examples include the National Grid, Royal Mail andNational Rail.

Question 17

Draw a natural monopoly digram (where there is Supernormal profit)

Answer 17

AC and MC continue to fall. The firm will profit maximise and produce where MC=MR at Q1P1, making supernormal profit of the shaded area.

Question 18

Why would it be pointless to enourges competition in monopolies?

Answer 18

It would raise average costs for the industry. If any new firm enters the market, they will be easily priced out as their costs will be so much higher. This raises questions for competition policy and nationalisation.

Question 19

Natural monopolies tend to be found in industries with very high _____ ______.

Answer 19

fixed costs

Question 20

Explain how the Railway’s operate as a natural monply.

Answer 20

In order to run one train you would need to invest billions in track, tunnels, bridges and stations whilst running extra trains represents a much smaller
relative increase in costs, meaning average costs will decrease drastically.

Question 21

What kind of efficency do/don’t monopolies have?

Answer 21

neither allocative nor productively efficient as there is no minimum on the AC curve and at allocative efficiency there would be a loss.

Question 22

What are the benefits of monopolies to firms?

Answer 22

● Monopolists have the potential to make huge profits for their shareholders through profit maximisation.
● The existence of supernormal profits means firms will have finance for investments and will be able to build up reserves to overcome short term difficulties.
● Firms with monopoly power will be able to compete against large overseas organisations.
● Large firms will be able to maximise economies of scale, reducing costs and increasing profit further.

Question 23

What are the costs of monopolies to firms

Answer 23

• However, firms may not always choose to profit maximise because of X-inefficiencies, sales or revenue maximising, profit satisficing or contestability leading to limit pricing.
• In the long run, the lack of competition may mean that firms become complacent and so they may not make maximum profits.

Question 24

What are cost/benefits of monopolies to employees?

Answer 24

• Monopolists produce at lower outputs, so will employ fewer workers.
  + However, the inefficiency of the monopoly may mean employees receive higher wages, particularly directors and senior managers. Profit satisficing or sales/revenue maximising may mean output is higher and so more employees are employed.

Question 25

What are cost/benefits of monopolies to Suppliers?

Answer 25

For suppliers, the impact of a monopolist will depend on the extent to which the **monopolist** is also a monopsonist . If the monopolist buys all or most of the suppliers’ goods (so is a monopsonist), it will reduce the suppliers’ profits as the monopolist will decrease prices.

Question 26

What are benefits/costs of monopolies to Consumers?

Answer 26

● With a natural monopoly, consumers tend to be better off than if there was competition. ● When firms enjoy economies of scale , they will be more efficient and customers will enjoy a higher consumer surplus. ● Monopolists may produce an increased range of goods or services due to cross subsidisation. ● The use of price discrimination will allow for survival of a product or service , and benefits some customers (those in the cheap market) whilst is negative for others. (For example, it is said that economy class flights are funded by business class flights) ● Consumers may pay higher prices and see a poorer quality service , due to a lack of competition. ● There is less choice for consumers, since there is only one firm producing the good.

Question 27

What are the cost/benefits of monopolies in terms of efficency?

Answer 27

- A monopoly is **productively inefficient,** since they don’t produce at MC=AC. They are also not allocative efficient as P>MC. - **X-inefficiency** because of the lack of competition. MC=AC may rise and this will cause an even further fall in consumer surplus. + Since a monopolist is likely to make supernormal profits, they will be dynamically efficient. However, if there is no competition, they may have no incentive to invest. + Enjoy large economies of scale which allow AC to fall. If these fall by a large enough amount, then consumer surplus will grow larger than would exist in perfect competition. + Will have large retained profits and will be able to exploit new products or production techniques without worrying about competitors. This would make them more productively efficient, as costs are lower, moreallocative efficient, as there are new products in the market, and dynamically efficient. + Also, monopolists avoid undesirable duplication of services and prevent amisallocation of resources. + Cross subsidisation may waste resources since profits from one sector finance losses in another, whilst instead they should just stop production of this good.

Question 28

Use a digram to show the effect of a monoplist vs perfect competition.

Answer 28

Williamson trade off, If the market was perfectly competitive itwould produce where **price=AR=MC** at Q1P1. If the industry was to become a monopoly it would produce MR=MC at Q2P2.

Question 29

Where would a monopoly produce and where would a firm in perfect competition produce?

Answer 29

perfectly competitive it would produce where **price=AR=MC** at Q1P1. monopoly it would produce **MR=MC at Q2P2.**

Question 30

PERFECT COMPETITION: **price=AR=MC** at Q1P1. MONOPOLY : **MR=MC at Q2P2.** what is the effect of this?

Answer 30

- **less production** of the good and therefore less resources used, which causes **deadweight loss** of BCD, theorange area. - There is a **fall in consumer surplus** from ADP1, the total shaded area, to ABP2, the yellow area. P2BCP1, the purple area, has been turned into producer surplus whilst BCD has been lost as deadweight loss.

Question 31

Why are there few permanent monopolies

Answer 31

supernormal profits give an incentive for other firms to break down the monopoly through a process of _creative destruction_

Question 32

how may monopolies be good in the short run?

Answer 32

Provides incentive to invest and innovate which is good for both the company and the economy

Question 33

how may monopolies be bad specifically in the long run?

Answer 33

bad aspects of monopoly are more likely to become true in the long run as firms can simply enjoy the benefits and become complacent

Question 34

How may the effects of a monopoly be dependant on the industry