Monopoly

Question 1

What are the conditions for a monopoly market

Answer 1

1. One seller dominating the market
2. Differentiated products so price maker
3. High barriers to entry/exit
4. Imperfect information
5. Profit maximiser (MC=MR)

Question 2

What is the difference between a pure monopoly and a legal monopoly

Answer 2

• Pure monopoly is 1 firm with 100% market share so the firm is the market but this a theoretical extreme and unrealistic
• Legal monopoly is what we see in real life. They aren’t a pure monopoly but they have monopoly power. A firm with monopoly power is defined as one with at least 25% market share

Question 3

How can you draw a monopoly diagram, showing supernormal profits

Answer 3

• AR is downward sloping as firms are price makers
• MR is 2x steep
• AC is a smiley face
• MC cuts AC at lowest point
• Monopoly is profit maximiser so produces where MC =MR at Q1
• Difference between AR and AC is unit supernormal profit and x by Q1 units for area

Question 4

Which curve do you read the price of off for a monopoly

Answer 4

the AR curve

Question 5

How allocatively efficient are monopolies

Answer 5

Not allocatively efficient as this would be where P = MC which means the monopoly is under producing and charging a higher price compared to the social optimum point

Question 6

Why is a monopoly’s lack of allocative efficiency bad for consumers

Answer 6

They have less choice, less quantity to buy, less consumer surplus due to higher prices. In addition the lack of competition could mean quality is low

Question 7

How productively efficient are monopolies

Answer 7

Not productively efficient as they are not producing at the minimum point of the AC curve so they are not maximising economies of scale

Question 8

How X efficient are monopolies

Answer 8

They are not x efficient as we can assume they have no incentive to produce on AC curve as there is not much competition and it would be difficult to fix and make employees not happy

Question 9

How dynamically efficient are monopolies

Answer 9

They are dynamically efficient because they have supernormal profits
- There are high barriers to entry and imperfect information so firms can’t come into market and supernormal profit persists in LR

Question 10

Compare a monopolies static and dynamic efficiency

Answer 10

Dynamically efficient but not statically efficient

Question 11

What is a deadweight welfare loss

Answer 11

• Deadweight means not recovered
• Welfare is society surplus i.e. sum of producer and consumer surplus

So total level of society surplus decreased

Question 12

How can you show the deadweight loss caused by a monopoly on a diagram

Answer 12

• CS at allocative efficient is area above price and below AR (demand) curve
• CS at MC = MR has decreased significantly (you can mark areas to show this)
• PS at allocative efficiency is area below price and above MC (supply) curve
• With PS at MC=MR, remember surplus is only gained until the quantity produced

Some of the lost consumer surplus is regained by producers but if you add up areas, total society surplus has still decreased, meaning monopolies cause market failure

Question 13

What types of firms are generally natural monopolies

Answer 13

They are mainly firms that distribute essential goods like water, internet, railway

Question 14

What are the characteristics of a natural monopoly market

Answer 14

1. Huge fixed costs, especially start up costs on infrastructure e.g. rail tracks or water pipework
2. Enormous potential for economies of scale
3. Rational sense for only 1 firm to supply market so competition is undesirable

Question 15

Why do natural monopolies have enormous potential for economies of scale

Answer 15

AC = TC/Q and since natural monopolies have huge TC due to the infrastructure, it takes a very large quantity to minimise AC

Therefore LRAC is continually decreasing for large quantities and MES is at a very high Q

Question 16

How does competition in a natural monopoly market cause allocative inefficiency

Answer 16

• The new firm entering would have to build their own expensive infrastructure
• The first firm was already exploiting EoS so has very low LRAC so the new firm can’t compete is forced to leave the market
• However, they have huge sunk costs as they cant sell on the infrastructure
• Therefore, there is a wasteful duplication of resources which the firm isn’t even using, which is allocatively inefficient

Question 17

How does competition in a natural monopoly market cause productive inefficiency

Answer 17

One big firm can produce massive quantities and exploit the economies of scale whereas many small firms means each firm can’t produce as much quantity so has less ability to exploit the economies of scale , causing productive inefficiency

Question 18

Under what circumstance does one firm dominating a natural monopoly market result in allocative and productive efficiency

Answer 18

As long as the natural monopolist is regulated

Question 19

How can you show allocative and productive inefficiency for a natural monopolist due to no regulation on a diagram

Answer 19

• Draw continually falling LRAC curve and then LRMC curve is shifted down version
• AR and MR are downward sloping due to price maker
• Firm is profit maximiser so produces where MC=MR and read price off AR curve
• Find area of supernormal profit by (AR-LRAC) x Q1
• High prices and low quantities for essential goods like water and railways is not allocatively efficient (should be P=LRMC)

Question 20

How do regulators allow for allocative and productive efficiency for a natural monopolist

Answer 20

• They want allocative efficiency due to the essential nature of these services
• Therefore, they force the natural monopoly to produce where P = MC (AR=LRMC)

Question 21

How can we show why regulators have to subsidise the natural monopolist

Answer 21

• At P=MC, the firm makes a large subnormal profit, especially because of the high quantity, so they would want to leave the market
• Therefore, the regulator will subsidise the subnormal profit so that the natural monopoly is making normal profit where the unit subsidy = unit subnormal profit (LRAC-AR)

Question 22

Why are many essential service industries state run instead of run by a private natural monopolist

Answer 22

• There is not much incentive for a private profit incentive firm to produce at normal profits so they are instead run by the public sector who want allocative efficiency
• An exception to this is the UK water industry which is run by private firms who are regulated and given huge subsidies

Question 23

How can you calculate firm concentration ratios

Answer 23

e.g. If you are trying to work out the 4 firm concentration ratio, add the market share of the highest 4 individual firms (so don’t include “other”)