Monopoly

Question 1

What is a monopoly ?

Answer 1

When there is only one seller in a market

Question 2

What assumption do we make about a monopoly?

Answer 2

-firm is itself an industry (one seller)
-price maker
-barriers to entry
-Downward sloping demand curve
-no close substitutes
-full control over supply

Question 3

What is meant by dynamic efficiency ?

Answer 3

Efficiently that considers the effect of innovation and technological progress on productive and allocative efficiency over a long period of time

Question 4

What is meant by x-inefficiency ?

Answer 4

Occurs when a firm is not operating at minimum cost for the given output/quantity produced. The firm is operating at an average cost above the lowest possible average curve.
X inefficiency can arise due to the lack of competition, which reduced the incentive to minimise costs

Question 5

What does a natural monopoly mean ?

Answer 5

A monopoly that arises in an industry in which there are such substantial, and continuing, economies of scale that only one firm is viable

Question 6

Diagram for a monopoly in the long run

Answer 6

Question 7

Diagram for monopoly in the short run making a supernormal profit

Answer 7

Question 8

Diagram for monopoly in the short run making an economic loss

Answer 8

Question 9

What is meant by economies of scale?

Answer 9

Refers to the cost advantages a firm gains as it increases its production and output, leading to a lower average cost per unit. This happens because large scale production allows for bulk purchasing of raw materials, efficient use of machinery, specialised labour.

Question 10

What barriers of entry are there (what restrictions prevent firmsentering the market?) pt 1

Answer 10

1) economies of scale - an incumbent firms may have significant economies of scale. A new entrant to the market may not be able to generate the economies of scale to compete, the average cost of the new entrant will be too high. The existing/incumbent firm is able to set prices below the average costs of the new entrant
2) lower costs for an established firm - established firm will have specialist expertise and may be able to use the most efficient techniques in production. Established firms may also have lower costs of finance as it may be deemed less risky to lend to.
3)product differentiation and brand loyalty - even if a new firm is able to produce at a lower average cost the product may not be sufficiently attractive to buyers to overcome the consumer loyalty to a particular existing brand. Advertising and brand proliferation may be deliberately used by incumbent firms.

Question 11

What barriers of entry are there (what restrictions prevent firms entering the market?) pt 2

Answer 11

4) ownership of, or control over, key factors of production/scare inputs.
Or incumbent firm may have existing contract with retail stores and may have control over wholesale and there may be clauses in those contracts that prevent these stores from burying from other firms.
5) legal protection - Patent and copyright laws , as well as, licensing. This allows one firm to operate without competition in a particular market. For example, reading buses which is owned by reading borough council is unlikely to allow the licenses for certain bus routes.
6) threat of mergers and takeovers - a firm with monopoly power may seek to takeover new entrants; the threat of hostile takeovers may discourage new firms entering the market h

Question 12

What barriers of entry are there (what prevents new firms entering the market?) pt 3

Answer 12

7) aggressive tactics - as a monopolist can usually sustain losses for a longer period than a new entrant, the incumbent dominant firm is able to sustain price wars until it forces out competition for longer
8) intimidation - a wide range of possible forms of harassment, legal or illegal, may be utilised to drive a new entrant out the market
9) exit barriers - significant costs of exit will act as a barrier to entry in the first instance. A firm would be very reluctant to enter a market when it seems the costs of exiting prohibitive. (Sunk costs)

Question 13

What does sunk costs mean?

Answer 13

Non recoverable costs when a firm leaves an industry. These include start up costs such as, marketing, some research and development, costs associate with not being able to recoup all costs when selling specialist capital equipment

Question 14

What are the Advantages of a monopoly?

Answer 14

1) if an monopoly has significant economies of scale, the monopoly may have significant lower average costs in production than a more competitive industry. I.e lower costs at higher outputs
2)supernormal profits earned by a monopoly may be reinvested into R and D rather than being returned to owners as dividends. Over time this may lead to dynamic efficiency
3)monopolists can use price discrimination. This may lead to a more equitable access to goods as monopolies can charge lower income households a lower price
4)Natural monopoly - continuing economies of scale may lead to a more efficient allocation of resources
5)monopoly suppliers may be in a better position to respond to unfair competition in foreign markets
6)monopoly firm/industry can be regulated
7)monopoly may follow and alternative objective which may improve the allocation of resources. (Revenue maximising leads to a lower price and a higher quantity

Question 15

What are the disadvantages of monopolies?

Answer 15

1) a profit maximising monopoly sets a higher price than would be the case in a market with perfect competition
2) a profit maximising monopoly supplies a lower quantity than would be the case in perfect competition
3) unlikely to be allocative efficiency due to profit maximising
4)unlikely to be productive efficiency
5)x inefficiency is more likely. Barriers to entry reduce competitive pressure to keep costs under control
6) there may be less drive to innovate in market with high monopolistic regulations. Restriction on dynamic efficiency
7) monopoly may get too big - may be diseconomies of scale
8)regulators may choose to regulate in the best interest of the monopoly. Industry insiders being employed as regulators.

Question 16

What are some examples of natural monopolies?

Answer 16

Common in industries where a significant level of fixed physical capital infrastructure is required to produce output:
-Rail tracks and networks
-National grid for electricity
-Water supply

Question 17

What is meant by technical efficiency ?

Answer 17

The ability to produce the maximum output from a given set of inputs, or to produce a given output with the minimum necessary inputs, without any waste

Question 18

What is a natural monopoly?

Answer 18

A monopoly that arises in an industry in which there are such substantial and continuing economies of scale that only one firm is viable

Question 19

What does a barrier to entry mean ?

Answer 19

A restriction to a seller, or buyer from participating in a market