Monopoly

Question 1

Define a monopoly

Answer 1

• a market structure in which there is a single seller
• there are no substitute products
• the firm has complete market power and is able to set prices and control output
• able to maximise supernormal profits which in the short run: operate at MC=MR
• high barriers to entry (they buy companies who are a potential threat)
• a firm with more than 25% market share
  There is no differentiation between the firm and the industry; they are price makers

Question 2

Outline the diagram of a monopoly at a profit maximising equilibrium

Answer 2

(Same as a collusive oligopoly diagram)

Axis:
Y: costs/rev/profit
X: output

Curves:
MR, AC,MR, downward sloping D=AR

Plots
Q1: MCxMR, up to D=AR
C1: Q1 to AC
P1: Q1 to D=AR

Question 3

Outline the advantages of a monopoly

Answer 3

• supernormal profits generate money for continued investment in technology and product innovation (dynamic efficiency)
• increased product innovation may result in a better quality product
• market power enables the firm to increase it’s global competitiveness
• price discrimination can increase revenue
• supernormal profits can result in higher wages
• cross subsidisation can lower prices on other products the firm provides
• prices may fall if firms pass on their cost saving to consumers
• increased sales volume for some suppliers

Question 4

Outline the disadvantages of a monopoly

Answer 4

• due to lack of competition, there is reduced incentive to be efficient
• there is a misallocation of resources as P>MC (as the price is above the opportunity cost of providing the goods)
• a lack of competition is likely to result in higher prices and no product innovation as no substitute goods are available, this may worsen the product quality over time
• may experience worse customer service as the incentive to improve is limited
• cross subsidisation is likely to increase prices on some products offered by the firm
• consumer surplus decreases

Question 5

Define price discrimination

Answer 5

When a firm charges a different price for the same good/service to maximise its revenue

Question 6

Outline the conditions required for price discrimination to occur

Answer 6

• market power
• varying consumer price elasticity of demand (some consumers must be willing to pay more than others)