monopoly

Question 1

monopoly facts

Answer 1

• A pure monopoly occurs when there is only one firm in the industry.
• In the UK a firm is said to have monopoly power if it has more than 25% of the market share.
• A monopoly will need some barriers to entry to prevent new firms entering the market

Question 2

monopoly diagram

Answer 2

• A monopolist maximises profit where MR = MC
• Therefore it sets Price = Pm and Quantity = Qm
• Firm makes supernormal profit = (AR- AC) * Q

Question 3

monopoly disadvantages

Answer 3

• Allocative inefficiency because P > MC
• Productive inefficient because output is not at the lowest point on the SRAC curve.
• X inefficient because a monopolist doesn’t have incentives to cut costs, therefore AC curve is higher than it could be.
• Less choice for consumers – only one firm.
• Quality of product is likely to be worse because there are fewer incentives for a monopolist to develop new products and offer best possible service.
• A monopoly may also have monopsony power in employing workers and buying products. This means the firm can pay workers lower wages, e.g. supermarkets can pay farmers lower prices.

Question 4

monopoly advantages 1

Answer 4

1. Economies of scale - If the industry has high fixed costs and economies of scale, then a large monopolist can bring benefits of lower average costs. Economies of scale will occur most in industries with high fixed costs or scope for specialisation, e.g. airlines and car companies tend to have high-fixed costs and therefore there tends to be a small number of large firms.
2. International competition - A domestic monopoly may be necessary to compete internationally. For example, Corus is the only steel producer in the UK, but it faces competition from oversees competitors.

Question 5

monopoly advantages 2

Answer 5

3. Research and development - A monopolist can use its supernormal profits to invest in developing new products which may require high investment. This is very important for industries such as the pharmaceutical industry, without high profits they would be unable to develop new drugs.
4. Monopolies may be efficient - A firm may gain monopoly power because it is efficient and innovative, e.g. Google. A monopoly isn’t necessarily inefficient.

Question 6

Examples of Barriers to Entry 1

Answer 6

1. High fixed costs. This enables the incumbent firm to benefit from economies of scale. If a new firm entered the market it would have higher average costs.
2. Vertical integration. This occurs when a firm has control over raw materials and other supplies necessary for the good.
3. Legal monopoly. For example, a patent on an invention.
4. Advertising. If a firm engages in saturation advertising then consumers may develop very strong brand loyalty to a particular firm.

Question 7

Examples of Barriers to Entry 2

Answer 7

5. Being the first firm in the industry: For example, Microsoft was the first firm and, therefore, people usually buy Microsoft Office to obtain compatibility with every one else.
6. Predatory pricing. If an incumbent firm cuts price when a new firm enters the market, it may be able to force the new firm out of business and retain its monopoly power.
7. Geographical barriers. Some monopolies are based on geographical barriers, such as having access to diamond mines or even local monopolies, like motorway service stations.

Question 8

Monopsony

Answer 8

• This occurs where a firm has market power in employing workers or purchasing raw materials. The government is a monopsony employer of fireman - firemen don’t have many alternative employers.
• Often a firm with monopoly power in selling goods also has a degree of monopsony power in buying raw materials.

Question 9

Disadvantages of Monopsony Power

Answer 9

It means the firm has the market power to pay lower prices to suppliers than in competitive markets. For example, farmers have argued that supermarkets are able to use their monopsony buying power to squeeze selling prices lower, leading to lower profit for farmers.

Question 10

Competition Policy

Answer 10

Abuse of monopoly power is likely to be against the public interest. Therefore governments are concerned to intervene and protect the interests of the consumers. Anti competitive practices the government regulates include Collusive Behaviour and abuse of monopoly power

Question 11

Collusive Behaviour

Answer 11

• Price fixing. This occurs when competitors agree to increase prices together.
• Vertical price fixing. These are arrangements when firms supplying goods encourage the retailer to keep prices high.
• Collusive tendering. This is when firms agree to both put in high prices to win a contract and prevent price competition, e.g. the concrete industry in the 1980s was found guilty of collusive tendering.
• Agreements to limit output and split up the market.

Question 12

abuse of monopoly power 1

Answer 12

Chapter 2 of the 1998 Competition Act states it is illegal for a dominant firm to abuse its monopoly power. Firstly, the Office of Fair Trading (OFT) must investigate whether firms have a dominant position they will look at:
• National or regional market share. Usually a firm would have to have at least 40% of the market to be considered to be a dominant firm.
• The contestability of the market. If barriers to entry are low then the incumbent firm is unlikely to be dominant even with a high market share because new firms can enter if profits are high.

Question 13

abuse of monopoly power 2

Answer 13

If the firm is considered to be dominant then the OFT will look at abuses of monopoly power, these include:
• Charging excessively high prices; if firms are making high profits then this is an indication of abusing monopoly power.
• Predatory pricing.
• Vertical restraints. This involves the monopoly firm imposing prices or restrictions on its suppliers or retailers. For example, this could involve:
- Selective or exclusive distribution
- Tie in sales. E.g. if you buy a printer, the company will try and make you buy their own brand ink which is more profitable than the printer.

Question 14

abuse of monopoly power 3

Answer 14

If firms are found guilty of abusing monopoly power the OFT can act to penalise the firms:

1. OFT can fine firms 10% of annual turnover.
2. Make recommendations about the structure of the industry.

Question 15

How to overcome barriers to entry

Answer 15

Takeovers from outside / inside the industry
Growing markets
Increased overseas competition
Transfers of brand names between sectors of the economy in companies that differentiate their product offerings
technology changes

Question 16

Other sources to monopoly power

Answer 16

Number of competitors

Product differentiation

Question 17

Other reasons why the dominant position of monopolies may not last even without Gov intervention/competition policy:

Answer 17

• Monopolies – if they are really high profit, creates enough of a profit incentive for external firms to invest to overcome barriers to entry
• Patents run out though firms create new patents or attempt evergreening (extending patents)
• Globalisation and EU/trade blocks + Government trends towards deregulation = contestability and competition from imports, foreign firms e.g. Aldi, new entrants etc
• Tech/Internet - price comparison websites etc has created competitive markets – energy markets etc

Question 18

creative destruction

Answer 18

a term coined by Joseph Schumpeter in his work entitled “Capitalism, Socialism and Democracy” (1942) - new industries/tech develops and kills off old markets e.g. smartphones killed old phones – Nokia. Kodak killed by smartphone cameras. Kodak had a dominant market position in the camera industry – a monopoly (not a pure monopoly 100%)