Theme 3 Topic 4.5

Question 1

characteristics of monopolies

Answer 1

1. There is a single seller
2. There are no substitute products
3. The firm has complete market power and is able to set prices and control output
   This allows the firm to maximise supernormal profit in the short-run
   There is no long-run erosion of supernormal profit as competitors are unable to enter the industry
4. High barriers to entry exist
   One of the main barriers is the ability of the monopoly to prevent any competition from entering the market
   E.g. by purchasing companies who are a potential threat

Question 2

what does the UK CMA define a legal monopoly as

Answer 2

any firm having more than 25% market share.

it acts to prevent this from happening in most industries.

Question 3

concentration ratio of monopoly

Answer 3

CR1 = 100%

there is no differentiation between the firm and the market.

since it’s a price maker/setter it’s demand and revenue curves are downward sloping.

maximises profits as MC= MR

Question 4

what is price discrimination ?

Answer 4

when a firm charges a different price for the same good/service in order to maximise its revenue

there are different types (degrees) of price discrimination

Question 5

what is 3rd degree price discrimination ?

Answer 5

when a firm charges different prices to different consumers for the same good/service
e.g. rail fares are priced differently depending on the time of travel

markets are often sub-divided based on time, age, income and geographic location

some airline tickets charge higher prices to apple users customers as they have higher income

Question 6

3 conditions needed to be met for 3rd degree price discrimination

Answer 6

1. market power (need to be able to change prices and this works best when there are no substitutes)
2. changing PED (some consumers are willing to pay more so the firm can identify them and split the market into sub markets)
3. preventing tickets from being resold (must be able to prevent consumers from buying in the low price elastic sub market and reselling in the higher price inelastic market. the cost of separating markets should never exceed the additional revenue gained from charging different prices)

Question 7

total market diagram =

Answer 7

combination of sub market diagrams

total profit is also a combination (inelastic and elastic)

total revenue will increase in both markets.

the firm’s total profits are higher than if they had charged a single price to all customers

Question 8

benefits of 3rd degree price discrimination to consumers

Answer 8

1. price elastic consumers benefit as they take advantage of lower prices which increases consumer surplus.
2. some consumers gain as a higher price decreases demand. in some markets this increases consumer utility.

Question 9

costs of 3rd degree price discrimination to consumers

Answer 9

many price inelastic consumers loose our as they pay more which lowers consumer surplus

Question 10

benefits of 3rd degree price discrimination to producers

Answer 10

1. total revenue of producers increases so higher profits (assuming no change in costs)
2. firms increase produced surplus at the expense of lower consumer surplus

Question 11

costs of 3rd degree price discrimination to producers

Answer 11

setting up and enforcing price discrimination can increase AC.
costs of price discrimination shouldn’t outweigh the additional revenue gained.

Question 12

CMA vs the firm

Answer 12

CMA can limit monopoly power but the firm can take the regulator to court and convince them that the firms market power will benefit consumers.
this is possible theoretically, yet it doesn’t occur as the desire to profit maximise is greater.

Question 13

Advantage of monopoly power to a firm

Answer 13

1. Supernormal profits, generate finance for continued investment in technology and product innovation
2. Market power enables firms to increase its global competitiveness
3. economies of scale can increase lowering the average costs.
4. producer surplus increases
5. price discrimination can increase total revenue

Question 14

Disadvantage of monopoly power to a firm

Answer 14

1. lack of competition means reduced incentive to be efficient
2. cross subsidisation (using profits made from one product to the price of another) can increase inefficiencies
3. monopolies lead to a miss allocation of resources as P >MC
4. Due to a lack of competition, Innovation can lack effectiveness

Question 15

Advantages and disadvantages of of monopolies to employees

Answer 15

Supernormal profits can lead to higher wages and greater job security however, having only one supplier in the industry limited opportunity to change employers

Question 16

Advantage to consumers of having monopoly power

Answer 16

1. Product innovation due to firms supernormal profits may lead to better quality products
2. cross subsidisation can lower prices on some products that the firm provides
3. Prices may fall if firms pass on cost savings (due to EOS) in the form of lower product prices

Question 17

Disadvantages to consumers of having monopoly power

Answer 17

1. Lack of competition is likely to lead to higher prices as there are no substitute goods available.
2. There may also be no product innovation and worse quality goods.
3. Many experience worse customer service as the incentive to improve it is limited
4. cross subsidisation is likely to increase prices of some products offered
5. consumer surplus falls

Question 18

Advantage to a supplier of having monopoly power

Answer 18

Increased sales volume for some suppliers as they’re able to supply products that are distributed internationally with a secure contract

Question 19

Disadvantages to suppliers of having monopoly power

Answer 19

1. There is less competition for their products and a monopoly often has the power to dictate what price they will pay to suppliers. this is monopsony power
2. price may not be profitable in the long run.

Question 20

Natural monopoly

Answer 20

This occurs when the optimum number of firms in the industry is one

Question 21

What are natural monopolies due to?

Answer 21

1. Association infrastructure issues for example, delivery of utility services like water.
2. Significant costs when entering or leaving in industry such as sunk costs.
3. Ability of economies of scale this lowers prices for consumers. It makes sense to have one firm building five nuclear power stations as opposed to 5 firms as average costs will be lower.

Even one firm can’t achieve an output of the lowest AC were AC = MC (productive efficiency) more competition means higher AC increasing prices

Question 22

Which industries do natural monopolies mostly occur in, and who are they regulated by?

Answer 22

Occur in utility industries are regulated by the government to ensure consumers are not charged high monopoly prices.

Regulation is often by a maximum price for a price cap.

However, government failure may occur with regulation and the imposition of maximum prices.

Also there is a lot of disagreements about the level of profits natural monopolies should be allowed to make and this is a normative issue.