Monopoly

State using examples, the assumed characteristics of a monopoly

a single or dominant firm in the market; no close substitutes; significant barriers to entry e.g AT&T

Summarize problems associated with monopolies and not perfect competition

They are productively and allocatively inefficient. They can charge a higher price for a lower level of output. They can exercise anti-competitive behaviour to keep their monopoly power.

What is a natural monopoly (+examples)?

An industry is a natural monopoly if there are only enough economies of scale available in the market to support one firm.Examples of natural monopolies include the industries that supply utilities such as water, electricity, and gas

Define barriers to entry

Barriers to entry are defined as the characteristics of a market that make it difficult for firms to enter the market

Abnormal profits in the long run + short run in monopoly

If a monopolist is able to make abnormal profits in the short run, and if the monopolist has effective barriers to entry, then other firms can't enter the industry and compete away the profits that are being earned. In this situation, the monopolist is able to make abnormal profits in the long run (PabC), for as long as the barriers to entry hold out. Without the entry of new firms to the industry this situation will continue.

The disadvantages of monopoly in comparison with perfect competition

If significant economies of scale do not exist in a monopoly, then the monopoly may restrict output and charge a higher price than under perfect competition. There are no differences in costs for the monopolist and the perfectly competitive market. If this is the case, then the monopolist will produce Q2 at a price of P2 , where MC = MR. The perfectly competitive market will, however, produce Q1 at a price of P1 , where industry supply meets industry demand. Thus higher prices and lower output would exist under monopoly. The high profits of monopolists may be considered as unfair, especially by competitive firms, or those on low incomes. The scale of the problem depends upon the size and power of the monopoly. The monopoly profits of your local post office may seem of little consequence when compared to the profits of a giant national company. These potential problems mean that monopolies can act against the public interest.

A monopolist making losses in the long run + short run

If the monopolist produces something for which there is little demand, then it will not earn abnormal profits. If a monopolist were making losses in the short run, then it would have the option of closing down temporarily (if it was not covering its variable costs) or continuing production for the time being. However, it would plan ahead in the long run to see whether changes could be made so that normal profits, at least, could be earned. If this were not possible, then the monopolist would close down the firm and, since the firm is the industry, the industry would cease to exist. Here, the firm is not able to cover costs in the long run, since the average cost is greater than the average revenue at all levels of output. Since there is nothing that can be done to rectify the situation, this will be an industry in which no firm will be willing to produce. There will be no industry.

Explain, using a diagram, the output and pricing decision of a revenue maximizing monopoly firm.

Instead of maximizing profits, and producing where MC=MR, the monopolist will produce where MR = 0 (see cost #4 and explanation). This means that the monopolist will reduce price from PPM to PRM and at the same time increase output from qPM to qRM. The revenue maximizing level of output is clear from a diagram, since it is the level of output where the MR curve cuts the horizontal axis

The advantages of monopoly in comparison with perfect competition

Monopolies may be able to achieve large economies of scale because of their size. If this pushes the MC curve down, then it is possible that the monopolist may produce at a higher output and at a lower price than in perfect competition (this idea is debateable) In perfect competition, the equilibrium price and quantity will be where demand=supply or P1,Q1. However, if the industry is a monopoly, with significant economies of scale, then the MC curve may well be substantially below the MC curve in perfect competition, which is the industry supply curve.f this is the case, then the monopolist will produce where MC=MR, maximizing profits and producing a greater quantity than perfect competition, Q2 , at a lower price, P2. Firms in perfect competition are relatively small so may find it difficult to invest in research and development. However, a monopolist making abnormal profits is in a better situation to use some of those profits to fund research and development. This would, in the long run, benefit consumers, who would have better products and even more choice.

Explain why a monopolist will never choose to operate on the inelastic portion of its average revenue curve.

Overall, the key points are: -> Profit maximizing output is determined by MC and MR intersect not elasticity ->Inelastic region of the demand curve is associated with lower prices and greater quantities that would not maximize profit ->Profit maximizing occurs in the region where MR is positive. Note: during a session a monopoly graph would be shown with points, curves and regions on display

Examine the role of barriers to entry in permitting the firm to earn economic profit (abnormal profit).

Since others cannot enter the industry due to barriers to entry, a monopoly firm's profits cannot be competed away and it can continue to make an abnormal profit in both the short and long run.

What is the average revenue curve for a monopoly

The average revenue curve for a monopolist is the market demand curve, which will be downward sloping. Know the relationship between demand, average revenue and marginal revenue in a monopoly. A monopolist will never choose to operate on the inelastic portion of its average revenue curve because he/she will lose profits.

Draw and explain a natural monopoly

The monopolist is the industry and has the demand curve D1 . The long-run average cost curve faced by the monopolist is LRAC and its position and shape are set by the economies of scale that the firm is experiencing. The monopolist is able to make abnormal profits by producing an output between q1 and q2 , because the average revenue is greater than the average cost for that range of output. If another firm were to enter the industry, then the firm would take demand from the monopolist and the monopolist's demand curve would shift to the left to D2 . The two firms would now be in a position where it is impossible for them to make even normal profits. Their LRACs would be above AR at every level of output. In this industry, the LRAC, which is shaped by the economies of scale experienced by the monopolist, will only give an abnormal profit if the monopolist is able to satisfy all of the demand in the market.

The demand curve and the profit-maximizing level of output in monopoly

The monopolist is the industry and so the monopolist's demand curve is the industry demand curve and is downward sloping. The monopolist can therefore control either the level of output or the price of the product, but not both. In order to sell more they must lower their price. The monopolist has a normal demand curve, with marginal revenue below it, and maximizes profit by producing at the level of output where marginal cost is equal to marginal revenue. We can see that, in this case, the monopolist sells a quantity q at a price per unit of P.

Explain, using diagrams, why the profit maximizing choices of a monopoly firm lead to allocative inefficiency (welfare loss) and productive inefficiency.

Unlike perfect competition, the monopolist produces at the level of output where there is neither productive efficiency nor allocative efficiency. The monopolist is producing at the profit-maximizing level of output, q. Output is being restricted in order to force up the price and to maximize profit. However, the most efficient level of output, q1 and the allocatively efficient level of output, q2 , are not being achieved.

Describe the barriers to entry

legal (e.g. pharmaceutical companies my have a monopoly over a certain drug by getting a patent forit) government granted monopoly (nationalized industry, e.g. water company) brand loyalty (extreme brand loyalty can cause the brand name to become the product, e.g. Scotch, Kleenex, Hoover etc.) anti-competitive behavior (a firm in a monopoly might charge restrictive prices to stop competition, there may be a price war to force out the new firm) natural monopoly (there is only space for one firm in the industry, e.g. MVG in Munich) economies of scale (these will work in favor of the firm in the monopoly and against firms trying to enter the market, for instance, banks may charge the new firms high interest on loans while the monopoly firm will enjoy financial economies of scale).