Features of Monopoly - the Features of Monopolistic Market

Monopoly Assumptions of a monopoly

• Imperfect knowledge: specialized information and production techniques are unavailable to potential producers.
• Unique product: no close substitutes.
• One large firm: the firm is the industry so has complete market share.
• High barriers to entry or exit: stops new firms entering, thus allowing abnormal profits in the long run.

Examples for monopoly include Microsoft, train lines and electricity providers. Sources of monopoly power

Economies of scale: these benefit monopolists as they have large firms, whereas new entrants would face higher average costs, as they cannot exploit bulk buying, specialisation etc., as much. Anti-competitive behaviour: monopolists adopt restrictive practices, legal or illegal. For instance they are in a strong position to start a price war. They would reduce their price to a loss making level which they would be able to sustain for a longer period of time than the new entrant.

Brand loyalty: consumers refer to the product as the brand, e.g. Hoover vacuum cleaners. Potential entrants believe that they cannot sufficiently differentiate themselves to generate strong brand loyalty.

Legal barriers: patents, copyrights and trademarks encourage invention in innovative products, as they can cause the firm to be protected from rivals, so it becomes a monopoly. The government can also grant individual firms to produce a certain product by nationalising its industry, e.g. postal service, and banning other entrants.

Natural monopoly: if there are only enough economies of scale to support one firm, if another firm entered, normal profits could not be made, let alone abnormal.

Possible profit situation in a monopoly

A firm can make abnormal profits in the long run because the effective barriers to entry prevent profits being competed away.

Producing at profit maximising level of output (MC=MR), but productive (MC=AC) and allocative (MC=AR) inefficient.

Monopolists do not always make profits as there may simply be no demand.

Revenue maximisation in a monopoly

Instead of profit maximising (MC=MR) the monopolist revenue maximises (MR=0). This is likely to please consumers as the price is less with greater output.

Disadvantages of monopoly:

• Lower competition – poor service/good, dated
• Lack of consumer sovereignty and choice
• High prices, anti-competitive behaviour
• Profits not invested – only employees benefit
• Diseconomies of scale – due to poor management
• Allocative and productive inefficient.

Advantages of monopoly:

• Avoids duplication and wastage of resources
• Benefits from economies of scale – large profits or lower consumer prices.
• Large profits to fund research and development – latest technologies improve efficiency
• Lower competition and advertising calls.
• Price discrimination
• Price discrimination: a producer sells identical products to different consumers at different prices. The price is not justified by a difference in cost.
• The producer must have price setting ability, so the market must be imperfect. It is therefore usually in a monopoly or oligopoly.
• Markets must be clearly separated to prevent consumers buying the product at the lower price and selling it on
• Consumers must have different price elasticities to be prepared to pay different prices.

First degree price discrimination: individuals pay different prices depending on their willingness to pay. Second degree price discrimination: individuals pay according to their consumption (utility companies). Third degree price discrimination: clearly separated markets for different prices charged.

Producers separate markets by:

• Time e.g. train
• Age e.g. cinema
• Gender e.g. football club
• Income e.g. lawyers
• Geographical distance e.g. DVDs
• Types of consumers e.g. market trader

Evaluation of price discrimination

Advantages for the firm:

• Consumer surplus eliminated – higher revenue from sales
• Producer produces more – economies of scale, lowering average costs and prices
• In the elastic market, competitors may be driven out – the firm undercuts them by using revenue from inelastic market to lower elastic prices.
• Makes use of spare capacity
• May increase research and development

Advantages to the consumers:

• Consumers of the elastic sector find prices more affordable
• Increasing total output makes products more available to more consumers

Disadvantages to the consumers:

• Any previous consumer surplus is lost
• Consumers with inelastic demand may have to pay ore – exploitation
• Increase revenue and competitive behaviour may allow a firm to gain monopoly power.