Table of Contents
- Monopoly Assumptions of a monopoly
- Possible profit situation in a monopoly
- Revenue maximisation in a monopoly
- Disadvantages of monopoly:
- Advantages of monopoly:
- Producers separate markets by:
- Evaluation of price discrimination
- Advantages to the consumers:
- Disadvantages to the consumers:
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.