Download these notes and other resources at https://WeAreQurious.com/Economics Teaching, learning and revision notes for Monopoly in A-Level Economics and IB Economics for all exam boards (Edexcel, AQA, OCR, Eduqas).

1. Monopoly
GCE A-LEVEL & IB ECONOMICS

2. Lesson Structure
◦Monopoly
◦ Assumptions
◦ Diagrams & Analysis
◦ Evaluation
◦ Natural Monopoly
◦ Government Intervention on Monopoly

3. Monopoly
Definition: When there is only one firm operating in the market/industry
(pure monopoly)
Most US state courts define firms have monopoly powers when they have 50%+ market share in a
geographic region

4. Monopoly
Monopoly Assumptions:
- Imperfect knowledge, potential firms do not have techniques to replicate production
- No close substitutes
- One firm in the industry with total market share
- High barriers to entry or exit, restricting new entrants and allows for abnormal profits
- Price maker, sets the price in the industry/market

5. Possible Barriers to Entry in a Monopoly
◦ Economies of scale
◦ Very low average costs due to high existing output, making new entrants difficult to compete
◦ Natural monopoly
◦ Upfront investment / fixed costs may be so large such that it is unprofitable for other
companies to incur the same costs e.g. building the same railway (in this case, AR > LRAC only
for one firm)
◦ Legal and technical barriers
◦ e.g. patents, copyrights for technology/creative industries

6. Possible Barriers to Entry in a Monopoly
◦ Brand loyalty
◦ If there have always been one firm in the industry and consumers may be reluctant to switch
to new entrants
◦ Anti-competitive behavior
◦ Limit pricing and predatory pricing (when monopolies deliberately lower their prices to fend
off competition)
◦ Ownership/Control of resources
◦ e.g. diamond mines, DeBeers

7. Examples of Monopolies

8. Revenues Under Monopolies
Under these assumptions, the firm
revenue/demand curve will be equal
to industry demand. Why?
Because there is only one firm in the
market with total market share. This
means the firm is a price-maker.
D = AR
Output0
Price/
Revenue
MR

9. Monopoly Diagram
Given the market power of a
monopoly which allows it to set
prices, how much output should a
monopoly produce and at what price?
AR
MR
Price
OutputQ10
MC
AC

10. Monopoly Diagram
How will profit maximization by a
monopoly affect society?
AR
MR
Price
OutputQ1
P1
0
MC
AC
C1

11. Monopoly Diagram – Welfare Loss
Recall the AR curve is the industry
demand curve.
The part where MC is higher than AC is
the industry supply curve. (As firms only
produce if they make normal profits, and they
need to cover the cost of each additional unit
of production to make more)
Hence according to demand and
supply, the efficient/competitive
market equilibrium will be at point A. AR=D
MR
Price
OutputQM
PM
0
MC=S
AC
PE
QE
A
B

12. Monopoly Diagram – Welfare Loss
However, when a monopoly maximizes
profits, they produce at QM, and
charge at PM.
Compared to producing at QE and PE,
they are restricting supply and
charging a higher price.
This causes a loss of consumer and
producer surplus that could have been
gained (shaded area).
AR=D
MR
Price
OutputQM
PM
0
MC=S
AC
PE
QE
A
B

13. Monopoly Diagram – Welfare Loss
AR=D
MR
Price
OutputQM
PM
0
MC=S
AC
PE
QE
AR=DMR
Price
OutputQM
PM
0
MC=S
AC
PE
QE
A
B
Surplus that could
be gained
Surplus under
profit maximization
B
A

14. Monopoly Diagram – Welfare Loss
Hence, monopolies result in a welfare loss
(deadweight loss) of the shaded
triangular-like area where it is not gained
by either the consumer or producer.
AR=DMR
Price
OutputQM
PM
0
MC=S
AC
PE
QE

15. Monopoly Diagram – Welfare Loss
Draw the monopoly diagram and try to label:
- Price and quantity the monopoly will produce at
- The profits and costs of the monopoly
- Deadweight loss of society

16. Imperfect Competition – Profit and Loss
AR
MR
Price
OutputQ10
MC
AC
AR
MR
Price
OutputQ10
MC
AC
AR
MR
Price
OutputQ1
P1
0
MC
AC
P1 = C1P1
C1
C1

17. Imperfect Competition – Profit and Loss
AR
MR
Price
OutputQ10
MC
AC
AR
MR
Price
OutputQ10
MC
AC
AR
MR
Price
OutputQ1
P1
0
MC
AC
P1 = C1P1
C1
C1
Loss Normal
Profits
Abnormal
Profits

18. Monopoly Diagram – Sales Maximization
However, a monopoly may not have
the objective of maximizing profits.
One possibility is when monopolies
maximize revenues instead. At what
quantity will the monopoly produce if
that is the case?
AR=DMR
Price
OutputQM
PM
0
MC=S
AC
PS
QE
Sales
Maximization

19. Monopoly – Advantages/Disadvantages
Advantages
◦ Economies of scale
◦ Very low average costs can be enjoyed by
monopolies due to their large output and
market share. This gain then be passed on
to consumers through lower prices
◦ Abnormal profits can be made for
research and development
◦ This allows for product innovation which
can increase consumer welfare
significantly in the long run (dynamic
efficiency).
Disadvantages
◦ Welfare loss and inefficiency
◦ Monopolies are fundamentally inefficient
when they are assumed to maximize profits
according to theory.
◦ No incentive to control costs
◦ Due to a lack of competition, there is no
incentive for monopolies to keep costs low
(X-inefficiency).
◦ Lack of choice
◦ Similarly, there is no need for a monopoly to
innovate and create new and better products
since what they are producing is assumed to
be unique without close substitutes.

20. Evaluation of Monopolies
◦ Can the benefits of Economies of Scale and R&D be passed onto consumers?
◦ Shareholders and managers of the firm has control over R&D and prices of the firm. Their
business objectives and incentives impacts the behaviour of the firm (e.g. profit maximization
or not-for-profit copmany?)
◦ Will gains from Economies of Scale or R&D be so significant that it outweighs having
competition / welfare loss in the industry?
◦ Monopoly with gov. intervention/regulation – best of both worlds?
◦ Can the government get the regulation right? How would they implement it?
◦ Natural monopolies
◦ Of course there is also the case of naturally occurring monopolies which is difficult to
avoid. This happens when there is greater cost to society if significant investment and
infrastructure is duplicated, and it may not be profitable for the new entrant.

21. More on Natural Monopolies

22. More on Natural Monopolies
AR=DMR
Price
OutputQM
PM
0
LRMC
LRACCC
Natural Monopoly
In the long run, a natural monopoly will
maximize profits and produce at QM. They will
receive supernormal profits of the yellow area.
If another firm enters into the market, the
quantity produced in the market will increase
from QM to QC. The market will become
competitive and operate at point A, where
AR=MC (Demand = Supply). However, at this
point both firms will operate with a loss of the
red area. Hence, the new entrant will decide
not to enter the market.
The significant fixed/investment costs acts as a
barrier to entry for a natural monopoly.
A
PC
CM
QC

23. More on Natural Monopolies
◦ Challenging the concept of natural monopolies...
◦ Can’t multiple firms operate using the same infrastructure? The gov. can cover the
infrastructure costs.
◦ Real life examples:
◦ Telecommunications companies using the same network... O2 and Giffgaff (although only
some uses optic-fiber)
◦ What about railways? Train operating companies bid competitively against each other to
manage particular routes. Did you know MTR (Hong Kong railroad operator will manage the new Crossrail?)

24. How Do You Tame a Monopoly?
???

25. How Do You Tame a Monopoly?
◦ Regulation & Legislation
◦ Banning abusive behavior by a firm dominating a market (e.g. limit pricing)
◦ Prohibiting agreements that restrict free trading (e.g. collusion)
◦ Supervising the mergers and acquisitions of large corporations
◦ Trade liberalisation
◦ Allow or encourage national/global competitors to enter the market (e.g. via subsidies,
deregulation, removal of trade barriers)
◦ This lowers barriers to entry and fosters competition

26. How Do You Tame a Monopoly?
◦ Nationalisation
◦ i.e. State-owned firms. There is no monopoly if the state owns the company... Right?
◦ More common for natural monopolies if government injected substantial amount of money
◦ A state-owned monopoly will not “maximize profits” and cause welfare loss (allocative inefficiency)
by restricting output and charging a high price
◦ But still gives rise to other inefficiencies due to lack of incentive?

27. Short Questions - Monopoly
- Draw out the monopoly diagram (no need to include surplus and competitive
equilibrium)
- Suggest 2 assumptions & 3 potential barriers to entry under a monopoly
- How does a monopoly cause welfare loss? How do they decide how much to
produce?
- What are 2 advantages and 2 disadvantages of a monopoly?
- What are 2 ways which a monopoly can be managed?