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Monopoly Notes - A-level & IB Economics
The document outlines the structure and analysis of monopolies in economics, including their definitions, assumptions, and diagrams for maximizing profits and understanding market power. It discusses potential barriers to entry, the impact of monopolies on consumer welfare, and the evaluation of their advantages and disadvantages. The document also addresses government interventions and regulation strategies to manage monopolies, particularly natural monopolies.
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Monopoly Notes - A-level & IB Economics
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- 2. Lesson Structure ◦Monopoly ◦ Assumptions ◦ Diagrams & Analysis ◦Evaluation ◦ Natural Monopoly ◦ Government Intervention on Monopoly
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- 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
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- 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
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- 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 behaviourof 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.
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- 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?)
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- 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?