1.5.3. Monopoly (HL only)

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    Definitions

     

    1. Monopoly is a market form where there is only one firm supplying the market, so the firm is the industry. Monopolies have high barriers to entry, enabling them to make abnormal profits in the long run.
    2. Barriers to entry are obstacles in the way of potential newcomers to a market, such as huge economies of scale, brand loyalty and legal protection.
    3. Natural monopoly is said to exist if the market size in relation to the available production technology is such that two firms cannot profitably exist. There are only enough economies of scale available in the market to support one firm.

     

    Assumptions of the model

    • Only one firm producing the product.
    • The firm is the industry.
    • Barriers to entry exists.
    • Monopolists make abnormal profits in the long run.

     

    Sources of monopoly power/barriers to entry

     

    1. Economies of scale

    • A large monopoly experiences economies of scale.
    • A new firm would be making losses if they enter a market where it is a monopoly as the production costs would be higher.

    2. Natural monopoly

    • Occurs when there is only enough economies of scale to support one firm in the industry.
    • When another firm enters the industry, they would take the demand from the monopolist and the monopolist’s demand curve shifts to the left.
    • Will only result in abnormal profits for firms.

    3. Legal barriers

    • A firm might have legal right to be the only firm in the industry.
    • Examples include patents, copyrights and trademarks.

     

    4. Brand loyalty

    • Monopolist produced a product that has gained brand loyalty.
    • New firms won’t be able to compete as the loyalty to one firm is too strong.

     

    5. Anti-competitive behavior

    • Monopolists might make legal or illegal moves to be the only firm in the market, such as reducing their price very low to remove new firms from competition.

     

    Profit Maximization

    • Happens where MC = MR.

    Revenue maximization

    • Happens where MR = 0.

     

    Movement from short run to long run in monopoly

     

    1. Short term normal profit to abnormal profit

    • When firms get discouraged from selling in a particular industry as they aren’t earning revenue due to high production costs, they tend to leave the market, so this shifts the supply curve to the left.
    • This causes the profit for the market to increase, so the industry is making abnormal profit.

     

    2. Short term losses to abnormal profit.

    • Same scenario as normal profit.

     

    Productive and allocative efficiency

    • Productive efficiency is where MC = MR.
    • Allocative efficiency is where MC = AR.

     

    Advantages of monopoly compared to perfect competition

    • Monopolies have large economies of scale because of their size
    • There will be higher levels of investment in research and development.

     

    Disadvantages of monopoly compared to perfect competition

    • Productively and allocatively inefficient.
    • Charge a higher price for lower level of output.
    • Exercise anti-competitive behavior to keep their monopoly power.