Study Notes

3.4.5 Monopoly (Edexcel)


Last updated 20 Sept 2023

This Edexcel study note covers monopoly.

a) Characteristics of Monopoly:

Monopoly is a market structure characterized by the following features:

  1. Single Seller: In a monopoly, there is only one firm or seller that dominates the entire market, with no close substitutes for its product.
  2. Unique Product: The monopolist typically offers a unique product that has no perfect substitutes. This lack of substitutes gives the monopolist significant control over pricing.
  3. High Barriers to Entry: Monopolies often maintain their dominant position due to high barriers to entry, which can include factors like patents, economies of scale, control over essential resources, and government regulations.
  4. Price Maker: A monopoly has the power to set the price of its product, and it faces a downward-sloping demand curve. It can choose the price and quantity of output to maximize its profits.
  5. Market Power: Monopolies have substantial market power, meaning they can influence market conditions, restrict output, and charge higher prices than would be possible in a competitive market.
  6. Long-Run Profitability: Monopolies can earn long-term economic profits because of their ability to set prices above their production costs.

b) Profit Maximizing Equilibrium:

In a monopoly, the profit-maximizing equilibrium occurs where marginal revenue (MR) equals marginal cost (MC). The steps to find this equilibrium are as follows:

  1. Determine the monopolist's marginal cost curve (MC).
  2. Calculate the marginal revenue curve (MR) by finding the change in total revenue resulting from a one-unit change in output.
  3. Identify the quantity of output where MR = MC. This is the profit-maximizing quantity (Q*).
  4. Determine the price (P*) at which the firm will sell this quantity by locating it on the demand curve.
  5. The monopolist will maximize profit by producing Q* units of output and charging P* as the price.

c) Diagrammatic Analysis:

A diagram of a monopoly market typically shows the demand curve, marginal revenue curve, and marginal cost curve. The monopolist's profit-maximizing point is where MC intersects MR. The price is found on the demand curve corresponding to the quantity produced. Any difference between price and average total cost represents the monopolist's profit.

d) Third Degree Price Discrimination:

Third-degree price discrimination involves charging different prices to different groups of consumers based on their willingness to pay. Necessary conditions include:

  • Market Segmentation: The firm must be able to segment the market into distinct groups with different price elasticities of demand.
  • Price Discrimination: The firm must have the ability to charge different prices to each segment.
  • No Arbitrage: Resale between segments should be prevented or discouraged.

In the diagrammatic analysis, the firm will charge higher prices to the group with less elastic demand and lower prices to the group with more elastic demand. This maximizes the firm's total profit.

Costs and benefits to consumers and producers:

  • Benefits: Producers can capture more consumer surplus, potentially increasing profits. Consumers in the less elastic group benefit from lower prices.
  • Costs: Consumers in the more elastic group pay higher prices, which can lead to reduced consumer surplus.

e) Costs and Benefits of Monopoly:

  • Firms: Monopolies can earn significant profits in the long run, but they may face regulatory scrutiny and risk of government intervention.
  • Consumers: Consumers may face higher prices, limited choices, and reduced consumer surplus.
  • Employees: Monopolies may offer job security but can also reduce competition in labor markets, potentially impacting wages.
  • Suppliers: Suppliers may have limited bargaining power and face pressure to offer lower prices.

f) Natural Monopoly:

A natural monopoly occurs when a single firm can efficiently serve the entire market due to significant economies of scale. Key features include:

  • High fixed costs relative to variable costs.
  • Declining average total cost as production scales up.
  • It is often found in industries like utilities (water, electricity) and infrastructure (railways, telecommunications).

Natural monopolies can benefit consumers by providing services at lower costs than multiple competing firms would achieve, but they require regulation to prevent potential abuse of market power.

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