Monopoly

This section explains monopolies, including: Characteristics of Monopoly, Profit Maximising Equilibrium, Costs and Benefits of Monopoly to Stakeholders and Natural Monopoly.

A monopoly is a market structure in which a single firm dominates the market. While monopolies can lead to productive inefficiencies and higher prices, they may also generate benefits through economies of scale and dynamic efficiency.

Characteristics of Monopoly

• Single seller: One firm dominates the market — typically over 25% market share in UK competition law.
• High barriers to entry: Legal, technological, financial, or strategic obstacles prevent new firms entering.
• Price maker: The firm has significant control over price due to lack of competition.
• Unique product: No close substitutes are available.
• Profit maximisation: The firm aims to maximise profit where marginal cost (MC) = marginal revenue (MR).

Profit Maximising Equilibrium

A monopoly maximises profit at the output where MC = MR. The corresponding price is set on the demand (AR) curve. Due to lack of competition, price is greater than MC, leading to allocative inefficiency.

Diagrammatic Analysis

• Downward-sloping AR and MR curves.
• U-shaped MC and AC curves.
• Profit-maximising output where MC = MR.
• Price found on the AR curve above this output.
• Area between AR and AC at this quantity represents supernormal profit.
• Illustrates productive and allocative inefficiency.

Third-Degree Price Discrimination

Necessary Conditions:

• The firm must have market power.
• Different consumer groups must have different price elasticities of demand.
• Market separation: The firm must be able to prevent resale (e.g., student vs adult tickets).

Diagrammatic Analysis:

• Separate MR = MC condition for each group.
• Higher prices charged to inelastic consumers, lower prices to elastic consumers.
• Firm maximises total profit by charging different prices in each market.

Costs and Benefits:

To Producers:

• Increases revenue and total profit.
• May improve efficiency through increased output.

To Consumers:

• Some pay lower prices (benefit).
• Others pay higher prices (loss).
• May allow services/products to be provided that wouldn’t be viable otherwise (e.g., off-peak transport).

Costs and Benefits of Monopoly to Stakeholders

Firms:

• Benefit from supernormal profits, economies of scale, and less risk of failure.
• Lack of competition may lead to X-inefficiency and complacency.

Consumers:

• Face higher prices, less choice, and potential exploitation.
• However, may benefit from innovation and long-term investment.

Employees:

• May enjoy greater job security in a profitable firm.
• But lack of competition could reduce pressure for wage growth or working conditions improvement.

Suppliers:

• May benefit from large, stable orders.
• Could suffer from monopsony power if the monopoly has bargaining dominance.

Natural Monopoly

A natural monopoly arises when a single firm can supply the entire market at a lower cost than multiple competing firms, due to extensive economies of scale.

• Typical in utilities (e.g., water, electricity).
• High fixed costs and low marginal costs.
• Duplication of infrastructure is inefficient.
• Natural monopolies are often regulated to ensure fair pricing and protect consumers.

Summary

While monopolies can result in higher prices and reduced efficiency, they may also allow for greater innovation, dynamic efficiency, and cost-effective production under certain conditions. Understanding the trade-offs is crucial for evaluating their overall economic impact.