This document provides an introduction to monopoly market structures. It defines a monopoly as a single seller of a good or service with 100% market share. While pure monopolies are rare, the legal definition is 25% market share. Key assumptions of monopolies include a single seller facing downward sloping demand and no substitutes for its products. Monopolies are price makers that can earn supernormal profits in both the short-run and long-run by producing at the point where marginal revenue equals marginal cost. This results in allocative and productive inefficiency. The document also discusses types of monopolies such as legal, natural, and competitive monopolies.
3. Intro to Monopoly
Definition: A monopoly is defined as a market with a single seller of a good or service
Under this definition, we assume that a monopoly possesses 100% market share.
However, pure monopolies are actually very rare (how many firms do you know with absolutely no
competitors?).
Accordingly, the legal definition of a monopoly is a firm which holds a market share of 25% or more –
the focus is therefore on whether a firm has enough market power that it can act independently of its
competitors.
Assumptions:
Single seller, many buyers: The firm has market power as the firm is the sole market supplier
Downward sloping D curve – representing demand for both the firm and the market (the sole firm is the market!)
Firm is a price-maker
No substitutes for the firm’s products: Either actual or potential
Buyers must rely on the monopolist only
High Barriers to entry: difficult for new firms to enter the market for reasons such as:
Legal protection - patents, copyrights, trademarks, trade secrets
R&D - a sunk cost which keeps products hi-tech and difficult to imitate
Brand loyalty - especially through advertising (a sunk cost)
Very high fixed costs - potentially sunk costs
Profit maximisation: The monopolist will produce at the level of output where MR = MC
Result: The combined result is that the firm is totally insulated from any competition and
should therefore make supernormal profits in both the short-run and the long-run
5. Monopoly Equilibrium
Equilibrium: Not only can firms can make supernormal profits, but they will look to
profit maximise (green rectangle). The market price is above the firm’s average
cost.
The sole firm individually produces at the point where MC meets the MR (q),
charging price pMon at average cost cMon
Allocatively inefficient (P > MC) and Productively inefficient (c > AC min)
There is a deadweight loss present for a profit maximising monopoly! Total welfare is not
maximised.
Quantity
C/R
AC
MC
D = AR
MR
qMon
pMon
cMon
DWL
6. Dynamic Efficiency: Supernormal profits allow the monopolist to spend money on
R&D and on innovations
There may be a faster rate of technological development that will reduce costs and produce
better quality items for consumers
Dynamic Efficiency!
However: for firms to innovate, they must be assured that they will be the ones to profit
from their research
They need patents that provide legal protection of an idea or process and prevent other firms
from duplicating their work and taking some of the industry’s profit
Otherwise there will be limited R&D and dynamic efficiency
X-inefficiency: if a monopolist isn’t threatened by new entrants, they will have
little incentive to control their costs
Their profits aren’t at risk so why there is only limited gain to working hard to keep costs low
Organizational slack occurs as the firm can hide behind barriers to entry and is insulated to
competition.
Also there are links to divorce between ownership and control. Non profit maximising
behaviour of workers may also increase costs e.g. CEO flying on a corporate jet
However: if a monopolist thinks their will be greater competition in future they will seek to
keep their costs from growing, so as to be in a stronger position to fight potential competitors
8. Types of Monopoly
Legal Monopoly (I) – permanent: A continuous monopoly protected by law
Usually having been created by the Gvt
E.g. Royal Mail prior to privatisation
Illegal for any other firm to deliver packages weighing <350g or charging <£1 for postage
But in 2006 Royal Mail has lost its government protected monopoly
Legal Monopoly (II) – temporary: where firms have temporary barriers to entry
that protect their monopoly power
Often created by Intellectual property rights (IPRs): Patents, Copyrights & Trademarks
Gives the owner of the IPR a temporary monopoly over their particular invention, idea or
design
E.g. Pharmaceutical products or technology (Apple vs Samsung)
Local Monopoly: Where there is no practical alternative to using the available
supplier
E.g. Ben & Jerry’s at the cinema, Canteen and vending machines at school, etc
Competitive Monopoly: Where a monopoly has arisen from a firm’s own actions
E.g. Microsoft – anticompetitive practices following differentiated products (Windows)
9. Natural Monopoly: Where the economies of scale are so great that there is only room for
one supplier in the market:
Very high Fixed costs that are usually sunk costs too. This means AC falls continuously with output.
Negligible MC which also falls continuously with output but more importantly, MC is always below the
AC curve for any realistic level of output
A second firm in the industry would mean: An unnecessary duplication of FC and a Loss
of scale economies for both firms
This would mean higher AC than is necessary, and high prices for the consumer
Hence removing a natural monopoly is worse for society than letting the monopoly exist
Quantity
C/R
ARMR
MC
AC
qNMon
pNMon
cNMon
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