A2 UNIT 3

Ch-6 : Monopoly

6.1 Features

• The industry consists of one firm (single seller)

• The monopolist can set the price, or the output, but not both
• Supernormal profit in the long run
• High barriers to entry, e.g. limit pricing

While a pure monopoly is a firm with 100% of the market share, a firm may
be classified legally as a monopoly in the UK if it has more than 25%. These
types of firms are called statutory monopolies.

Barriers to Entry A monopoly may exist due to barriers to entry, which

prevent other firms from entering the industry. These may include:

• Limit pricing: The monopolist may be able to charge a price which

is low enough to discourage potential entrants. E.g. as the
monopolist is a large firm enjoying economies of scale, its average
cost will be lower. Therefore it can charge a price which is lower than
the new firm’s average cost, but still high enough for the monopolist
to make a supernormal profit.

• Technology: The monopoly may be protected by a patent, which

prevents other firms from using its technology. This can prevent new
firms from entering, as they are denied access to the technology.

• Sunk costs: An industry with high sunk costs will make it difficult
for new firms to enter, as these costs cannot be recovered. Examples
may include high expenditure on advertising, or purchase of
equipment with little or no resale value.

• Legal barriers: The government may prevent new firms from setting
up in certain areas, by denying planning permission. This could allow
existing firms such as a large supermarket to enjoy monopoly power.
6.2 Short Run

A monopoly can make supernormal profits in the short run, as shown

below.

Profit maximising output level is Q1 (MC=MR). Price = A = P1,

Average Total Cost = B. Total supernormal profit = P1ABC1 (shaded
area)

However, it is also possible for a monopoly to make losses in the short

run.

At the profit maximising output level (Q1), ATC>AR (average total cost
‘A’ is greater than the price ‘B’. The monopolist may however continue
production as it may hope to achieve supernormal profits in the long
run.
6.3 Long Run

In the long run, the monopoly can make supernormal profit. At profit
maximising output level Q1, AR>AC.

However, this output level is neither productively efficient (as it is not

producing at the lowest point of the average cost curve), nor allocatively
efficient (as it is not producing where AR = MC)

6.4 Natural Monopoly

A natural monopoly is a firm which enjoys large economies of scale in

an industry with high set up costs. A new firm entering the industry will
face very high average costs when they set up initially.

Examples include the telecom industry and water supply.

As the additional cost of providing the good/service to the customer is

very low, MC is below AC, and therefore average costs are always falling.
6.5 Advantages / Disadvantages of a Monopoly

The arguments in favour of a monopoly are:

• Supernormal profits can be used to finance high levels of research

and development, which can lead to better quality products.
• A monopolist is a large firm, which should be enjoying economies
of scale. This means its average costs are low, and could lead to
lower prices.
• A natural monopoly should not be broken down, as average costs
within the industry will rise, leading to higher prices for
consumers. It should be owned or regulated by the government.
• Price discrimination by a monopoly may allow low income groups
to consume a good or service at a lower price.

The arguments against a monopoly are:

• The firm may charge a higher price, as there is no competition.

Quality may also be low.
• Consumers have no choice, as there are no other firms to
choose from.
• The monopoly fails to achieve either allocative or productive
efficiency, and restricts output levels.
• Resources are wasted, as the monopoly may cross-subsidise
(use profits from one sector to finance losses in a less efficient
one)