Platinum Business Academy

No 10, Vincent Joseph Mawatha,

Wattala, Sri Lanka Advanced Level Cambridge

Monopoly
1) Monopolies exist when there is a single seller/one firm in the market. They are identified as monopolist.
If a firm controls more than 25% of the market it is considered as monopoly. (Alern Anderton, 5th
edition, 2018)
2) The firm and industry is the same. Therefore the market demand curve and the firms demand curve is the
same, it is downward sloping from left to right.
3) Firms is a price setter or a quantity setter, they cannot do both at the same time.
4) In perfect competition P=AR=MR but not in monopoly P=AR but not MR. MR is always below AR.
This is because in order to sell more units, price has to be reduced; therefore additional income generated
keeps reducing.

• MR curve should be drawn ½ of AR curve, because MR is twice as steep as AR.

• TR increases and thereafter declines, because on order to sell more firms has to reduce the price.
• When MR is positive TR is increasing as elasticity is greater than one. When MR is negative TR is
decreasing as elasticity is less than one.
• A monopoly will never operate when elasticity is less than one because in such a situation MR is
negative. Costs are always positive, the intersection of MR and MC cannot occur under such
conditions. Therefore they operate when elasticity is greater than one

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Wasim Imtiasz
BA (Hons) Middlesex University (UK), CIMA passed finalist, ACCA finalist, Edexcel Dual HND in Business & Management +
Business & Human Resources (UK)
Platinum Business Academy
No 10, Vincent Joseph Mawatha,

Wattala, Sri Lanka Advanced Level Cambridge

5) Monopoly firms continue to maintain market power in the long run as there are barriers to entry. These
barriers prevent new firms from entering the market

Barriers to entry
a. Capital cost- capital cost such as buying a Lorry, plant is extremely expensive and may act as a
barrier. This capital cost varies from industry to industry. E.g. telephone wires, railway track etc.
b. Sunk cost- these are irrecoverable costs. If sunk cost is very high they act as a barrier but on the
other hand they might encourage the firms to enter the industry. E.g. advertising costs, fixed cost that
have no alternative use.
c. Economics of scale- results in a low average cost which acts as a barrier.
d. Legal barrier- the law may give the firms particular privileges. Patent right will prevent competitor
firm from producing a product for a given number of years after its invention. Similarly copy right.
The government may give firm exclusive rights of production. E.g. Issue of license to commercial
television companies.

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Wasim Imtiasz
BA (Hons) Middlesex University (UK), CIMA passed finalist, ACCA finalist, Edexcel Dual HND in Business & Management +
Business & Human Resources (UK)
Platinum Business Academy
No 10, Vincent Joseph Mawatha,

Wattala, Sri Lanka Advanced Level Cambridge

e. Marketing barrier- existing firms in an industry may be able to overcome very high barriers through
high spending on advertising and marketing which will result in strengthening the brand image. E.g.-
Tipex, Xerox
f. Natural cost advantage – some of the monopolist possess unique advantage since they own factors
superior to others. E.g. accessibility of quality raw materials, location and skilled workers.
• Swiss – Watches and Chocolates
• Sri Lanka - Tea
6) Monopoly is a short run profit maximiser. They produce an output level where MR=MC and in the short
run they will operate if the average variable costs are covered.
7) In the long run they will stop production if the total cost is not covered.

Abnormal Profit (Short run and Long run)

Abnormal Loss (Short run)

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Wasim Imtiasz
BA (Hons) Middlesex University (UK), CIMA passed finalist, ACCA finalist, Edexcel Dual HND in Business & Management +
Business & Human Resources (UK)
Platinum Business Academy
No 10, Vincent Joseph Mawatha,

Wattala, Sri Lanka Advanced Level Cambridge

Comparison of perfective competitive market with Monopoly in terms of price and
output

Evaluation – Potential Economic Benefits of Monopoly

The possible benefits of monopoly power suggest that the government and the competition authorities
should be careful about intervening directly in markets and try to break up a monopoly. Market power can
bring advantages both to the firms themselves and also to consumers and these should be included in any
evaluation of a particular market or industry.

• Research and development spending: Huge corporations enjoying big profits are well placed to fund
capital investment and research and development projects. The positive spill-over effects of research can
be seen in more innovation. This is particularly the case in industries such as telecommunications and
pharmaceuticals. This can lead to gains in dynamic efficiency and social benefits.
• Exploitation of economies of scale: Because monopoly producers often supply on a large scale, they may
achieve economies of scale – leading to a fall in average costs.
• Monopolies and international competitiveness: The British economy needs multinational companies
operating on a scale large enough to compete in global markets. A firm may enjoy domestic monopoly
power, but still face competition in overseas markets.

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Wasim Imtiasz
BA (Hons) Middlesex University (UK), CIMA passed finalist, ACCA finalist, Edexcel Dual HND in Business & Management +
Business & Human Resources (UK)
Platinum Business Academy
No 10, Vincent Joseph Mawatha,

Wattala, Sri Lanka Advanced Level Cambridge

SPEW
Here is a good way to remember some of the issues we have covered regarding monopoly, efficiency and
economic welfare

Service - does the lack of competition affect the quality of service to consumers?

Prices - how high are prices compared to competitive / contestable market

Efficiency - productive, allocative and dynamic

Welfare - what are the overall welfare outcomes? Is there a net loss of welfare in markets dominated by
businesses with monopoly power?

source: Ruth Tarrant

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Wasim Imtiasz
BA (Hons) Middlesex University (UK), CIMA passed finalist, ACCA finalist, Edexcel Dual HND in Business & Management +
Business & Human Resources (UK)
Platinum Business Academy
No 10, Vincent Joseph Mawatha,

Wattala, Sri Lanka Advanced Level Cambridge

A competitive industry will produce in the long run where market demand = market supply. Consider the
diagrams below. Equilibrium output and price is at Q1 and Pcomp on the left hand diagram and Pcomp and
Q1 on the right hand diagram. At this point, Price = MC and the industry meets the conditions for allocative
efficiency.

If the industry is taken over by a monopolist the profit-maximising point (MC=MR) is at price Pmon and
output Q2. The monopolist is able to charge a higher price restrict total output and thereby reduce welfare
because the rise in price to Pmon reduces consumer surplus.

Some of this reduction in welfare is a pure transfer to the producer through higher profits, but some of the
loss is not reassigned to any other agent. This is known as the deadweight welfare loss or the social cost of
monopoly and is equal to the area ABC.

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Wasim Imtiasz
BA (Hons) Middlesex University (UK), CIMA passed finalist, ACCA finalist, Edexcel Dual HND in Business & Management +
Business & Human Resources (UK)
Platinum Business Academy
No 10, Vincent Joseph Mawatha,

Wattala, Sri Lanka Advanced Level Cambridge

A similar result is seen in the next diagram which makes the assumption of constant long-run average and
marginal costs under both competition and monopoly. The deadweight loss of welfare under monopoly
(whose profit maximising price is P1 and Q1) is shown by the triangle ABC. The competitive price and
output is Pc and Qc respectively.

Anti-competitive behavior
➢ Dumping, where a company sells a product in a competitive market at a loss. Though the company loses
money for each sale, the company hopes to force other competitors out of the market, after which the
company would be free to raise prices for a greater profit.
➢ Exclusive dealing, where a retailer or wholesaler is obliged by contract to only purchase from the
contracted supplier.
➢ Price fixing, where companies collude to set prices, effectively dismantling the free market.
➢ Limit Pricing, where the price is set by a monopolist at a level intended to discourage entry into a
market.
➢ Tying, where products that aren't naturally related must be purchased together.
➢ Resale price maintenance, where resellers are not allowed to set prices independently.

7
Wasim Imtiasz
BA (Hons) Middlesex University (UK), CIMA passed finalist, ACCA finalist, Edexcel Dual HND in Business & Management +
Business & Human Resources (UK)
Platinum Business Academy
No 10, Vincent Joseph Mawatha,

Wattala, Sri Lanka Advanced Level Cambridge

Advantages and disadvantages of monopoly:

Advantages Disadvantages
Supernormal profit means: Supernormal profit means:
• Finance for investment to maintain competitive • Less incentive to be efficient and to develop new
edge. products.
• Firms can also create reserves to overcome short- • Existence of resources to protect market
term difficulties, giving stability to employment. dominance by raising barriers to entry.
• Funds for research and development.
These are important advantages in global markets.
Monopoly power means: Monopoly power means:
• Firms will have the financial power to match • Higher prices and lower output for domestic
large overseas competitors. consumers.
• Monopolies may also be a powerful • Reduced consumer surplus compared to a
counterbalance to a monopsony. competitive market.
Cross subsidisation (using profits from one sector to Cross subsidisation:
finance losses in another): • Resources might be wasted.
• May lead to an increased range of goods or • Cross subsidisation might occur when a
services. monopolist is predatory pricing or limit pricing.
• These goods or services might not have been
provided otherwise.
• E.g. the provision of services that are loss-making
but provide an external benefit, such as rural bus
services.
Price discrimination: Price discrimination:
• This may raise the firm’s total revenue to a point • This may raise producer surplus while reducing
where it allows the survival of a product or consumer surplus.
service.
• It can benefit some consumers who pay a lower
price.
Efficiency: Efficiency:
• Producers can take advantage of economies of • Monopolists do not produce at the most
scale, which lowers cost per unit – if this lowers productively efficient point of output.
prices then consumer surplus is higher than • Monopolies are not allocatively efficient.
competition. • Monopolists can become complacent and
• Marginal cost pricing (as practiced in perfect develop X-inefficiencies.
competition) can actually lead to huge losses, as
it does not cover fixed costs in declining cost
industries.
• There are few permanent monopolies and the
supernormal profit opportunities act as an
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Wasim Imtiasz
BA (Hons) Middlesex University (UK), CIMA passed finalist, ACCA finalist, Edexcel Dual HND in Business & Management +
Business & Human Resources (UK)
Platinum Business Academy
No 10, Vincent Joseph Mawatha,

Wattala, Sri Lanka Advanced Level Cambridge

incentive for rival firms to break down the
monopoly through a process of creative
destruction, i.e. breaking the monopoly by
product development and innovation, and
therefore bypassing barriers to entry.
Duplication: Duplication:
• Monopolies avoid the problems of duplication • Monopolies deny consumers the variety and
and wasteful advertising, and some industries choice which is available in competitive markets.
are natural monopolies.

Natural monopolies:
• Exist where an industry can only support one firm – typical where there are high sunk costs and large
levels of output are needed to exploit economies of scale.
• Introduction of competition by some government agency will not be possible in the long run – neither of
the competing firms would be able to obtain sufficient market share to ensure that it is best able to
exploit economies of scale.
• Exist in the supply of water, gas and electricity:
- High start up costs.
- High infrastructure costs.
- Costs of establishing a competing firm will outweigh any economic/social benefit that may
materialise.

Are there any examples in the real world?

Pure monopolies are almost as rare as perfectly competitive markets. The Post Office has a pure monopoly
in the market for sending letters. Otherwise, there are many monopolistic markets, put no pure monopolies.

The recently privatised utilities used to be monopolies. British Telecom used to be the only company that
supplied telephone services. It still has some monopolistic power, but the industry is now much more
competitive, especially with the threat from mobile phones. Water, gas and electricity all used to be pure,
state run, monopolies as well. There is now a lot of competition in the markets for gas and electricity, but
although the Water industry has been split up, some would say that the resulting firms are now regional
monopolies. This means that they have monopoly power over the area they serve, but not, any longer, over
the whole of the UK. See the Learn-It on privatisation for more detail.

9
Wasim Imtiasz
BA (Hons) Middlesex University (UK), CIMA passed finalist, ACCA finalist, Edexcel Dual HND in Business & Management +
Business & Human Resources (UK)
Platinum Business Academy
No 10, Vincent Joseph Mawatha,

Wattala, Sri Lanka Advanced Level Cambridge

10
Wasim Imtiasz
BA (Hons) Middlesex University (UK), CIMA passed finalist, ACCA finalist, Edexcel Dual HND in Business & Management +
Business & Human Resources (UK)