A market where one firm dominates the market for a good that has no substitutes and where significant barriers to entry exist.
- There is only one seller (price maker)
- The product is unique, there are no substitutes
- There are very high barriers to entry into and exit (high setting up cost) from the market
- Firms outside the market will lack perfect information
Barriers to entry
A range of obstacles that deter or prevent new firms from entering a market to compete with existing firms. (so, there is no difference between short-run and long-run)
- High fixed cost or setup cost
- Advertising and brand names with a high degree of consumer loyalty
- Economic of scale
- The pace of product innovation
- Collaboration between existing producers to develop new products may act as a barrier
- Profit-maximising monopolist would choose the output where MC = MR.
- If the total revenue is higher than the production costs, it will make abnormal profit. This will be a permanent feature.
- In monopoly, there is no distinction between the short run and the long run because of the barriers that prevent the entry of competitors.
- There is no economic incentive for the monopolist to move away from the profit-maximizing output Q
A firm that has economies of scale so large that it is possible for the single firm alone to supply the entire market at a lower average cost than two or more firms. It occurs in a market where the lowest costs can be achieved when only one firm sells to the market. It is typically associated with large fixed start-up costs.
If the market demand for a product is within the range of falling LRATC, this means that a single large firm can produce for the entire market at a lower average total cost than two or more smaller firms. When this occurs, the firm is called a natural monopoly.
If new firm B enter the market, the market demand will be divided by firm A and B. Thus, the demand curve for firm A will be shifted leftward.
Outcomes of monopoly
- Higher price and lower output
- Allocative inefficiency (MC is not equal to AR, loss of consumer and producer surplus)
- Productive inefficiency (production at higher than minimum ATC) a. Lack of competition in monopoly may lead to higher cost (X-inefficiency: producing at higher than necessary ATC) due to poor management, a poorly motivated workforce, lack of innovation and use of new technologies.
Legislation (government can force the firm to charge a price equal to its average total cost)
- To promote competition by preventing collusion between oligopolistic firms.
- To manage and control mergers
- To ensure more socially desirable price and quantity outcomes
- The laws themselves may be vague, allowing much room for different interpretations
- Laws in particular country may be enforced to varying degrees.
- It is difficult to discover evidence of the collusion and to prove it
Nationalization (State ownership)
Trade liberalization (introduce foreign competitors)
Privatization (Encourage competition)
Situations which government should NOT control the monopoly power
- Natural monopolies (some are state-owned & do not aim to maximize profit)
- Ability to achieve economies of scale may lead to lower unit cost and price than a competitive industry
- Monopoly profits as a source of funds for investment / research & development
- They need to keep innovating to maintain economic profit
- Protect intellectual property right
- Protection of strategic industries against foreign competition
- Provision of otherwise profitable goods through price discrimination
Situations which government should control the monopoly power
- Abuse of monopoly power: higher price and lower output
- Less choice for consumers
- Abnormal profits are not justified
- Lack of competition: leads to lower incentive to improve & to innovate
- Allocative & productive inefficiency & misallocation of resources
Evaluation of monopoly compare to perfect competition market
- Ability to finance R&D
- Possibility of substantial Eos
- Higher price & lower output
- Lack of allocative & productive efficiency
- Lack of competition