Theory of Monopoly - Unit 3 (AQA)

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Economics ­ Theory of Monopoly (12/9/12)
Theory of Monopoly
Definition = One firm makes up the total market and no other firms are able to enter the
industry
The firm is the `industry' ­ this one firm produces the whole output of the industry
Barriers to entry ­ No other firm can enter into the market
The firm is a `Price Maker' ­ They cannot charge a price that consumers cannot bear
though
Barriers to Entry:
Incumbent Firm (Existing Firm) has exploited economies of scale ­ They can produce
at a lower cost than a new would-be entrant into the market could ­ They could `limit
pricing' if need be to threaten any potential new entrants
Government Nationalised Industry ­ The One firm has been granted with a charter
that prevents competition by law
Patent Laws & Copyright ­ Designer of the product has the sole right to the invention
for a set number of years
Incumbent firm can create very high fixed costs ­ Make it very expensive for new
entrants ­ If the costs are `sunk costs' and unlikely recoverable if the firm leaves the
industry this makes it even more risky for new entrants ­ An example could be
advertising on a large scale (new firms don't stand a chance of competing with it)
Incumbent Firm has control of essential raw material ­ An example of this would be
local water companies; they own all of the water so no one else can enter the market
and sell it
Abnormal Profits are being made by the
monopoly (Economic Profit)
An allowance for normal profit is already
included in the Total Costs
The Monopoly can continue to make
Abnormal Profits as it is the only firm in the
industry and there are barriers to entry for
new firms to come in and correct the
situation

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Natural Monopoly:
Competition would be inefficient as it would increase costs
Example: Railways (competing rail lines would amplify costs and use scarce
resources, land, inefficiently)
Characteristics of Natural Monopolies:
Extremely high capital cost to set up
Duplication is unnecessary & wasteful
Minimum Efficient Scale does not occur until extremely high level of output ­ this is
because economies of scale do not appear to diminish in the foreseeable future
(costs seem to keep falling)
MC is falling in the Long-Run which is pulling
the LRATC…read more

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Are not productively or Allocatively efficient ­ no incentive to do so; no threat of a
new entrant undercutting (they may chose to be Allocatively efficient though)
Often achieve dynamic efficiency ­ they have an incentive to innovate as there is no
perfect knowledge
Price Discrimination:
Both Monopolists & Oligopolists may be in a position to Price Discriminate ­ Vary
prices according to the customer
Conditions for PD (See TTU sheet for more detail):
Vendor can control whatever is offers ­ There are no other…read more

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Examples = Electricity, Mobile Phones, Gas
Third Degree:
The same product or service is sold at different prices to different consumers
Consumers are split into different groupings based on; income, location, time, age
Examples = Train Fares, Cinema Tickets…read more

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