Monopoly

A monopoly is a market structure where a single firm dominates, so they can abuse their market power.

Legal monopoly - 25% market share
Economic monopoly - 40% market share

Monopoly diagram

Characteristics

  • Very high barriers to entry
  • Price makers
  • SNP in SR and LR
  • Profit maximiser
  • One firm dominates / very high concentration ratio
  • Large Economies of Scale
  • Likely to abuse market power

Examples

  • Tesco - legal monopoly
  • Microsoft
  • Blu-tac

Abuse of market power

A monopoly firm can use its market power to abuse various parties

Consumers

Raise prices above market equilibrium, since consumers have no alternative. They can also reduce output to create scarcity and raise the price of their product.

Rival firms

Lower prices below market equilibrium and make losses until the other firm is forced to leave the market

Suppliers

Refuse to buy raw materials unless they drop their prices - since suppliers depend on the firm for profit.

Natural Monopoly

In some cases, competition decreases efficiency, for example:

  • Railways
  • Water provision
  • Electricity - National grid

Characteristics

  • Extremely high capital cost to set up
  • Duplication is unnecessary and wasteful
  • Competition does not benefit the consumer

A Natural monopoly diagram, showing costs start very high and continually decrease

Costs fall in the LR due to Economies of Scale, but do not increase due to Diseconomies of Scale.

The Law of Diminishing returns does not apply to Natural Monopolies because there is so much Capital, that you can keep adding variable factors to it.

Price Discrimination

Price discrimination is a way to reduce consumer surplus and turn in into producer surplus.

You can eliminate consumer surplus with first degree price discrimination, in an auction. This allows you to extract the highest price from every consumer.

Types

First degree - Different price to each individual consumer (perfect price discrimination)
Second degree - Different price to different groups of customers
Third degree - Different price in each country

Consequences of Price Discrimination

  • Increased profits redistribute income from consumers to producers
  • Output will be larger -> Greater Economies of Scale
  • Higher revenue -> Potential for greater SNP -> More R&D / Dynamic efficiency

Effect on Consumers

  • Loss of welfare - Consumer surplus disappears in 1st degree price discrimination
  • Inequitable - Some consumers have to pay more than others
  • If profits reinvested, consumers may get LR benefits, such as increased efficiency -> lower costs and prices
  • Lower prices might mean poorer consumers may be able to afford the product

Examples of second degree price discrimination

  • Adult vs Child tickets
  • Insurance -> age, no claims
  • Train -> Peak and off-peak
  • Flights -> School holidays / when you book

Why can train passengers be charged more for peak travel

Peak travellers are travelling as a necessity, so their demand is inelastic, so they can raise prices without losing many customers. On the other hand, off-peak is usually leisure travel, so it is elastic, and if prices are raised, demand will fall quickly.

Uber Surge pricing

Uber varies it prices a lot depending on:

  • Time
  • Demand
  • Rain / weather
  • Amount of available drivers / supply
  • Location