1.4.4 Monopoly and monopoly power
What is the objective of a player in the game of monopoly?
What percentage of the board do you think you need to own to
realistically win the game?
How many major players do you think there are in:
• The supermarket industry
• Banking
• UK rail travel
• Soft drinks industry?
Y1: 4.1.5 Perfect
competition,
imperfectly
competitive markets
and monopoly
AS: 3.1.4 Competitive and concentrated
markets
1.4.4 M ONOPOLY
AND MONOPOLY POWER

The difference between pure monopoly and monopoly power

Monopoly power is influenced by factors such as barriers to entry, the number of competitors,
advertising and the degree of product differentiation

Concentration ratios and how to calculate concentration ratios

The basic model of monopoly suggests that higher prices and profits and inefficiency may result in a
misallocation of resources compared to the outcome in a competitive market

The potential benefits from monopoly, for example, economies of scale and possibly more invention
and innovation

You should appreciate that there are few examples of pure monopoly but many firms have monopoly
power

A formal diagrammatic analysis of monopoly is not required but you should be able to use a demand
curve to illustrate that if a monopolist raises the market price above the competitive level, output will
fall

You should also be able to use a long-run average cost curve to illustrate the benefits from economies
of scale that may result from monopoly

You should appreciate the various factors which affect the behaviour and performance of firms in a
variety of real-world markets
M ONOPOLY -
The key
characteristics are
that there is only one
firm in the industry
and there is no entry
into the market by
other firms.

A pure monopoly has
only one firm in the
industry.
In the UK a monopoly
is classed as any firm
with 25% market
share and a
dominant monopoly
as one with 40%
market share.
CHARACTERISTICS
A monopolist:

Is the only firm in the industry. Therefore, the firm is the industry

This means that the firm’s demand curve and the market
demand curve are the same

The demand curve is also the average revenue curve

Aims to profit maximise

Makes supernormal profits as it produces where AR is greater
than AC

Is a price maker i.e. it sets the price in the market

Barriers to entry stop other firms entering the industry

Monopoly can be seen as the opposite of perfect competition
M ONOPOLY
A monopoly exists
where there is only
one firm in the
market. However,
the Government
refer to any company
that has at least 25%
market share as
having monopoly
powers.
Market power is the
ability of a firm to set
price above marginal
cost.
Monopolies can
exploit consumers by
charging high prices.
Therefore,
monopolies are
regulated in order to
protect the customer.
AND MARKET POWER

A monopoly occurs when there is only one producer in an
industry

This provides the monopolist with market power leading to
higher prices and supernormal profits

There will be allocative inefficiency and a misallocation of
resources

Therefore, a monopoly is an example of market failure
How can monopolies use their power to exploit the customer?
What role do governments play in regulating monopolies?
S OURCES
OF MONOPOLY POWER

Sources of monopoly power are the factors that allow a firm to control
price and output in a market

These sources protect the firm in the industry and lead to different
behaviour by firms under conditions of monopoly and oligopoly than
under that of perfect competition

The monopolist has an inelastic price elasticity of demand allowing it to
set higher prices

There are no close substitutes for the monopolist’s product so
consumers have no choice in where they buy from

Monopoly power exists in different market structures

The greater the degree of competition the less likely is a firm to have
monopoly power
B ARRIERS
Barriers to entry
are any factors that
stop a firm from
entering a market.
Some markets will
have high barriers
to entry e.g. the
cost of
research and
development in hitech industries.
Can you identify
an example of
each of these
barriers to entry
operating in UK
industries?
TO ENTRY

Barriers to entry exist in monopoly markets. These stop firms from
entering the market

They include:

High costs to enter the market, especially high capital costs

Economies of scale experienced by large firms e.g. bulk buying

Intellectual property rights/legal barriers – patents, trademark
and copyright restrict other firms from producing a good or
service

Unfair competition e.g. predatory pricing attempting to force
competitors out of a market e.g. selling products below cost
price for a time period

Government regulation restricting firms from entering a market
e.g. giving sole rights to one supplier
T HE
The degree of
concentration
within a market is
the number of
firms that
dominate the
market.
NUMBER OF COMPETITORS
The degree of concentration within a market refers to the number of firms
that dominate the market:
MONOPOLY
DUOPOLY
OLIGOPOLY
MONOPOLISTIC
COMPETITION
PERFECT
COMPETITION
1. Monopoly – one firm dominates the market
2. Duopoly – two firms dominate the market
3. Oligopoly – a small number of firms are in the industry
4. Monopolistic Competition – many firms compete in the industry selling
differentiated products
5. Perfect competition – many firms in the industry with no influence on
market price
T HE

Monopoly ensures that there are no other firms in the market

This means that the monopolist can set both the price and the
output of their product

In oligopoly there are only a few firms in the market, each firm is
interdependent of each other

The concentration ratio tells us the number of firms that dominate
the market


How would you
describe the UK
energy market?
NUMBER OF COMPETITORS
For example 3:75 means that 3 firms have 75% market share
Less competition enables the firm to behave more like a monopoly
A DVERTISING

Firms invest heavily in advertising their products in order to create
awareness and deter new entrants into the market

Advertising is in effect a form of product differentiation as it
changes the perception of the product in the eyes of the consumer

Advertising will increase fixed costs and therefore increase the
scale of production at which a firm needs to operate profitably

Effective advertising will lead to an increase in the level of profit for
a monopolist
How effective is advertising in
deterring new entrants and
achieving product differentiation?
T HE
Product
differentiation occurs
when firms try to
make their product
different to the
competition by
adapting the actual
product in some way
or by distinguishing
the product through
advertising and
branding.
This helps to provide a
Unique Selling Point
(USP) - something that
distinguishes the
product of one firm
from those of its
competitors.
DEGREE OF PRODUCT DIFFERENTIATION

Product differentiation provides a competitive advantage to a firm
and ensures a degree of monopoly power

Product differentiation includes:

Quality features that competitors’ products do not have

Functional and design features that competitors’ products do
not have

Imperfect information where consumers are more aware of one
firm’s products over those of the competition

Advertising creating perceived differences in the mind of the
consumer

Location, where the product can only be bought geographically
through one supplier
A DVANTAGES
OF MONOPOLY
Product invention
occurs when an
original product or
process is created.

Economies of scale mean that monopolies can force down unit costs
becoming more productively efficient

These lower costs can be passed on to the benefit of society
Product innovation
occurs when a
product or process
that already exists is
adapted.

They have large research and development budgets allowing for the
development of new products that can benefit society:
Natural monopolies
exist where the
nature of the
industry means that
there would be high
productive
inefficiency if more
than one firm
supplied the product
e.g. the water
industry.

This creates dynamic efficiency as innovation leads to better
processes lowering the LRAC curve further

Better quality products can be developed as monopolies can
invest without the threat of competitors

This can lead to product invention and product innovation

Natural monopolies occur when it would be too expensive for a
number of competing firms to provide the same product e.g. water
and gas provision to households

In some cases no firms would supply the infrastructure for a market
due to high costs so the government intervene
P URE
MONOPOLY
In conditions of pure monopoly we see continual
returns to scale. This leads to an L-shaped LRAC
curve where average costs are always falling.
A pure monopoly is
often highly regulated
by the government as
there is no
competition. Consumer
exploitation might
occur if the industry
was left to its own
devices.
Costs
This will give a firm the incentive to keep
increasing the scale of production to reduce
average costs further.
This leads to highly significant barriers to entry.
LRAC
Output
D ISADVANTAGES

OF MONOPOLY
A monopolist:

Removes competition due to barriers to entry

Makes supernormal profits in the long run by charging higher
prices than would occur under competitive markets

This leads to the consumer being exploited

Is productively inefficient as it does not produce at the lowest
point on its LRAC curve

Is allocatively inefficient as it does not produce at the point
where P = MC

Is x-inefficient as no competition means less incentive to control
costs

Can reduce choice and quality as there is no competition
A MARKET DEMAND CURVE SHOWING THE
EFFECT ON PRICE OF PRODUCING A LOWER
OUTPUT
In a pure monopoly
there is only one
supplier. Therefore,
demand for the
monopolist's products
is the demand for the
whole of the market.
As the monopolist
reduces output price
will increase. As it
does not have to
worry about the
competition, the
monopolist can
choose the price that
will maximise profits.
Here, we can see that
P1Q1 provides
greater total revenue
than PQ.
The monopolist prices its
product at P. At this point
output is Q.
Price
By reducing output to Q1 the
monopolist is able to increase
price to P1.
P1
P
D
O
Q1
Q
Quantity
T EST
YOURSELF
1.
With the use of a diagram explain how a
monopoly can use its power to maximise profits?
2.
State and briefly explain two barriers to entry.
3.
What is meant by the term natural monopoly?