A-Level Economics Notes on Monopolies and Barriers to Entry

Definitions

1. Monopoly: A market structure characterized by a single seller, selling a unique product with no close substitutes and high barriers to entry for any potential competitors.
2. Barriers to Entry: Factors that make it difficult for new firms to enter an industry, which may include high start-up costs, legal restrictions, or strong brand loyalty for existing products.
3. Natural Monopoly: A type of monopoly that exists due to the high fixed or start-up costs of operating in a specific industry, which make it inefficient for new firms to enter the market.
4. Legal Monopoly: A monopoly status conferred by the government, often through the issue of patents, licenses, or the control of resources, which legally restricts others from entering the market.
5. Economies of Scale: The cost advantages that a business obtains due to expansion, which often leads to lower average costs per unit as scale is increased.
6. Marginal Cost (MC): The additional cost incurred by producing one more unit of a product.
7. Marginal Revenue (MR): The additional revenue gained from selling one more unit of a product.
8. Price Maker: A firm that has the power to influence the price of its product by controlling the quantity supplied or by altering the product’s characteristics, typically associated with monopolies.
9. Product Differentiation: The process of distinguishing a product from others, to make it more attractive to a particular target market.
10. Predatory Pricing: The practice of selling a product at a very low price with the intention of driving competitors out of the market, or to create a barrier to entry for new entrants.
11. Price Discrimination: The strategy of selling the same product to different customers at different prices based on the willingness to pay, not based on cost differences.
12. Monopolistic Competition: A market structure characterized by many firms selling products that are substitutes but different enough from each other to give each firm some degree of market power.
13. Oligopoly: A market structure in which a few large firms dominate a market, with each firm aware of the others’ actions, often leading to strategic planning and collusion.
14. Perfect Competition: A market structure characterized by a large number of small firms, a homogeneous product, freedom of entry and exit, and perfect knowledge.
15. Allocative Efficiency: A state of the market where production represents consumer preferences; in other words, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.
16. Productive Efficiency: A situation in which a good or service is produced at the lowest possible cost, which occurs when economic agents produce goods or services at the lowest average total cost.
17. Consumer Surplus: The difference between the total amount that consumers are willing and able to pay for a good or service and the total amount that they actually do pay.
18. Producer Surplus: The difference between what producers are willing to sell a good for and the price they actually receive.
19. Deadweight Loss: A loss of economic efficiency that can occur when the equilibrium for a good or a service is not achieved or is not achievable.
20. Monopoly Profit: The excess profit that a monopoly makes from being the only seller in the market, as opposed to normal profit, which could be made in a competitive market.

Monopolies

Definition:

• A monopoly is a market structure characterized by a single seller, selling a unique product in the market. In a monopoly market, the seller faces no competition, as he is the sole seller of goods with no close substitute.

Characteristics of a Monopoly:

• Single Seller: There is only one dominant firm or seller in the market.
• Price Maker: The monopolist can set the price as they are the only provider of the product or service.
• High Barriers to Entry: New firms find it difficult to enter the market due to high barriers.
• Consumer Perception: There may be no close substitutes for the product, leading consumers to perceive that there are no available alternative products.
• Elasticity of Demand: The demand for a monopolist’s product is typically less elastic because there are no close substitutes.

Sources of Monopoly Power:

• Ownership of Key Resources: Exclusive control over a resource necessary for production.
• Government Regulation: Legal barriers such as patents and licenses.
• The Network Effect: Where the value of a product increases as more people use it.
• Economies of Scale: When the cost per unit falls as a firm’s production increases.

Monopoly Pricing and Output Decisions:

• Profit Maximization: A monopolist will seek to maximize profits where MR (Marginal Revenue) = MC (Marginal Cost).
• Output Effect: Selling one more unit will increase total revenue.
• Price Effect: Selling one more unit will lower the price for all units sold and reduce revenue.

Graph Analysis:

• Monopoly graphs typically show the demand curve (downward-sloping) and marginal revenue curve (steeper than demand curve) intersecting with the marginal cost curve to determine the profit-maximizing output.

Barriers to Entry

Definition:

• Barriers to entry are obstacles that prevent new competitors from easily entering an industry or area of business.

Types of Barriers to Entry:

• Structural Barriers: Result from the basic nature of the industry. Examples include economies of scale and network effects.
• Strategic Barriers: Established by incumbent firms to deter entry. Examples include predatory pricing or excessive advertising.
• Legal Barriers: Created by government legislation. Examples include patents, licenses, and trade restrictions.

Impact of Barriers to Entry on Monopolies:

• Prevent Competition: High barriers to entry protect monopolies from potential competitors.
• Innovation: Patents provide a temporary monopoly to encourage innovation.
• Economies of Scale: Large firms with cost advantages can maintain their monopoly by producing at a lower cost than potential entrants.
• Control of Resources: Monopolies may arise when a firm has exclusive access to or control over a critical resource.

Regulation of Monopolies:

• Anti-competitive Practices: Governments may regulate or prohibit practices that reinforce monopolies.
• Price Controls: To prevent monopolies from charging excessively high prices.
• Break-up of Monopolies: In some cases, governments may break up a monopoly into smaller firms to enhance competition.

Evaluation of Monopolies:

• Advantages:
  • Potential for large-scale production and lower costs.
  • Ability to invest in research and development.
• Disadvantages:
  • Higher prices and lower output compared to competitive markets.
  • Potential for allocative and productive inefficiency.
  • May lead to a loss of consumer surplus and a gain in producer surplus.

Case Studies and Examples:

• Natural Monopolies: Utilities such as water and electricity.
• Technology Monopolies: Companies like Google in search engine markets.
• Patent-Driven Monopolies: Pharmaceutical companies with patented drugs.