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Monopoly
By the end of this chapter, you should be able to:
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barriers to entry
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There is only one firm producing the product so the firm is the
industry.
Barriers to entry exist, which stop new firms from entering the
industry and maintains the monopoly.
As a consequence of barriers to entry the monopolist may be able
to make abnormal profits in the long run.
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8.
A,4onopoly
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your school
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your doctor
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Economies of scale
As we have seen in Chapter 6, firms gain average cost advantages as
their size increases: these are known as economies of scale. Things
such as specialization, the division of labour, bull<-buying, and
financial economies may lead to cost savings and lower unit costs. If a
monopoly is large, then they will be experiencing economies of scale.
Any firm wishing to enter the industry wiLl probably have to start up
in a relatively small way and so will not have the economies of scale
that are enjoyed by the monopolist. Even if the new firm were able
to start up with the same size as the monopolist, it would still not
have the economies that come from expertise in the industry, such as
managerial economies, promotional economies, and research and
development.
Natural monoPoly
8.I.
In this case, the monopolist is the industry and has the demand curve
Dr. The long-run average cost cuwe faced by the monopolist is LRAC
and its position and shape are set by the economies of scale that the
firm is experiencing. The monopolist is able to make abnormal profits
by producing an output between qr and qr, because the average
revenue is greater than the average cost for that range of output.
Quantity demanded
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8.
Monopoly
If another firm were to enter the industry, then the firm would take
demand from the monopolist and the monopolist,s demand curve
would shift to the left, in this case to D2. Since we can assume that
the situation will be the same for both Iirms, the two firms would
now be in a position where it is impossible for them to make even
normal profits. Their LRACs would be above AR at every level of
output.
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3 Legal barriers
In certain situations, a firm may have been given a legal right to be
the only producer in an industry, i.e. rhe legal right to be a monopoly.
This is the case with patents, which give a firm the right to be the
only producer of a product for a certain number oI years after it has
been invented. Patents are usually valid for approximately 20 ycars.
When a patent expires other producers will then be allowed to
produce and sell the product. Patents exist as a means to encourage
invention. If individuals or firms put time and money into
inventions, only to find that they were copied as soon as they were
successful, then there would be little incentive to do so. However, if a
firm knows that, if its invention is successful, it will have a protected
monopoly for a number of years, then it is more likely to invest in
Pernlttcl to
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Brand loyalty
It may be that a monopolist produces a product that has gained
huge brand loyalty. The consumers think of the product as the
brand. For example, in the early days of the vacuum cleaner they
were simply known by their brand name, Hoover. If the brand
loyalty is so strong then new firms may be put off from enrering the
industry, since they will feel that rhey are not able to produce a
product that will be sufliciently different in order to generate such
strong brand loyalty.
experience
Can you think of any other
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8.
Student workpoint
Monopoty
IIIE
8.!
Be reflective
Use the information below to explain the possible
advantages and disadvantages of pharmaceutical
patents for the different stakeholders involved.
and release it as
soon as the patent
expires.
3.
Anti-competitive behaviour
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8 o Monopoly
again in 2008 for failure to comply with the ruling, and was ordered
to pay 899 million Euros, the largest fine ever given by the
European Compe tition Con-lmission.
That is not the end of it, however. In 2009, the EU Competition
Commission again found Microsoft guilty of anti-competitive
practices, this time for bundling its Internet Explorer browser into
its Windows operating system. According to the commission:
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"The evidence gathered during the investigation leads the Commission to believe
that the tying of Internet Explorer with Wnd.owL which makes Internet
Explorer available on 90% of the wo d's PCs, distofts competition on the
meits between competing web br1wsers insofar as it proides Intemet Exploret
with an artificial distribution advantage which other web browserc are
unable to match. The Commission is concerned that through the tying, Miffosoft
shields Internet Explorer from head to head competition with other browsers
which is detrime tal to the paee of proiluct innovation and to the
quality of produds which eonsumers ultimately obtain. In addition, the
an annotated time
line to briefly explain the
series of events and
decisions in the Microsoft
leSal baftle with the
N/lake
European Union
Competition Commission.
of output in monopoly
output or the price of the product, but not both. Students often
assume that monopolists can charge whatever price they like and still
sell their products, but this is not the case. In order to sell more they
must lower their price.
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Oritput
FiSure 8.2 The demand curve facing a
monopolist
o"c
Output
run in monopoly
8.
It is sometimes assumed that a monopolist will always eam abnormal
profits, but this is not true. If the monopolist produces something for
which there is little demand, then it will not eam abnormal profits. II
a monopolist were making losses in the short run, then it would have
the option of dosing down temporarily (iI it was not covering its
variable costs) or continuing production for the time being. However,
it would plan ahead in ttre long run to see whetber changes could be
made so that normal profits, at least, could be eamed. ff this were not
possible, then the rnonopolist would dose dovrm the firm and, since
the firm is the industry, the industry would cease to exist. This
situation is shown in Figure 8.4.
Here, the firrn is not able to cover costs in the long run, since the
average cost is greater than the average revenue at all levels oI output.
Since there is nothing that can be done to rectify the situation, this
will be an industry in which no firm will be willing to produce. Ttrere
Monopoly
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6:
Output
will be no industry.
8.I.
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g
PPM
PRM
Output
Figure 8.5 Revenue maximizing as
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8.
i\,4onopory
Efficiency in monopoly
Unlike perfect comptition, the monopolist produces at the level ol
output where there is neither productive efficiency nor allocative
efficiency. This is shown in Figure 8.6.
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competition
Monopolies may be able to achieve large economies of scale simply
because of their size. Monopolies do not have to be big, but if rhe
industry is big, then the monopolist should gain substantial economies
of scale. If this pushes the MC curve down, then it is possible that the
monopolist may produce at a higher output and at a lower price than
in perfect competition. This idea of relative price and output in
monopoly and perfect competition is very debateable. The situation is
shown in Figure 8.7.
Output
If this is the case, then the monopolist will produce where MC:MR,
maximizing profits and producing a greater quantity than perfect
competition, Q2, at a lower price, Pr.
Output
8.
N,4onopoly
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perfect competition
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PJ
Output
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These potential problems mean that monopolies can act against the
public interest. As a result, all governments have laws and policies to
12.
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8.
N,4onopoly
EXAMINATION QUESTIONS
Paper I, pail (a) questions
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2
5
Explain
[10 norks]
[10 morks]
Using appropriate diagrams, explain whether a monopoly is likely to be more efficient or less
[t0 norks]
I a
b
firm to be a monopoly.
[lo
morks]
[15 moks]
wlting
Ranbaxy and
Dr
Reddy's
Laboratories are expected to be
major beneficiaries to take
advantage of a multi-billion dollar
sales vacuum created by the patent
erpiry of two popular drugs in the
US. One of the drugs is a cholesterol-
a compary
loses its exclusive patent for a
branded drug,
it is no longer a
monopoly in the market, and the
in 2006.
tremendous
a
b
120
patent
[2 morks]
monopoly.
[2 narks]
UsinS an appropriate diagram, explain why Merck was able to earn huge
profits from its sales of Zocor.
[4 morks]
[4
Using information from the text and your knowledge of economics, evaluate the effects
of the Zocor patent expjry on the market for cholesterolreducing medicines.
[8 mo*s]
nork]