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You are expected to explain/analyze (AO2) monopolies and natural monopolies, draw (AO4) a monopoly with normal profit, abnormal profit, and loss, and a natural monopoly, explain/analyze (AO2) why monopolies result in market failure, and draw (AO4) the market failure of a monopoly (HL)
Characteristics of a Monopoly (AO2)
Characteristics of a Monopoly (AO2)
A monopoly is a market structure with the following characteristics:
One dominant firm
Very differentiated product: There are no close substitutes to the product, meaning consumers can't easily switch to another market
Very high barriers to entry: For example high costs or complicated laws
Significant market power: The one firm is in control of the market
Firm is a price maker: It sets the price of the product to where it wants
Monopoly Diagram (AO4)
Monopoly Diagram (AO4)
The Monopoly diagram features various variables:
AR: Average Revenue: The average amount of money the sale of a product generates for the firm. It is the same as the price of the product, and works as the demand line on the diagram.
MR: Marginal Revenue: The extra amount of revenue the sale of one additional product brings. Its slope is twice as steep as AR.
AC: Average Cost: Pretty self-explanatory. Its slope is like a wide U, and its minimum is always where it intersects with MC
MC: Marginal Cost: The extra amount of costs the production of one additional product brings. Its slope is like a hockey stick, and intersects AC where it is at its minimum
There are three forms of the monopoly diagram you need to know how to draw:
When the firm is making normal profit (Costs = Revenue)
When the firm is making a loss (Costs > Revenue)
When the firm is making abnormal profit (Costs < Revenue)
Notice that the only thing that changes is the placement of the AC curve.
You can use the notes from rational producer behavior to see if a profit is made or not ->
Market Failure (AO3, AO4)
Market Failure (AO3, AO4)
A monopoly causes market failure, as they produce less of a product than what is optimal for society (not allocatively efficient).
Because they are profit maximizing, they produce where MR = MC
However, the social optimum is where MC = AR
In other words, the monopoly produces less than what's required so prices remain high
This means there will be a higher price and lower quantity than what is optimal
This means there is a welfare loss, indicated by this triangle-like shape (luckily, you do not need to calculate the area of this shape).
Natural Monopoly (AO2, AO4)
Natural Monopoly (AO2, AO4)
Even though monopolies cause welfare loss and are therefore often undesired, there are some cases in which it is actually better to only have one firm in the market.
For example, imagine there were 50 different electricity companies in your city, all running their own power plants and operating their own wires to each of their customer's houses. Imagine the chaos!
This is why it is sometimes desired to only have one big player in the market, and is very typical for utilities such as water, electricity, telecoms, etc.
Its diagram is a little complicated, but I will try to break it down:
Instead of AC and MC, you have LRAC and LRMC - this indicates that it is the long run.
Instead of being hockey-stick/U shaped, LRMC and LRAC now are both L-shaped and go downwards
MR and D = AR remain the same
The presence of both an abnormal profit and a loss on the same diagram may confuse you, but these are representations of two different scenarios, explained in the slideshow below:
It is unclear just how much you are supposed to know about natural monopolies, as it is very vague in the syllabus guide. No past assessment has had anything on natural monopolies either (maybe you will be the first)
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