ChainWhat it assumes · how to break it
Start
One firm supplies most of a market and is protected by barriers to entry, for example a dominant supplier of a product with no close substitutes.
1
As a result, the firm faces the whole market demand curve, which slopes downwards, so it can choose its price instead of accepting the market price.
price maker · barriers to entry
price maker · barriers to entry
Assumes: Consumers have no close substitutes.
But: If close substitutes exist in other industries, demand is price elastic and the firm's freedom to raise price is limited.
2
Since the firm aims to maximise profit, it produces where MC = MR, and because MR lies below AR this output is lower than a competitive industry would produce.
profit maximisation · MC = MR
profit maximisation · MC = MR
Assumes: The firm's objective is profit maximisation.
But: A firm pursuing sales or revenue maximisation, or managers who satisfice, may produce more and charge less than the profit-maximising price.
3
Therefore, price is higher and output lower than under competition, so part of consumer surplus is transferred to the firm as supernormal profit and part is lost as deadweight loss.
consumer surplus · deadweight loss
consumer surplus · deadweight loss
Assumes: Consumers have no close substitutes to switch to.
But: If substitutes exist, for example another mode of transport, the firm must keep price nearer the competitive level and the loss of consumer surplus is small.
4
In addition, consumers have only one supplier, so they cannot switch if quality or service is poor, and the firm has little reason to improve its product.
consumer choice · quality
consumer choice · quality
Best link to attack
Assumes: Without rivals, the firm has no reason to keep quality high.
Assumes: Without rivals, the firm has no reason to keep quality high.
But: A firm that wants to protect its reputation, deter entry or avoid regulation may keep quality high, and supernormal profit can fund better products.
End
Consumers pay higher prices, lose consumer surplus and have less choice and possibly lower quality.
Evaluation chain
- E1However, the effect on consumers depends on whether the monopoly uses its position to cut quality or to improve its product.
- E2Because supernormal profit gives the firm funds for research and the security to invest, it can develop new products that small competitive firms could not afford.
- E3As a result, consumers may gain better quality and new products over time, even while they pay a price above MC.
- E4So monopoly harms consumers most where the firm is protected and complacent; the harm is smaller, or offset over time, where it reinvests its profit in better products.
Can you say this chain from memory?
Members can hide the links, test themselves and track which chains they have mastered.
Practise this chainMembers can hide the links, test themselves and track which chains they have mastered.
Questions this answers
- Assess the impact of monopoly power on consumers.
- Explain how a monopoly reduces consumer surplus.
- Discuss whether consumers always lose when a market is dominated by one firm.
Diagram
Monopoly diagram: compare the competitive price and output (MC = AR) with the monopoly price and output (MC = MR). Shade the consumer surplus transferred to the firm as profit and the deadweight loss triangle.
Reverse and related
More competition → lower prices, more consumer surplus and more choice, as firms compete for customers.