IB Economics 2.11.2 Monopoly - Single or Dominant Firm, High Barriers to Entry, No Close Substitutes Notes

Monopoly: One Seller, No Substitutes, High Barriers

1. A monopoly is a market supplied by a single seller, or by one firm so dominant it sets the terms for everyone else.
2. With no real rival the firm is the market, which makes it the strongest form of imperfect competition.
3. Single or dominant seller
   1. A local water company is the clearest case, since one network of pipes serves the whole town.
   2. In looser cases a firm holds such a large share, like a dominant search engine, that it acts like a monopoly even with tiny competitors.
4. No close substitutes
   1. The product stands alone, so buyers who want it have nowhere else to turn.
   2. A patented medicine with no alternative treatment is the pure case.
5. High barriers to entry
   1. These are the obstacles that stop new firms entering and competing the monopoly away.
   2. They are what make the first two features last.

The Barriers That Keep Rivals Out

1. Barriers to entry are what protect a monopoly.
2. Without them, high prices and profits would pull new firms in until the monopoly disappeared.
3. Legal barriers
   1. Patents give a pharmaceutical firm sole rights to a drug for years, and copyrights do the same for a song or film.
4. Brand equity
   1. Decades of marketing make a brand like Coca-Cola hard to displace, so buyers stay loyal even to an identical-tasting drink.
5. Economies of scale
   1. A software firm's cost per extra unit falls toward zero once it has scale, so a newcomer cannot match its prices.
6. Large start-up capital
   1. Industries such as real estate development need so much money up front that few firms can afford to enter.
7. Control of essential resources
   1. Owning the key input shuts others out, whether an ore deposit for mining, refining capacity for oil, or scarce land for data centres.
8. Aggressive tactics
   1. Predatory pricing cuts the price below cost to drive a new rival out.
   2. Limit pricing holds the price low enough that entry is not worth attempting.

From These Features to Market Power

1. Put the three features together and the result is market power, the ability to set the price rather than take it.
2. Because there are no close substitutes, the monopolist faces the whole market's demand curve, which slopes downward.
3. So it can raise its price and still keep most of its buyers.
4. This is the opposite of a perfectly competitive firm, which faces a flat demand line and must accept the going price.
5. The monopolist instead chooses a price above marginal cost, and the barriers mean no rival can undercut it.
6. Its marginal revenue lies below the demand curve, because to sell one more unit it must lower the price on every unit.
   1. The demand curve is also the firm's average revenue, so $D = AR$, while $MR$ falls away faster beneath it.

The Cost to Buyers: Higher Prices and Weaker Information

1. That gap between price and marginal cost is the monopolist's power, and the root of the market failure a monopoly can cause.
2. The absence of rivals also leaves buyers with less information.
   1. In a competitive market, many sellers and similar products give buyers a benchmark for a fair price and quality.
   2. Facing a single seller, buyers have nothing to compare against.
3. So the firm's information advantage over them is harder to discipline, leaving buyers with little bargaining power and few or no alternatives.