Monopoly Review for AP Economics
Review questions for this study guide can be found at:
Main Topics: Structural Characteristics, Monopoly Demand, Profit Maximization, Efficiency Analysis, Price Discrimination
Structural Characteristics of Monopoly
Since monopoly is the very opposite of perfect competition in the range of market structures, we can expect that the structural characteristics are also quite different.
- A single producer. This is pretty self-explanatory, but a strict definition of monopoly requires that there are no other firms in the industry.
- No close substitutes. Consumers cannot find a similar product in other markets.
- Barriers to entry. Perhaps the most important characteristic of monopoly is that there exists something that prevents rival firms from entering the market to provide competition to the monopolist and choice to consumers.
- Market power. This is the result of the first three characteristics. With no competition and barriers to entry, the unregulated monopolist has market power, or monopoly price-setting ability.
- Again, it is rare to find a firm that satisfies all of the characteristics of monopoly, but the DeBeers firm holds a near monopoly on global diamond production. The only gas station or bank in a small town might also act as a local monopolist.
Barriers to Entry
If there were no barrier to entry, a monopolist earning positive economic profits would be history and this chapter would be done. So before moving on to the behavior of monopoly, let's talk a little more about this necessary condition for the existence of monopoly.
- Legal barriers. In your local television market only one firm is given the right to broadcast on a specific frequency. There might be only one firm given the right to sell liquor in a small community. There are patents, trademarks, and copyright laws to protect inventions and intellectual property. In a move popular with 14-year-old boys everywhere, Carmen Electra was recently given the sole right to the Internet address bearing her name. These legal protections do not provide for absolute monopoly for there are often viable substitutes available to consumers.
- Economies of scale. In Chapter 8 this concept was introduced. As a firm grows larger in the long run, average total costs fall, providing the larger firm a cost advantage over smaller firms. If extensive economies of scale exist, an industry could evolve into one with only one enormous producer. A natural monopoly is a case where economies of scale are so extensive that it is less costly for one firm to supply the entire range of demand. Power plants are a good example of natural monopoly within a local area.
- Control of key resources. If a firm controlled most of the available resources in the production of a good, it would be very difficult for a competitor to enter the market. For example, if a producer of granulated sugar wanted to monopolize the market, the firm might wish to control all of the sugarcane plantations.
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