Types of Markets: Competition & Monopoly
Microeconomic Decision Makers
A monopoly is a market supplied by a single firm (or, more loosely, one firm with a dominant share). With no close competitor, the firm has the power to set its own price rather than accept a market price. Such a firm is sometimes called a price maker.
A monopoly often arises from that keep rivals out: control of an essential resource, very large set-up costs, patents, or legal protection.
Common exam question
Recognising a monopoly by its features
Question: Pick the features of a single dominant firm, or what keeps its profit high (1 mark, multiple choice).
Set in 4 of the 13 multiple-choice papers. A monopoly has high barriers to entry, is a price maker and makes high profit in the long run, not just the short run, since rivals cannot enter to compete it away. Keeping new firms out is the keyed cause of that profit, not government protection or low costs. Wrong options pair one firm with low barriers, many firms with high barriers, or a price taker. When a competitive market turns into a monopoly, barriers to entry, economies of scale and firm size all rise.
Asked in 1 of the 11 structured papers (4 marks): name and explain two characteristics, a mark for each step, such as the only firm (no real competition), high barriers (entry is hard) or a price maker (it sets the price).
Effect of one firm on price, quality, choice and profit
| Feature | Effect under monopoly |
|---|---|
| Price | Higher — with no competitor to undercut it, the firm can restrict supply and raise the price above the competitive level. |
| Quality | May be lower — with no competitive pressure, the firm has less incentive to improve. (It may also be high if the firm reinvests its profits.) |
| Choice | Narrower — a single supplier means consumers have little or no alternative. |
| Profit | Higher — protected from competition, the firm can earn large, lasting profits. |
Disadvantages of monopoly
- Higher prices and restricted supply. To maximise profit, the monopolist produces less and charges more than a competitive market would, so consumers are worse off and resources are misallocated.
- Less choice for consumers, who cannot switch to a rival.
- Weaker incentive to improve quality or cut costs, because no competitor threatens the firm's sales.
- Possible exploitation. The firm's market power can be used against the interests of consumers and, sometimes, of its suppliers.
Advantages of monopoly
A monopoly is not always harmful, and the syllabus expects you to see both sides.
- Economies of scale. A single large firm produces on a very large scale, so its average costs may be lower than those of many small firms — and some of that saving may be passed on as lower prices.
- Funds for research and innovation. High profits give the monopolist the money to invest in research, new technology and product development.
- Avoiding wasteful duplication. One firm avoids the duplicated networks and advertising of many competing firms — useful for a natural monopoly such as a water or rail network, where having one supplier of the infrastructure is the most efficient arrangement.
Common exam question
Price, profit and the case for a monopoly
Question: Compare price and profit with one firm and with many, or pick an advantage a monopoly can bring (1 mark, multiple choice).
Set in 3 of the 13 multiple-choice papers. Compared with a monopoly, a highly competitive market has lower prices and lower profits. A monopoly's advantages come from its size and its profit: economies of scale may cut its costs and so its prices, and high profits can pay for research and development, the keyed reason some governments let a monopoly exist. The wrong options are features of competition (wider choice, more output, prices set by market forces) or gains for the firm at consumers' expense (higher prices, maximum profit); drawing new firms in is the opposite of what a monopoly does.