Let’s take a look at the monopoly market structure.
By the end of this video you should be able to confidently do two things.
First, you should be able to explain the characteristics of a monopoly.
Then, we’ll look at a monopolist’s diagram in both the short and long run.
But before all that, let’s establish what we mean by a monopoly.
A pure monopoly is typically the first type of monopoly students have in their mind when
they first learn of this topic.
A pure monopoly exists when a firm controls 100% of a market.
Although rare in practice, they do exist.
We’ll focus our discussion on pure monopolies and firms that are considered by the government
to be monopolies.
In a later video we’ll consider natural monopolies.
A firm may be considered a monopoly by the UK government if it controls more than 25%
of a market.
This percentage may vary by country but the value determined by the UK Competition and
Markets Authority will be the basis of our discussion.
A third type of monopoly we’ll explore in the future is a natural monopoly.
A natural monopoly exists when significant economies of scale exist by having only one
firm in the industry.
For now we’ll focus on the first two types mentioned but will return to the natural monopoly
in the next video.
Let’s look at 5 characteristics of a monopoly.
First, as we’ve already established, there is one dominant seller.
In this data from November 2013, Google controls 70.9% of the desktop search engine market
share.
This would allow Google to exert significant control over the search engine market.
Second, the monopolist produces a unique product with no or few close substitutes.
If you think of certain life-saving medicines that are one-of-a-kind, you’ll understand
this characteristic.
Third, there are high barriers to entry.
These could be legal protections as seen here such as patents, trademarks or copyrights.
They could also be advertising barriers for large firms which limit the ability of new
firms to enter the market.
Also, there are certain industries that require high levels of resources to be dedicated to
research and development, which are out of reach for new firms looking to enter a market.
Monopolists have price making power because they offer unique products to consumers.
This is a picture of Martin Shkreli who ran a pharmaceutical company that raised the price
of one of its vital medicines Daraprim from $13.50 to $750 overnight.
The price of the medicine in the United States is now $800 per pill and despite all the negative
press they faced, the firm has maintained the drugs price as of the date of this video.
Martin Shkreli was able to get away with this because there is was no alternative medicine
available and consumers had to purchase the drug to treat their unique diseases.
For context, the price of this drug in the UK is $0.66 a pill and in Brazil its about
$0.02.
In fact, let me now if you agree or disagree with his action in the comments.
It’s worth looking up his justification of this measure to understand his motives.
Finally, due to this market power and protection from competition through high barriers to
entry – the firm can maintain supernormal profits in both the short and long run.
How the firm can use these profits will be analysed later.
Now that we understand the characteristics of a monopoly, let’s draw the diagram.
We first draw in a downward sloping demand curve or average revenue curve because the
firm has price making ability and would need to lower their prices to sell more of a product.
Monopolies cannot charge any price they like as consumers wouldn’t necessarily always
pay it.
Second, the marginal revenue has twice the slope of the demand curve.
Third we add in a marginal cost curve and finally the U-shaped average cost curve.
To find the profit maximizing level of output, we need to find where marginal cost = marginal
revenue and drop down to the X-axis for the profit maximizing quantity which is Q*.
Next we draw up to the demand curve to establish the price charged by the firm and take that
across to the Y-axis to label P*.
Next we find where that vertical dotted line cross the average cost curve and draw across
from there to establish our average cost per unit.
It should be evident that the price we receive per unit is greater than our cost per unit
at this quantity of production.
The area for the total revenue for the firm is represented by the square shaded green.
It is greater than our total costs which are bordered on the right by Q* and above by the
cost per unit.
It should be obvious by now that our total revenue is greater than our total cost which
leads us to our supernormal profit.
This blue region represents the supernormal profit earned by the monopolist in the short-run
and long-run.
The key thing to remember is that the high barriers to entry and market power of the
monopolist prevent new firms from entering the market and eroding these supernormal profits.
Firms can use these profits in a variety of ways.
We’ll consider that in a later video.
You should feel much more confident in your understanding of the characteristics of monopoly
as well as your ability to analyse the monopolist’s diagram.
If you have any questions, leave them below or email me at enhancetuition@gmail.com.
I’ll do my best to reply!
That’s this one done, and I’ll see you in the next one.