Tra My Nguyen Magda IB1

Economics HL Essay

MONOPOLY

a) Outline the ways in which monopoly power might arise.b) Should governments seek to control the growth of monopoly

power?

a) [602 words]

The monopolist is the sole producer in an industry. In order to remain monopolist, the firm must be able to prevent other firms from entering the industry. The ways to prevent other firms from entering the industry are known as barriers to entry. There are a number of possible barriers to entry, such as: legal barriers, sunk costs, capital costs, scale economies, natural monopoly, anti-competitive practices and marketing barriers including advertising. The higher the barriers, the stronger the monopoly power. Therefore, to arise the monopoly power, barriers to entry should be maximised.

Legal barriers occurs when a firm is given a legal right to be the only producer in an industry (The legal right to be a monopoly). This will arise monopoly power because when a firm is going to invest knowing that it might be copied, they would be little incentive to do so. But if they want to invest and they are guaranteed not to be copied, they would be more likely to invest more time and more money. Therefore, the stronger the legal barriers, the stronger the monopoly power.

Sunk costs are the costs that if a firm wants to entry the industry, it has to pay that costs. They are additional and invisible costs, but entrants must pay them. If the costs are high, firms will be less likely to entry the industry, if the costs are quite small, the firms will tend to entry more and more. Or similar to the capital cost, which is the opportunity cost of the funds employed as the result of an investment decision. So the higher the costs, the stronger the monopoly power.

~~MONOPOLY~~:*

Tra My Nguyen Magda IB1

Economics HL Essay

Economies of scale is when firms gain average cost advantages as their size increases. Every large monopoly is experiencing scale economies that come from expertise in the industry. Any firm that wants to enter the industry usually starts up in a relatively small way, or even in a same size as the monopolist, it will not have the economies of scale that are enjoyed by the monopolist. That is because if any firm enters the industry, the existing monopoly will just have to reduce price to the level of normal profits, where new entrants will make be making losses because the averare costs are higher than the revenue earned at the level of normal profits. So to prevent other firms from enetring the industry, the monopoly should enlarge its economies of scale, because lack of ecnomies of scale acts as a deterrent to firms that might want to enter a monopoly industry.

An industry is a natural monopoly if there are only enough economies of scale available in the market to support one firm.

(diagram Natural Monopoly)

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LRAC

a

b

D1 = AR1

D2 = AR2

Q1 Q2 0

Price ($)

Q demanded

Tra My Nguyen Magda IB1

Economics HL Essay

When a new firm enters the industry, the monopolist shifts the demand curve to the left, from D1 to D2, where average cost is much higher then average revenue and therefore, both firms will make losses. However, the strong monopolist can sustain that losses and pushes the new firm out of industry.

Anti-competitive behavior takes place when the current monopoly is able to start a “price war” with any firm that is entering the industry. Meaning, when a new entrant wants to enter the industry, the current monopolist can lower its price to a loss-making level and sustain longer than the new entrant, so that the entrant must leave the industry. Then to arise the monopoly power here, the monopolist needs to raise its position to a very strong level, so that it will be possible to lower the price in order to force the new firm out of the industry.

b)

Monopoly power, in other words, barriers to entry or price descrimination, is defined as a degree of price setting power held by a supplier on the basis of its market share. And whether or not should the government control the monopoly power, there is a need to dive into some aspects of the matter.

First of all, if the government control the monopoly power, that will influence the production of monopolist.

~~MONOPOLY~~:*