Hi everybody, let's in this video consider the market structure of monopoly. We're going to study it in the same way as always, looking at the characteristics first, then the diagram mapping firm behavior, and then we'll analyze and evaluate the market structure using efficiency at the end. Okay, let's get straight into the characteristics.
Well, clearly, monopoly, so there is one firm, one seller dominating the market here. But we can look at that in two ways. We can look at it from a pure theoretical extreme, where you've got a pure monopoly, one firm with 100% market share, where one firm is the entire industry.
That's a theoretical extreme, not very realistic at all. Or we can look at it in a more realistic sense of monopoly power, where a firm has got the power, has got the potential to act like a monopoly. That's known as monopoly power.
And the legal definition of that is when one firm on their own has got more than 25% control of the market. So one firm has got at least 25% market share. They're considered to have monopoly power.
This is also known as a legal monopoly. There are differentiated products here, unique products, which means that naturally the monopoly is a price maker. There are high barriers to entry and exit. That's fundamental.
And that means that supernormal profits can persist over time for this firm. There is imperfect information of market conditions. That's another reason that keeps firms out from this market. And we assume that the firm is a profit maximizer, producing where MR is equal to MC.
So understanding all of these key characteristics of monopoly, let's understand how monopolists behave going to our diagram. Well, knowing that this firm is a price maker, they're going to have downward sloping revenue curves. So average revenue is going to look like that. That is the demand curve.
Marginal revenue is going to be twice as steep, looking something like that. Average cost, remember, is our little smiley face. So average cost is going to look something. like that and marginal cost cuts average cost at its lowest point looks like a nike tick so we can get marginal cost on like that brilliant that's the basis of our diagram remember this firm is a profit maximizer so they're going to produce where marginal cost equals marginal revenue and that takes us to that point here so let's call that point q1 where do we read the price from we read the price from the ar curve the ar curve is the price we have to go up to ar and that will give us a price of P1.
The diagram isn't finished here. What we can work out is at quantity Q1, the level of profit the monopolist is making. To do that, we have to compare average revenue and average cost. Well, at quantity Q1, it's clear that average revenue is way up here.
Average cost is way down there. The vertical difference between the two dots is the unit level of super normal profit. We know it's super normal profit because average revenue is greater than average cost. That vertical distance is the supernormal profit per unit multiplied by Q1 and we get the total profit.
So we can take this point across, let's call that point C1. That box is the area of total supernormal profit made by this monopolist. We need to label it as such. So there's our supernormal profit, the wonderful juicy supernormal profits that this monopoly is making. Now the diagram is complete.
Fantastic. Now we need to look at analyzing and evaluating this market structure by efficiency analysis. So let's have a look here.
Is this monopolist allocatively efficient? Well, we have to look at quantity Q1, but the quantity they're producing, are they being allocatively efficient? Well, remember, allocative efficiency occurs where price is equal to marginal cost. Well, clearly, where price equals marginal cost is over there.
That's where competitive firms will be pricing and producing. We can clearly see here that at quantity Q1, a monopolist is charging a price of P1 much higher than marginal cost at the quantity of Q1. So a monopoly is definitely not allocatively efficient. They're charging a price greater than marginal cost, exploiting consumers in that sense.
So your analysis has got to be, yeah, P is higher than MC. Monopolies are charging a price higher than what it costs. And in doing so, they're exploiting consumers with high prices, low consumer surplus. but they're also restricting output in this market.
Quantity should be higher if we look at where allocative efficiency is in the market. Quantity should be higher, but monopolists are restricting output in order to raise prices and make these profits. So output is low in the market, choice is low in the market as a result. Resources are not following consumer demand at all. There is also risk that quality could be low as well because of a lack of competitive forces here.
So allocative inefficiency is very much- bad news for the consumer in a monopoly market. What about productive efficiency? Well it's clear to see from this diagram as well that even if this monopoly was operating on their average cost curve that's not going to be at the minimum point. It's going to be somewhere to the left of the minimum point which means that this monopoly is not productively efficient.
They are voluntarily foregoing economies of scale by not producing at the minimum point on their average cost curve. That's what this diagram says. That's just the way I've drawn this diagram. The other way of looking at productive inefficiency is if a monopolist gets too large and there are diseconomies of scale, if they end up producing on the rising part of their average cost curve here. But if we go the other way, in which case they are voluntarily foregoing economies of scale, that's another reason why prices tend to be higher in monopoly markets, inefficiency there.
We can also assume X inefficiency. We can't see that from the diagram, but we can assume it with basic logic. Remember, X inefficiency occurs when monopolists are producing beyond their average cost curve, above their AC curve, allowing for waste to creep in here, excess costs.
Why would a monopolist allow for this? Well, one reason, they become complacent with a lack of a competitive drive. That's one reason why they can get away with it and thus charge higher prices for it.
But the second reason is simply because it's very difficult to reduce waste, to cut down your costs to the absolute minimum. It's a difficult process. And if a firm doesn't need to do so, then they're not necessarily going to do so.
So we can say X efficiency, no as well, which means our monopolist is statically inefficient. The three static efficiencies are not being met. They are statically inefficient. However, there is potential for dynamic efficiency because there are long run super normal profits being made. No firms can come in because of high barriers to entry.
And also there is imperfect. So that keeps other firms out of the market, which allows these supernormal profits to persist in the long term. And because of that, this monopolist could reinvest those profits back into the company in the form of new technology, in the form of innovative new products, in the form of research and development, in the form of new capital, upgraded capital, etc.
Capital investment is the basic idea, and that is in the long run interest of consumers. and also in the long run interests of the business as well. So there is that potential upside to monopolies too. This is a very simple story to conclude.
We can actually go into much more detail with monopolies. And a video later in this playlist really does go into that detail, looking at the pros and cons of monopoly in far more elaborated detail than this. So make sure you watch that video to get a real good detailed understanding of the pros and cons of monopoly. But that's the basic idea of a monopoly market structure.
Thank you very much for watching guys. I'll see you all in the next video.