Definition
A monopoly exists when one firm dominates a market. In A-Level Economics this usually means one firm with more than 25% market share, or a single seller with no close substitutes.
A pure monopoly is a single firm supplying the entire market.
Characteristics
- One dominant firm
- High barriers to entry
- Price-setting power
- Limited substitutes
- Potentially supernormal profit in the long run
Barriers to entry
| Barrier | Example |
|---|---|
| Legal | Patents, licences, franchises |
| Economies of scale | Large firms have lower average costs |
| Brand loyalty | Consumers trust an established brand |
| Control of resources | Exclusive access to raw materials |
| Sunk costs | High setup costs that cannot be recovered |
The diagram
A profit-maximising monopoly produces where marginal revenue = marginal cost.
- Draw AR (demand) downward sloping.
- Draw MR below AR.
- Draw MC upward sloping.
- Find output where MR = MC.
- Read the price from the AR curve at that output.
- Note that price is above marginal cost.
The efficiency problem
Because price is above marginal cost, the monopoly produces less than the socially efficient output.
A monopoly restricts output to raise price. At the profit-maximising output, price exceeds marginal cost, so some consumers who value the good more than its cost of production do not buy it. This creates a deadweight loss, because the market underproduces relative to the allocatively efficient level. Resources are underallocated to this market.
That is a strong analysis chain.
Are monopolies always bad?
No. This is where evaluation marks are won.
Arguments that monopolies can benefit consumers:
- Economies of scale can lower average costs, and lower prices.
- Supernormal profit can fund research and development.
- Natural monopolies (water, rail) may be more efficient as a single provider because duplicating infrastructure is wasteful.
- International competitiveness — large firms may compete better globally.
Arguments that monopolies harm consumers:
- Higher prices and restricted output
- Less choice
- Less incentive to be efficient (X-inefficiency)
- Potential to exploit suppliers
- Barriers that block innovation
A balanced evaluation
A monopoly may not always harm consumers. If the firm benefits from substantial economies of scale, its average costs may be lower than those of smaller competitors, and some of this saving may be passed on as lower prices. In addition, supernormal profit can finance research and development that improves quality. However, this depends on the strength of competition and regulation. Without competitive pressure or an effective regulator, the firm has less incentive to pass on savings or to innovate, so the consumer may still lose.
Common lost marks
- Saying "monopoly is bad" without a mechanism. Explain the output restriction.
- Diagram errors. MR must be below AR, and output is where MR = MC.
- Ignoring natural monopoly. It is a key evaluation point.
- Confusing market share with market power. Market definition matters.
- No judgement. If asked to evaluate, decide.
Evaluation angles
- How contestable is the market?
- Are there strong economies of scale?
- Is there an effective regulator?
- Does the firm face international competition?
- Is the monopoly temporary or permanent?
Quick check
- Define monopoly.
- Explain why a monopoly produces less than the efficient output.
- Give two benefits a monopoly might create.
- Explain one reason a regulator might fail.