Study Notes
A monopoly is a market structure where a single firm is the sole seller of a product with no close substitutes, allowing it to be a price maker with significant market power. Monopolies can earn abnormal profits due to high barriers to entry and lack of competition, but they may also lead to allocative inefficiency and market failure. A natural monopoly occurs when a single firm can supply the entire market more efficiently than multiple firms due to high fixed costs and economies of scale.
- Monopoly — a single seller of a good or service in a market. Example: A utility company providing electricity in a region.
- Abnormal Profit — profit exceeding the normal profit level, where price per unit is higher than average cost. Example: A monopolist setting prices above production costs.
- Allocative Inefficiency — occurs when resources are not distributed optimally, leading to a welfare loss. Example: A monopoly setting prices higher than marginal cost.
- Natural Monopoly — a market where a single firm can supply the entire market more efficiently than multiple firms. Example: A water supply company with extensive infrastructure.
- Barriers to Entry — obstacles that prevent new competitors from easily entering an industry. Example: High startup costs or legal restrictions.
Exam Tips
Key Definitions to Remember
- Monopoly
- Abnormal Profit
- Allocative Inefficiency
- Natural Monopoly
- Barriers to Entry
Common Confusions
- Confusing normal profit with abnormal profit
- Misunderstanding the concept of allocative inefficiency
Typical Exam Questions
- What is a monopoly? A market structure with a single seller and no close substitutes.
- How do monopolies earn abnormal profits? By setting prices above average costs due to lack of competition.
- Why are natural monopolies considered efficient? Because they can supply the entire market at a lower cost than multiple firms.
What Examiners Usually Test
- Understanding of monopoly characteristics and market power
- Ability to explain and illustrate abnormal profits and allocative inefficiency
- Knowledge of barriers to entry and their impact on market structure