IB Docs (2) Team
Monopoly (HL only)
Introduction
This lesson focuses on monopoly structures and specifically the way that a monopoly is able to take advantage of barriers to entry to establish their position as the only firm within the industry. It is also important for your classes to understand the characteristics of a natural monopoly and crucially how to use diagrams to illustrate the market for a monopoly in both the short run and the long run.
Enquiry question
What is a monopoly and what role do barriers to entry play in permitting the monopolist to earn long run economic profit (abnormal profit).
Lesson notes
Lesson time: 80 minutes
Lesson objectives:
Describe, using examples, the assumed characteristics of a monopoly: a single or dominant firm in the market; no close substitutes; significant barriers to entry.
Understanding the relationship between demand, average revenue and marginal revenue in a monopoly.
Explain why a monopolist will never choose to operate on the inelastic portion of its average revenue curve.
Explain, using a diagram, the short- and long-run equilibrium output and pricing decision of a profit maximising (loss minimising) monopolist, identifying the firm’s economic profit (abnormal profit), or losses.
Examine the role of barriers to entry in permitting the firm to earn economic profit (abnormal profit).
Teacher notes:
1. Beginning activity - begin with the two opening activities and allow 10 minutes for your classes to complete the question and discuss the video. (10 minutes)
2. Processes - technical Vocabulary - the students can learn the key concepts through the notes as well as drawing the diagrams activity, activity 2. This should take 20 minutes to go through and discuss and it is important to have your classes practise drawing the appropriate diagrams.
3. Practise activities included on the handout should take around 30 minutes. These are a combination of short answer and diagrammatic exercises. (30 minutes)
4. Reflection exercise - contains a relevant paper one style question on this topic that your students can look at and discuss. This topic of course can be included on papers one and three of the examination and this page contains both types of questions to practise on. This activity could also be set as a homework or classwork exercise. (10 minutes)
5. Final fun activity - who is the world's richest man, 1995 to 2019? (10 minutes)
Beginning activity
Take a look at the following video and then answer the following questions:
1. Identify examples of monopolies within your country?
2. What percentage of a market does a business need to control in order to qualify as a monopoly?
A monopoly is a company which controls 25% or more of the market. This may not sound much but some monopolies actually have bigger revenues than the majority of countries, as the following table illustrates.
| Company | Sales revenue (2015) | National income rank if it were a whole country (2017) compared to individual nations nominal GDP |
| Walmart | $ 485.65 Bn | 23 |
| Sinopec | $ 433.33 Bn | 26 |
| Royal Dutch Shell | $ 385.63 BN | 30 |
| Petro China | $ 367.85 Bn | 32 |
| Exon Mobil | $ 364.76 Bn | 32 |
Key terms:
Monopoly - a market structure where there is only one firm in the industry or a single firm dominates the market.
Barriers to entry - methods employed by monopolies to prevent other firms from entering the industry, thus maintaining their monopoly position in the long run.
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Examples of entry barriers:
Economies of scale: A monopoly, as it grows is likely to be in a position where they can take advantage of the economies of scale available to them, making it almost impossible for a new business to compete financially with the dominant firm.
Natural monopoly: This is another type of economy of scale and exists in an industry where the economies of scale are so great that there is only room for one firm in the market.
Legal barriers: Sometimes there are legal barriers to prevent other firms joining the market. This can be granted for a period of time as a result of a patent, copyright or trademark or maybe for an indefinite period as with some public utilities.
Brand loyalty: Some firms e.g. Coke and Pepsi are so synonymous with particular industries that it is almost impossible to enter the market.
Anti-competitive behaviour: Where a monopoly firm uses anti-competitive behaviour to maintain their dominant position in the market − either legally or illegally.
Available as a worksheet in PDF form at: 
Monopoly power
Activity 1
Using the definition of monopoly as a business which controls at least 25% market share, which of the following businesses count as monopoly?
General Motors
This automobile giant is one of the worlds most recognisable brands with sales of $ 135.6 billion. If GM was a country it would be 57th largest country in the world, sandwiched between Iraq and Kazakhstan. However, with only 17.7% of the world market it is not considered a monopoly.
Luxottica
Luxottica, founded in 1961 in a small village in Northern Italy is the largest manufacturer of glasses in the world. They officially qualify as a monopoly.
YKK
Produce zips, approximately half of the world's zips to be precise. YKK definitely qualifies as a monopoly.
Adidas
Adidas is one of the largest shoe brands in the world with an annual revenue in excess of $ 20 billion. However, with a market share of only 16% it does not qualify as a monopoly.
ABInBev
This too is a monopoly. The business produces and distributes more than 200 types of beer around the world, including Budweiser, Corona, Stella Artois, Beck’s, Leffe, Hoegaarden, Skol and Michelob Ultra. Their net income was over $14.3 billion in 2013. Keep that in mind the next time you’re at the bar - they may all taste different, but your money is going to the same place.
Netflix?
With over 50 million subscribers, Netflix is quickly becoming an Internet superpower. However they are not officially classified as a monopoly yet due to the number of competitors in the same market e.g. Hulu, Comcast, Vudu, iTunes and HBO’s streaming service.
Activity 2: Guidance on drawing the graphs
When completing paper one style examination questions you will need to illustrate your responses on a graph showing a firm making either a loss, normal profit or abnormal profits. The easiest way to do this is to start by drawing three identical diagrams showing the MR, AR and MC curves.
Next draw the profit maximising point where MC = MR and show the selling price.
To finish your diagrams draw the AC curve. It is this curve which determines whether your firm is making a loss or profit. To draw a firm making normal profit simply position the AC curve so that it touches the AR curve at output Q. To draw a loss making firm position the AC curve above so that at output Q the level of average cost is greater than average revenue. Lastly to illustrate a firm making abnormal profit simply draw the AC curve below the AR curve at output level Q.
Check your completed diagrams with your teacher.
Activity 3
Watch the following short video and then using the monopoly diagram included, answer the following questions.
(a) Profit maximising quantity and price.
P1 and Q1
(b) Revenue maximising quantity and price.
P2 and Q2
(c) Total revenue at the profit maximising level of output.
P1 x Q1
(d) Area of profit
Shade in (AR-AC) x Q1
(e) The PED elastic and inelastic range of the demand curve
(f) The allocatively efficient level of output
Q4
(g) The level of output resulting in normal profit
Q5
(h) The deadweight loss arising from the firm not producing at the socially optimum level of output
The triangle represented by P1, P6 and D
(i) The productively efficient level
Q3
(2) Explain why a monopolist will never choose to operate on the inelastic portion of its average revenue curve.
The revenue maximising level of output is at point B, where MR=0. At all points to the right of this, on the PED inelastic portion of the AR curve, the MR < 0.
(3) Will the firm be able to maintain the abnormal profits in the long run?
Because barriers to entry will prevent other firms from joining the market and raising industry supply to force down the price to the normal profit level.
Activity 4
(a) Will a firm in monopoly be allocatively efficient in the long run?
No or at least very unlikely because allocative efficiency occurs when a good is produced at a level that maximizes social welfare. Because the price of a good in monopoly will exceed the marginal cost, the market can never be allocatively efficient.
(b) Can a monopolist lose money?
Yes a monopolist will make a loss if ATC exceeds the price that people are willing to pay for any quantity of output. This can be caused by a change in consumer tastes or by changes in the cost of inputs.
(c) Will monopoly businesses always produce where MC=MR?
In economics we make the presumption that businesses produce at the profit maximising level. There are of course exceptions to this rule such as firms choosing to maximise revenue or profit satisfy. Some monopolies, controlled or run by the public sector, for example may prioritise service over profit.
(d) Based on what you have learnt so far about monopolies are governments right to legislate to reduce their dominance of some markets?
Monopolies are seen as bad by many economists because with higher prices, consumers will demand less quantity, and hence the quantity produced and consumed will be lower than it would be under a more competitive market structure.
(e) What legislative measures can a government take to prevent the abuse of monopoly power.
Governments have introduced a raft of legislation aimed at prohibiting business practices that unreasonably deprive consumers of the benefits of competition, resulting in higher prices for products and services.
Activity 5
One of the contentious political issues in many parts of the world is the extent to which governments should seek to restrict the power of monopolies. Watch the following video about the proposed merger between Heinz and Kraft and then outline the advantages and disadvantages of the proposed merger from the point of view of the following stakeholders:
- the consumer
- the shareholders
- rival companies
- the government
The newly merged business would provide benefits to both businesses in terms of economies of scale. The impact on the customer depends entirely on whether the firm passes the benefits of economies of scale on to the consumer or not? Rival companies may well be alarmed by a loss of market share to the new business.
Activity 6: Natural monopolies
Watch the following video which explains what a natural monopoly is and then answer the questions which come afterwards.
(a) What is a natural monopoly?
A natural monopoly is a type of monopoly where the economies of scale that exist in the industry are so significant that there is only room for one firm in the market. Competition would simply raise costs for the industry and force all businesses operating in it to make a loss e.g. the space industry (NASA). This is illustrated by the diagram. With just one firm in the market there is sufficient demand to provide a profit. By introducing a second demand for each business falls to D2 and both businesses are forced to shut down.
(b) Which businesses in your country are likely to be natural monopolies?
Natural monopolies are usually companies providing large scale infrastructure projects, including cables and grids for electricity supply, pipelines for gas and water supply, and networks for rail and underground. These industries are characterised by very high fixed costs. Railways are also often considered a typical example of a natural monopoly.
Activity 7: Link to the assessment
Examples of relevant paper one question include:
Part (a) question
Explain two ways that a government may regulate to prevent the abuse of monopoly power. [10 marks]
Command term: Explain
This part (a) question means provide a detailed account of two ways in which a government may regulate monopolies.
Key term to define: Monopoly
There are a number of different examples that candidates may use in this response but these can generally be divided into one of two different types.
The first of these involves regulation which prevents monopolies forming, for example in UK BAA were considered to be operating as a monopoly and were forced to sell three of their airports - Gatwick, Edinburgh and London Stansted. Similarly the government blocked the proposed merger between two telecommunications giants, Three and O2, on the grounds that it was against the public interest.
The second way that a government may regulate monopolies is by forcing them to open up the business to other businesses, so that they can provide competition for the monopoly. An example of this would include the decision by the UK government to open up the domestic energy supply market to other firms. Previously all domestic property were supplied with gas to heat their homes by just one company - British Gas.
Note the use of specific examples in this response.
Part (b) questions
Using real world examples, discuss the effectiveness of government policies aimed at reducing monopoly power. [15 marks]
Command term: Discuss
Key terms to define: monopoly power, anti-competitive legislation which exists e.g. anti-competition laws, mergers and acquisition laws e.t.c. plus regulatory bodies such as Ofwat, Of gas e.t.c.
Responses should also include the following:
Real life examples might include situations where governments have successfully prevented the formation of a monopoly, e.g. the UK governments decision to refuse permission for the merger of THREE and O2 or attempts by the USA government to restrict monopolies, such as the acquisition of T-Mobile by AT&T. Responses should also include examples of markets where the government has failed to prevent the formation of a monopoly such as with social media outlets such as Facebook, Twitter e.t.c.
Diagrams which illustrate the comparison of output and price within monopolies and perfectly competitive industries, without economies of scale (to the left), where the customer would benefit from greater competition within the industry and a diagram illustrating circumstances where the firm enjoys significant economies of scale, passed onto the consumer in the form of lower prices, represented by the diagram below and to the right.
An explanation that without significant economies of scale (diagram above) the monopolist would charge more (Pm) and produce at a lower level (Qm) than a perfectly competitive industry, making a compelling case for government intervention restricting monopoly power.
Discussion regarding other solutions to reduce monopoly power such as nationalisation, privatisation and trade liberalisation.
An evaluation of whether governments should restrict monopoly power or not? This should include the benefits to the following stakeholders - consumers, shareholders of monopoly businesses, as well as the arguments over situations in which the benefits gained from economies of scale outweigh the costs of monopoly power e.g. natural monopolies.
A recognition of situations where the monopolist uses a significant proportion of the benefits gained from producing on a mass scale to reduce prices and increase consumer choice. This might include the notion that abnormal profits can be diverted towards R and D and provide consumers with improved products in the future. This is illustrated by the second diagram where as a result of gains made from returns to scale the monopoly charges lower prices and at a higher output than the industry in a competitive market.
Activity 8: Who is the worlds richest man?
End the lesson with the following enjoyable video - who is the current world's richest man?
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