Monopoly

A monopoly exists when a single firm dominates a market, possessing sufficient market power to act as a price maker rather than a price taker. In UK competition law, a firm is considered to hold a monopoly position if it has 25% or more of the market share — though in economic theory, a pure monopoly means a single seller supplying 100% of the market. This lesson examines the sources of monopoly power, the behaviour of a monopolist, and the welfare implications.

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Sources of Monopoly Power: Barriers to Entry

A monopolist can maintain its dominant position only if there are barriers to entry — obstacles that prevent or discourage new firms from entering the market.

Barrier	Explanation	Example
Economies of scale	If MES is large relative to market demand, new entrants cannot achieve competitive costs	Aircraft manufacturing — only Boeing and Airbus survive
Legal barriers	Patents, copyrights, licences, and statutory monopolies granted by government	Pharmaceutical patents (typically 20 years); the Royal Mail's former statutory monopoly on letter delivery
Control of essential resources	A firm controls a raw material or input that competitors need	De Beers historically controlled the majority of the world's diamond supply
Brand loyalty	Established brands create customer loyalty that new entrants struggle to overcome	Coca-Cola, Apple — decades of advertising investment
Predatory pricing	An incumbent temporarily cuts prices below cost to drive out or deter new entrants	Alleged predatory behaviour by British Airways against Laker Airways in the 1980s
Sunk costs	If entry requires large irrecoverable investments, the risk of entry increases	Building a new railway line — if the business fails, the track has no alternative use
Network effects	The value of a product increases as more people use it, creating a winner-takes-all dynamic	Meta (Facebook), WhatsApp — users stay because their friends are on the platform

Exam Tip: Barriers to entry are central to understanding monopoly power. In exam answers, categorise barriers as structural (arising from the nature of the industry, such as economies of scale) or strategic (deliberately created by the incumbent, such as predatory pricing or limit pricing). This shows sophisticated classification.

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Natural Monopoly

A natural monopoly exists when the entire market demand can be served at lowest cost by a single firm. This occurs when:

• Economies of scale persist throughout the relevant range of output
• The LRAC curve is continuously falling
• The infrastructure costs are so high that duplication would be wasteful

Example	Why It Is a Natural Monopoly
Water supply (e.g., Thames Water)	Building a second network of water pipes to each home would be enormously expensive and wasteful
Electricity distribution (e.g., UK Power Networks)	The local distribution grid is a natural monopoly — two sets of cables would double the cost without doubling the benefit
Railway track (e.g., Network Rail)	A single rail infrastructure is more efficient than competing parallel networks

Exam Tip: Distinguish between the natural monopoly element (the infrastructure/network) and potentially competitive elements. In UK utilities, regulation separates the network (natural monopoly, regulated) from the supply (potentially competitive). For example, the electricity market separates distribution (monopoly, regulated by Ofgem) from retail supply (competitive — customers can switch between suppliers like British Gas, EDF, Octopus Energy).

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Revenue Curves Under Monopoly

Unlike a perfectly competitive firm, the monopolist is the entire industry. Its demand curve is the market demand curve — downward-sloping.

Feature	Perfect Competition	Monopoly
Demand curve	Perfectly elastic (horizontal)	Downward-sloping (the market demand curve)
AR and MR	AR = MR = P	AR > MR; MR lies below AR
Price and output	P is given by the market	The monopolist chooses P and Q (but not independently — they are linked by the demand curve)

Why MR < AR Under Monopoly

To sell an additional unit, the monopolist must lower the price on all units sold. The marginal revenue from the extra unit is therefore less than the price received for it, because the price reduction on all existing units must be subtracted.

If the demand curve is linear, the MR curve has the same intercept on the vertical axis and twice the gradient — it bisects the horizontal distance between the vertical axis and the demand curve.

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Profit Maximisation Under Monopoly

The monopolist maximises profit at the output where MC = MR, then charges the price on the demand curve corresponding to that output.

Key Features

• The monopolist produces less output and charges a higher price than a competitive industry would
• The monopolist earns supernormal profit in both the short run and the long run (because barriers to entry prevent new firms from entering and competing away the profit)
• The monopolist does not produce at minimum ATC — it is not productively efficient
• The monopolist does not set P = MC — it is not allocatively efficient

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Welfare Analysis: Deadweight Loss

When comparing monopoly with perfect competition: