1.4.5 Monopoly and the allocation of resources
What is the objective in a game of monopoly?
Use your knowledge of economics to explain why a
hotel on Old Kent Road is cheaper than one on
Mayfair.
AQA E CON 1: M ARKETS AND
MARKET FAILURE
1.4.5 W HAT
YOU NEED TO KNOW

Candidates should understand that monopolies have market power and that the
basic model of monopoly suggests that higher prices and profits and inefficiency
may result in a misallocation of resources compared to the outcome in a
competitive market

Candidates should understand that monopoly can provide an example of market
failure

Candidates should be aware of the various factors which affect the behaviour
and performance of firms in a variety of real world markets and are sources of
monopoly power. The factors include different barriers to entry and the degree
of concentration and product differentiation

Candidates should understand the potential benefits from monopoly, for
example, economies of scale and possibly more invention and innovation

Note: candidates are not expected to know the formal model of monopoly.
However, candidates should be able to use two diagrams to illustrate the costs
and benefits of monopoly: a market demand curve showing the effect on price of
producing a lower output; and a cost curve to show economies and diseconomies
of scale. Knowledge of monopoly revenue curves is not required.
M ONOPOLY
A monopoly exists
where there is only
one firm in the
market. However,
the Government
refer to any company
that has at least 25%
market share as
having monopoly
powers.
Market power is the
ability of a firm to set
price above marginal
cost.
Monopolies can
exploit consumers by
charging high prices.
Therefore,
monopolies are
regulated in order to
protect the
customer.
POWER

A monopoly occurs when there is only one producer in an
industry

This provides the monopolist with market power leading to
higher prices and abnormal profits

There will be allocative inefficiency and a misallocation of
resources

Therefore, a monopoly is an example of market failure
How can monopolies use their power to exploit the customer?
What role do governments play in regulating monopolies?
M ONOPOLY
Barriers to entry are
any factors that stop a
firm from entering a
market. Some markets
will have high barriers
to entry e.g. the cost of
research and
development in hi-tech
industries.
POWER

Barriers to entry exist in monopoly markets. These stop firms from
entering the market

They include:

High costs to enter the market, especially high capital costs

Economies of scale experienced by large firms e.g. bulk buying

Intellectual property rights/legal barriers – patents, trademark and
copyright restrict other firms from producing a good or service

Unfair competition – attempting to force competitors out of a market
e.g. selling products below cost price for a time period

Government regulation – restricting firms from entering a market e.g.
giving sole rights to one supplier
M ONOPOLY
The degree of
concentration within
a market is the
number of firms that
operate within the
market.
POWER
The degree of concentration within a market refers to the number of firms
that exist within that market:
MONOPOLY
DUOPOLY
OLIGOPOLY
MONOPOLISTIC
COMPETITION
PERFECT
COMPETITION
1. Monopoly – one firm dominates the market
2. Duopoly – two firms dominate the market
3. Oligopoly – a small number of firms are in the industry
4. Monopolistic Competition – many firms compete in the industry selling
differentiated products
5. Perfect competition – many firms in the industry with no influence on
market price
M ONOPOLY
Product differentiation
occurs when firms try to
make their product
different to the
competition by adapting
the actual product in
some way or by
distinguishing the product
through advertising and
branding.
This helps to provide a
Unique Selling Point
(USP) - something that
distinguishes the product
of a firm from those of its
competitors.
POWER

Product differentiation provides a competitive advantage to a firm
and ensures a degree of monopoly power

Product differentiation includes:

Quality features that competitors’ products do not have

Functional and design features that competitors’ products do not have

Imperfect information where consumers are ignorant regarding the
product or of competitors’ products

Advertising creating perceived differences in the mind of the consumer

Location, where the product can only be bought geographically through
one supplier
B ENEFITS
OF MONOPOLY
Product invention occurs
when an original product
or process is created.

Economies of scale mean that monopolies can force down unit
costs becoming more productively efficient
Product innovation
occurs when a product or
process that already
exists is adapted.

These lower costs can be passed on to the benefit of society

They have large research and development budgets allowing for
the development of new products that can benefit society

This can lead to product invention and product innovation

Natural monopolies occur when it would be too expensive for a
number of competing firms to provide the same product e.g.
water and gas provision to households

In some cases no firms would supply the infrastructure for a
market due to high costs so the government intervene
Natural monopolies exist
where the nature of the
industry means that
there would be high
productive inefficiency if
more than one firm
supplied the product e.g.
the water industry.
A C OST C URVE TO SHOW EC ONOMIE S AND
D ISEC ONO M I E S O F SC ALE
As seen in unit 1.3.3 the
benefits and
disadvantages of
increasing the scale of
production can be shown
diagrammatically.
At first unit costs (ATC)
fall due to economies of
scale. At this point
economies outweigh
diseconomies.
The optimum output
occurs when unit costs
are at a minimum
(productive efficiency).
After this unit costs rise
and diseconomies
outweigh economies.
Average
total cost
Economies
of scale
Diseconomies
of scale
Productive
efficiency
Output
A MARKET DEMAND CURVE SHOWING THE EFFECT
ON PRICE OF PRODUCING A LOWER OUTPUT
In a monopoly there is
only one supplier.
Therefore, demand for
the monopolist's
products is the demand
for the whole of the
market.
As the monopolist
reduces output price
will increase. As it
does not have to worry
about the competition,
the monopolist can
choose the price that
will maximise profits.
The monopolist prices its
product at P. At this point
output is Q.
Price
By reducing output to Q1 the
monopolist is able to increase
price to P1.
P1
P
D
O
Q1
Q
Quantity
T EST
YOURSELF
1.
With the use of a diagram explain how a
monopoly can use its power to maximise profits?
2.
State and briefly explain 2 barriers to entry.
3.
What is meant by the term natural monopoly?