Here is a model answer to a question on monopoly.
This is written in the style of an Edexcel A Economics A Level 25 mark question and answer.
For students studying theme 3, this is a great example of a market structures essay.
25 mark question
Technology companies can have high market shares. Google has a 90% market share in search engine use in the UK, while about 56% of smartphones sold in the UK in 2023 were Apple iPhones.
Evaluate the benefits of a monopoly (25 marks).
Extended essay plan
I split this essay into five paragraphs:
- KAA paragraph 1:
- Note KAA stands for knowledge, application and analysis.
- Dynamic efficiency.
- Use the monopoly cost/revenue diagram, showing the area of supernormal profit.
- Extend by explaining the dynamic efficiency benefits for firms and consumers.
- Example: Google and 90% market share.
- E (evaluation) paragraph 1:
- This depends where the firm allocates its supernormal profit.
- If used for dividends, then there may not be dynamic efficiency.
- KAA2:
- Natural monopoly.
- Use the natural monopoly cost/revenue diagram, with LRAC and LRMC sloping downwards, showing consumer surplus.
- Extend by discussing the benefits of economies of scale for firms and consumers. Link to productive efficiency and minimum efficient scale on LRAC.
- Example: Google and data servers.
- E2:
- Depends on firm size. There may be diseconomies of scale if the monopoly firm is too large.
- Conclusion:
- Benefits of monopoly are large in the case of natural monopoly due to economies of scale. Benefits of monopoly are small otherwise.
- Price cap can help ensure benefits for natural monopoly are passed on to consumers e.g. water price caps.
Model answer
KAA paragraph 1
Monopoly firms are price makers, meaning they can influence the price being set. This means a firm is incentivised to raise the price above the allocatively efficient price, in order to increase revenue and profits. An example of this is Google, with a 90% share of internet searches, charging 30-40% more per click for advertising space compared to other search engines Specifically the firm produces the quantity q where MC=MR, which maximises profit. The supernormal profit (SNP) for the firm is shaded in yellow. Monopoly power leads to dynamic efficiency – efficiency over time. It means that firms have the supernormal profits to reinvest in reducing costs or improving the quality of the product. For example Google could invest in energy efficiency to run its servers on less energy. Lower costs could be passed onto consumers in the form of lower prices over time, increasing consumer surplus. Google could also use the funds to improve its internet search algorithm, improving search outcomes for users of internet search and increasing consumer welfare. This reinvestment of profits also benefits the firm, as lower costs over time, and higher demand due to higher quality products, leads to higher future SNP too.
Evaluation paragraph 1
These effects depend on how the monopoly firm allocates its profits. If profits made today go to dividends for shareholders instead of investment, then there is less reinvestment into improving quality or lowering costs. For example, Apple in the past has allocated up to 25% of profits to dividends, a high share of profits. In this case, consumers might not see as much of an improvement in the quality of the product, nor do firms see lower costs from more innovation. So the firm is not dynamically efficient.
KAA paragraph 2
A natural monopoly has high fixed costs and significant economies of scale, meaning the long-run average cost falls as output increases. For example Google invests heavily in its data centres which host internet servers. Google can spread the fixed cost of running these data centres over more units of output, achieving economies of scale. The larger the firm, the lower the long run average cost (LRAC). So natural monopolies result in lower LRAC costs, which may be passed on to consumers with lower prices, increasing consumer surplus. The diagram below shows the downward-sloping LRATC curve reflecting the economies of scale. With one firm in the market, the firm maximises profit where MR=(LR)MC, so the firm produces quantity q at price p. Suppose instead this firm splits up into two firms, each producing half of the output of a monopoly firm, at q1. Then the price is higher at p1. Consumers actually face higher prices when there are more firms in the market, because long-run average costs are higher and the firms are not taking full advantage of the economies of scale. As a result of monopoly, the price falls from p1 to p. Consumer surplus rises from to area ACp under monopoly, whereas consumer surplus will be lower under duopoly. Firms also benefit from higher supernormal profit, because of lower LRAC. This means the monopoly is operating closer to the minimum efficient scale than a market with many firms, in other words the monopoly is closer to productive efficiency when looking at LRAC curves.
Evaluation paragraph 2
This depends on the size of the monopoly firm. If the monopoly firm there could be diseconomies of scale in some industries. For example for a large firm like Google with about 180,000 employees, it could be difficult to communicate and coordinate, leading to slower decision-making and multiple divisions having overlapping goals. In this case having one large firm could be undesirable, with higher long-run average costs compared to smaller firms. The higher LRAC could be passed on to consumers in the form of higher prices.
Conclusion
Overall the benefits of monopoly are large for industries with a natural monopoly cost structure, where there are significant economies of scale to be passed on to consumers in the form of lower prices. This could also include technology companies such as Google as well as utilities such as water and energy, where duplicating networks of pipes would be inefficient and increase costs. However the benefits of monopoly may be small in other markets where consumers are exploited with higher prices and there aren’t significant economies of scale. Whether the benefits of a natural monopoly are large depend on whether regulators intervene with price caps. A price cap, such as Ofwat’s five-year “price reviews” for the water industry, would prevent natural monopolies from making very large supernormal profits, encouraging the monopoly to keep prices low to avoid fines, increasing consumer surplus compared to a firm without a price cap.
Comments on the essay
This essay includes:
- High quality knowledge, application and analysis paragraphs.
- Note in particular the use of real world examples of monopolies such as Google.
- Also pay attention to the depth of analysis, for instance areas labelled on diagrams and extensions to the chain of reasoning.
- Great evaluation points.
- Note the evaluation paragraphs are well explained.
- There is a justified conclusion that answers the question.
- The conclusion ends with a new evaluation point that the final judgement may depend upon. This is a great way to round off a conclusion.
As a result, this essay is likely to score full marks or close to this.
Other possible points
Other possible points related to monopoly could include but are not limited to:
- The fact that monopolies may have arrived at their monopoly position because they sell a better quality product.
- The fact that monopoly firms have price-making power, which allows them to engage in price discrimination.
- A benefit of supernormal profit and giving this to shareholders is that it can attract greater firm investment over time.
- Changes to the degree of choice.
- Domestic monopolies may still face competition, just from abroad.
- Depends on the level of contestability.
- Productive, allocative and X inefficiency associated with monopoly.
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