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MONOPOLY - MONOPOLY MONOPOLY A theory of market structure...

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MONOPOLY MONOPOLY A theory of market structure based on three assumptions: There is one seller, it sells a product for which no close substitutes exist, and there are extremely high barriers to entry. 1) There is one seller: This means that the firm is the industry 2) The single seller sells a product for which there are no close substitutes: Because of this, the monopolist faces little, if any, competition. 3) There are extremely high barriers to entry: It is difficult to enter the market Examples: Electricity, water, gas, local phone services and postal service (first class mail) BARIERS TO ENTRY Legal barriers, economies of scale, or one firm’s exclusive ownership of a scarce resource may make it difficult or impossible for new firms to enter the market. 1) Legal Barriers These include public franchises, patents and government licenses a) Public Franchise A right granted to a firm by the government that permits the firm to provide a particular good or services and excludes all others from doing the same (thus eliminating potential competition by law). E.g., U.S Postal Service, public utilities operate under state and local franchises b) Patents Exclusive right granted to inventors of a product or process for a period of 17 years. The rationale behind patents is to encourage innovation in an economy c) License Entry into some industries and occupations requires a government granted license. E.g. radio, television stations can’t be operated without a license from the Federal Communication Commission (FCC). In most states, a person needs to be licensed to join the ranks of physicians, dentists, architects, nurses, barbers, etc. 2) Economies of Scale In some industries, low ATC are only obtained through large-scale production. This means that if new entrants are to be competitive in the industry, they must enter it on a large scale. But this is risky and costly and acts as a barrier to entry. If economies of scale are so pronounced in an industry that only use firm can survive Natural monopoly Natural Monopoly The condition where economies of scale are so pronounced in an industry that only one firm can survive, e.g. public utilities, gas, electricity, H 2 0.
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3) Exclusive Ownership of a necessary Resource A firm owning a raw material, which is essential in production, can also prohibit the creation of rival firms. Examples: International Nickel Company of Canada which controls about 90% of the world's known nickel resource, the DeBeers company of S. Africa owns most of the world’s known diamond mines, and the Aluminum Company of America (Alcoa), which for a time controlled almost all sources of bauxite in the U.S, late 19 th century 4) Financial factor Some industries are high capital intensive that entry into such an industry will require heavy capital investment before production could even begin on a scale necessary to compete with already well established firms. This will scare potential competitors, e.g. iron & steel, gas, railway, airways an even shipping.
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