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ECN 104 Lecture Notes - Perfect Competition, Natural Monopoly

Course Code
ECN 104
Eric Kam

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Conditions for Monopoly
In a perfectly competitive market, there are many firms, none of which is large in size.
In contrast, in a monopolistic market there is only one firm, which is large in size.
This one firm provides all of the market's supply. Hence, in a monopolistic market,
there is no difference between the firm's supply and market supply.
Three conditions characterize a monopolistic market structure. First, there is only one
firm operating in the market. Second, there are high barriers to entry. These barriers
are so high that they prevent any other firm from entering the market. Third, there
are no close substitutes for the good the monopoly firm produces. Because there are no
close substitutes, the monopoly does not face any competition.
Barriers to entry. A barrier to entry is anything that prevents firms from entering a
market. Many types of barriers to entry give rise to a monopolistic market structure.
Some of the more common barriers to entry are
1. Patents: If a firm holds a patent on a production process, it can legally exclude
other firms from using that process for a number of years. If there are no other
production processes that can be used, the firm that holds the patent will have a
2. Large start-up costs: In some markets, firms will face large start-up costsfor
example, the cost of building a new production facility. If these start-up costs are
large enough, most firms will be discouraged from entering the market.
3. Limited access to resources: A monopolistic market structure is likely to arise
when access to resources needed for production is limited. The market for
diamonds, for example, is dominated by a single firm that owns most of the
world's diamond mines.
Natural monopolies. Not all monopolies arise from these kinds of barriers to entry. A
few monopolies arise naturally, in markets where there are large economies of scale.
For example, a local telephone company's marginal and average costs tend to decline
as it adds more customers; as the company increases its network of telephone lines, it
costs the company less and less to add additional customers. The telephone company's
long-run average costs may eventually rise but only at a level of output that is beyond
the level the local market demands. Hence, in the market for local telephone services,
there is a need for only one firm; competition will not naturally arise. Gas, electric
power, and other local utilities are also examples of natural monopolies.
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