Question

Economies of scale are one of the most powerful forces in economics. Answer the following questions related to this very important principle of economics:

A. Explain how economies of scale are particularly important to a monopolist, be they real (in reality, there are very few examples of monopoly in the real economy) or hypothetical.

B. Building on question (a.) above, in the event that a new competitor decided to enter this otherwise monopolistic market and building on their natural competitive advantage of economies of scale, what would the embedded monopolist do to thwart the new competition?

C. Are there any economic lessons that a non-monopoly firm can learn from the hypothetical monopolist in the development of its own strategy for building a competitive advantage in the real world in which it operates?

Answer 1

1) Economies of scale refers to decrease in average cost because of large scale operation.

A) monopolist faces a market in which he is the only seller and producer. If the market that he serves is that much give, to serve that his operations run of large scale then he can enjoy econmies of scale. By being able to produce at large as the monopolsit is the only provider to the market, the monopolist can make his avergae cost reduced much. This reduction in cost can help him serving all the consumers in teh market with all types (high and low) demand by chraging lesser price to all or charging lesser price to low demand people if he can differentiate among them. However to charge low price in each case he would be needing to produce at large scale to gain econmies of scale.

b.) The monopolist threat to that product define by the substitute product or the complementary product so that it cannot be harm to them and also the important thing is there is less chance of new competititor to survive in the market.

c). The monopolist should increase production to a point where average costs are decreased even further than its initial average cost before the advent of the new competitor. The lower average cost will allow the monopolist will to charge a lower price for the product than the competitor, and the high output will allow it to sell to more of the market and leave only a small portion of the market to the new competitor. Even if the average cost of the monopoly was already minimized before, the monopolist should still lower their prices to the point that is above its own average cost but below the average cost of the new competitor, assuming that the monopolist does indeed have a lower average cost due to its economies of scale. The lower price for the entrant will lead to their shutdown condition when Price < Average Variable Cost (short run) or Price < Average Cost