Question

11. Sources of monopoly power

A monopoly, unlike a perfectly competitive firm, has some market power. Thus, it can raise its price, within limits, without quantity demanded falling to zero. The main way monopolies retain their market power is through barriers to entry, which prevent other companies from entering monopolized markets and competing for customers.

Consider the market for tanzanite. The mines for this blue-purple gemstone, found only in Tanzania, are owned by the local government. Given that no one is allowed into the mines without government permission, the market structure for tanzanite highly resembles that of a monopoly.

Which of the following best explains the barriers to entry that exist in this scenario?

a) Legal barriers

b) Increasing returns to scale

c) Control over an important input

Answer 1

Solution: A monopoly can raise its price without quantity demanded falling to zero because it is the only option available to the consumers. The main way monopolies retain their market power is through barriers to entry, which prevent other companies from entering monopolized markets and competing for customers.

In the market for tanzanite, blue-purple gemstone is found which can only be found in Tanzania mines. The mines are owned by the local government which doesn't allow anyone without the permission of the government.

The possible barriers of entry that exist in this case are:

a) Legal Barriers

In this barrier of entry, the government can restrict the entry of any other industries or mining authorities to enter into the market of mines where the rare blue-purple gemstone is found. This barrier may be in the form of licensing or lack of access to resources by the government. A monopoly is established in this case, as the mines are owned only by the local government and they have established a monopoly in the market of Tanzania.

c) Control over an important input

Blue-purple gemstone is a resource that can only be found in Tanzania. The local government has taken a full control over the mines of this blue-purple gemstone and restricts or limits the entry of any other company into it. The price of the blue-purple gemstone can be raised as much as the Tanzanian local government likes because they have a monopolistic control over the market of the gemstone.

Both answers are possible but the best that explains the barrier to entry is the c) Control over an important input

This is the main reason why legal barriers may be put to restrict entry of anyone without the permission of the government itself.