Explain how two types of economies of scale can lead to a fall in long-run average costs.

Discuss the view that barriers to entry in a monopoly will always lead to abnormal profits in the long run.

PLEASE NOTE: This question part is not on the syllabus for first teaching 2020/first exams 2022.

Marks should be allocated according to the paper 1 markbands for May 2013 forward, part A.

Answers may include:

• definitions of economies of scale, long-run average costs
• diagram to show movement along the downward-sloping portion of the long-run average cost curve
• explanation of how economies of scale lead to lower average costs as a firm increases scale of production in the long run that refers to two clearly different types of economies of scale, such as specialization, efficiency, marketing and indivisibilities
• examples of specific firms (or industries) that have possibly experienced falling long-run average costs in practice because of economies of scale.

Marks should be allocated according to the paper 1 markbands for May 2013 forward, part B.

Answers may include:

• definitions of barriers to entry, monopoly, abnormal (economic) profit, long run
• diagram to show a monopoly realizing abnormal profit
• explanation that monopoly firms can maintain monopoly profits in the long run because of barriers to entry such as economies of scale, branding and legal barriers
• examples of specific barriers to entry that enable monopoly firms to make abnormal profits in the long run in practice
• synthesis or evaluation (discuss).

Discussion may include: monopoly firms do not always earn abnormal profits even with barriers to entry due to insufficient demand for their products (resulting from changing consumer tastes, technological obsolescence, etc); governments often regulate or nationalize monopolies, resulting in lower prices and profits; monopolies may have goals different from profit maximization (such as revenue maximization, technology development, etc); consideration of the word “always”.

Examiners should be aware that candidates may take a different approach which, if appropriate, should be rewarded.

NB It should be noted that definitions, theory, and examples that have already been given in part (a), and then referred to in part (b) should be rewarded.