The two primary factors determining monopoly market power are the firm's

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Question restatement: The two primary factors determining monopoly market power are the firm's

answer option provided: 'demand curve and its cost structure'

Analysis of the option:
- First element (demand curve): In a monopoly, the demand curve the firm faces is crucial because it determines how price changes affect quantity sold and hence revenue. The monopolist faces the downward-sloping market demand curve, which gives MR (marginal revenue) that typically lies below price. This relationship is central to choosing the profit-maximizing output where MR = MC. So, the demand curve is indeed a fundamental determinant of the degree of market power because it governs how responsive buyers are to price changes and how high a price the monopolist can charge.
- Second element (cost structure): While a firm’s cost structure (costs per unit, fixed vs. variable costs, economies of scale) affects the minimum efficient scale and the firm’s profitability at different output levels, it does not by itself establish market power. Market power is primarily about the ability to set prices above marginal cost and the barriers that prevent entry by other firms. Cost structure influences the monopolist’s optimal output and profitability but is not the core determinant of how much market power exists in the market.

Possible conceptual gaps in the option:
- Barriers to entry: A major determinant of monopoly power is the presence of high barriers to entry (legal restrictions, control of essential facilities, high capital requirements, etc.), which prevent competitors from eroding the monopolist’s market power. This factor is often more central than cost structure in explaining enduring monopoly power.
- Demand elasticity and market demand: The shape and position of the demand curve facing the monopolist determine how much price increases reduce quantity demanded, influencing pricing power.
- Product differentiation and strategic behavior: These can also affect market power by shaping consumer preferences and the ease with which rivals can lure customers.

Why the option is incomplete or potentially misleading:
- The phrase 'demand curve and its cost structure' combines two components, one of which (the demand curve) is a core determinant, while the other (cost structure) is not typically categorized as a primary determinant of monopoly power. In many analyses, barriers to entry and demand conditions are emphasized over cost structure for explaining why monopolists can maintain power.
- In some contexts, a natural monopoly arises precisely due to scale economies in the cost structure, which can be a reason for monopoly formation. However, even in natural monopolies, power arises because the firm can serve the entire market with lower costs, and the power is still mediated by demand and barriers to entry in the broader sense.

Bottom line for understanding: The monopolist’s market power is best understood through the lens of the demand they face (and the resulting revenue/price-setting potential) and the barriers to entry that prevent competition. While cost structure matters for the firm’s profitability and optimal output, it is not the primary determinant of sustained monopoly power. Hence, relying on 'demand curve and its cost structure' as a complete answer misrepresents the main drivers, since barriers to entry and demand conditions play a pivotal role in sustaining monopoly power over time.

ECON 203-0001 Exam 2

The two primary factors determining monopoly market power are the firm's

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