IGCSE Economics 0455: Competitive Markets versus Monopoly

In the town of Aldermoor, fourteen independent hair salons compete for customers along the same high street. Each salon offers a broadly similar haircut for around $18, and salons regularly change their opening offers and styling options to attract passers-by.

In the neighbouring village of Rushcombe, a single company, Rushcombe Water Co. is the only supplier of piped drinking water to every household, under an exclusive 40-year contract that prevents any rival company from building its own water network in the village.

(a) State two characteristics of a competitive market, using Aldermoor's hair salon market as an example. [2]

(b) State two characteristics of a monopoly market, using Rushcombe Water Co.'s position as an example. [2]

(c) Explain why Rushcombe Water Co. is likely to be able to charge a higher price for water than would be charged if several water companies competed for customers in the village. [2]

Part (a): Characteristics of a competitive market

Aldermoor’s hair salon market shows the hallmarks of a competitive market:

There is a large number of firms, fourteen salons, all competing for the same customers on the same high street.
The salons sell a similar service (a broadly similar haircut), and because customers can easily switch from one salon to another, no single salon can raise its price much above $18 without losing business to a rival.

Part (b): Characteristics of a monopoly market

Rushcombe Water Co.’s position shows the hallmarks of a monopoly market:

It is the only firm supplying piped drinking water to the village. There is no second water network for households to choose instead.
Its exclusive 40-year contract acts as a barrier to entry, legally preventing any rival company from building a competing water network in Rushcombe.

Part (c): Why the monopoly can charge a higher price

In Aldermoor, if one hair salon raised its price too far above $18, customers could simply walk to one of the other thirteen salons instead. Competition disciplines the price each salon can charge.

Rushcombe households have no such alternative. Because the exclusive 40-year contract stops any rival company from building a second water network, no other supplier can offer households a cheaper option even if Rushcombe Water Co. raises its price. With no competing firm to lose customers to, Rushcombe Water Co. can charge a higher price for water than would be sustainable in a market with several competing suppliers.

Final answers

(a) Aldermoor’s hair salon market: many firms selling a similar service, and easy switching between them limits each salon’s pricing power.
(b) Rushcombe Water Co.: the only supplier in the market, protected by a barrier to entry, the exclusive 40-year contract.
(c) With no rival supplier that households can switch to, Rushcombe Water Co. faces no competitive pressure to keep its price down, so it can charge more than a competitive market would allow.