Key Terms
Monopoly: A situation in which a single company or group owns all or nearly the entire market share for a given type of product or service.
Barriers to entry: Obstacles that stop new firms entering a market.
Natural monopoly: A firm that can theoretically gain continuous economies of scale and where it is thus uneconomic for more than one form to supply the market.
Super-normal profit: Extra profit above the level of normal profit
Barriers to entry: Obstacles that stop new firms entering a market.
Natural monopoly: A firm that can theoretically gain continuous economies of scale and where it is thus uneconomic for more than one form to supply the market.
Super-normal profit: Extra profit above the level of normal profit
Theory
What is a Monopoly?
Theoretically a pure monopoly is a firm that is the single supplier in a market. In the real world however we cansider a firm to be a monopoly when it control 25% or more of a market.
Features of Monopoly Market
Examples of Monopoly
Diagram
Like all firms a monopoly seeks to maximise profit where MR = MC. Since there are no other firms in the market the monpoly is a the price maker and can set the price at any level it chooses, in this case PM.
In monopoly, the price level is found by finding where the MC crosses the MR and then going directly upwards until you hit the average revenue (AR) curve, at this spot you can determine the price (PM).
Sources Of Monopoly Power
1) Natural Monopoly
This occurs when there is only room in the market for one firm to fully benefit from the exploitation of economies of scale. Until recently utility industries such as gas and water were considered to be natural monopolies. This is because water and gas are provided through distribution grids.
Opening up a distribution grid to competition requires a duplication of fixed capacity, thus causing unneccesarily high fixed costs.
2) Geographical Monopoly
Monopoly can arise through the location of a supplier. Consider a shop in an isolated town. Most villagers will find it inconvenient to travel anywhere else, therefore the shop exercises monopoly power. Knowing this, prices are likely to be set higher in the village as the village shop is the only supplier.
3) Government-created Monopoly (Nationalisation)
Governments have the power to create monopoly if they believe that the market is too inefficient or too important to leave to the free market. This process of transfering private assets to the public sector is known as nationalisation.
4) Advertising as a source of monopoly power
Large firms can prevent small firms from entering the industry by using saturation advertising. Advertising is neccesary to persuade retailers to stock the firms product. Small firms are unable to afford the minimum level of advertising and are effectively crowded out of the market.
Advantages of Monopoly
1) Dynamic Efficiency
Super-normal profit may also be invested in new production processes enabling a reduction in short-run and long-run average costs.
Reinvestment may also result in:
Better management of human capital = ↑ job satisfaction
New technology = ↑ capital / labour productivity
2) Economies of Scale
A monopoly can also have particular advantages if it choses to exploit economies of scale. For example supernormal profit in the long-run may be invested in patents leading to a faster rate of technological advancement.
This may lead to:
Lower costs
Better quality goods for consumers
However just because firms can reinvest doesn’t mean they will, in fact they often don’t. Many multi-nationals have huge cash reserves that are not reinvested.
3) Penetrate overseas markets
If domestic monopolies are allowed to occur, they may be able to penetrate foreign markets. Thus leading to macro-economic benefits. E.g. TESCO have opened branches in China, Japan and South Korea. By opening branches in foreign countries the level of exports will rise.
4) Aquisition of inefficient firms
By making super-normal profit in the long-run, firms that exersize monopoly power have the resources to aquire inefficient firms. By aquiring another firm, the monopoly gains more capital equipment perhaps resulting in an overall greater productivity.
5) Aquisition of smaller innovative firms / Increase consumer choice
Monopoly firms such as google often aquire smaller firms that produce innovative products. Small firms don't have the capital to pay for advertising, therefore their products are relatively unknown. Monopolies do have the finances to pay for advertising and can therefore increase consumer choice by aquiring the smaller firms and promoting the products.
Super-normal profit may also be invested in new production processes enabling a reduction in short-run and long-run average costs.
Reinvestment may also result in:
2) Economies of Scale
A monopoly can also have particular advantages if it choses to exploit economies of scale. For example supernormal profit in the long-run may be invested in patents leading to a faster rate of technological advancement.
This may lead to:
However just because firms can reinvest doesn’t mean they will, in fact they often don’t. Many multi-nationals have huge cash reserves that are not reinvested.
3) Penetrate overseas markets
If domestic monopolies are allowed to occur, they may be able to penetrate foreign markets. Thus leading to macro-economic benefits. E.g. TESCO have opened branches in China, Japan and South Korea. By opening branches in foreign countries the level of exports will rise.
4) Aquisition of inefficient firms
By making super-normal profit in the long-run, firms that exersize monopoly power have the resources to aquire inefficient firms. By aquiring another firm, the monopoly gains more capital equipment perhaps resulting in an overall greater productivity.
5) Aquisition of smaller innovative firms / Increase consumer choice
Monopoly firms such as google often aquire smaller firms that produce innovative products. Small firms don't have the capital to pay for advertising, therefore their products are relatively unknown. Monopolies do have the finances to pay for advertising and can therefore increase consumer choice by aquiring the smaller firms and promoting the products.
Disadvantages of Monopoly
1) Inefficiency
Whilst a market dominated by a monopoly firm may be dynamically efficient, the market may also be inefficient in other areas:
Allocative Inefficiency
Monopoly is allocatively inefficient because in monopoly the price is greater than MC resulting in a deadweight loss (red area) and a reduction in consumer surplus.
Productive Inefficiency
Monopoly maybe productively inefficient because of X-inefficiency. The monopolist has less of an incentive to cut costs due to lack of competition. Therefore the AC curve is higher than it should be, in turn output does not occur at lowest point on AC.
2) Diseconomies of Scale
If a monopoly gets too big it may experience diseconomies of scale resulting in:
Higher costs of production
Higher prices for consumers
3) Equity issues
By selling products a price higher than P = MC, consumer surplus is reduced. This could be percieved as unfair to low income households.
Whilst a market dominated by a monopoly firm may be dynamically efficient, the market may also be inefficient in other areas:
Allocative Inefficiency
Monopoly is allocatively inefficient because in monopoly the price is greater than MC resulting in a deadweight loss (red area) and a reduction in consumer surplus.
Productive Inefficiency
Monopoly maybe productively inefficient because of X-inefficiency. The monopolist has less of an incentive to cut costs due to lack of competition. Therefore the AC curve is higher than it should be, in turn output does not occur at lowest point on AC.
2) Diseconomies of Scale
If a monopoly gets too big it may experience diseconomies of scale resulting in:
3) Equity issues
By selling products a price higher than P = MC, consumer surplus is reduced. This could be percieved as unfair to low income households.
Evaluation
Joseph Schumpeter’s hypothesis is that inefficient firms, including monopolies, will eventually be replaced by more efficient firms through a process of creative destruction.
Considering markets such as computer technology, Schumpeter would appear to be correct in his hypothesis. IBM once monopolised the computer market, however the efficient and innovative idea's spearheaded by companies such as Apple, Microsoft and Google have since lead to the relative demise of IBM.
Further more, monopolists do face competitive pressure from substitute products. For example British Gas in the 90's was forced to act competitively in the market despite being a pure monopoly. This was due to substitue energy product such as electricity and oil.
Considering markets such as computer technology, Schumpeter would appear to be correct in his hypothesis. IBM once monopolised the computer market, however the efficient and innovative idea's spearheaded by companies such as Apple, Microsoft and Google have since lead to the relative demise of IBM.
Further more, monopolists do face competitive pressure from substitute products. For example British Gas in the 90's was forced to act competitively in the market despite being a pure monopoly. This was due to substitue energy product such as electricity and oil.
Intervention to Correct Monopoly
1) Nationalisation
Advantages of Nationalisation
Disadvantages of Nationalisation
2) Revenue-cap regulation:
Amongst their functions, they are able to limit price increases. They can do this with a formula RPI-X.
X is the amount by which they have to cut prices by in real terms. If inflation is 3% and X= 1%. Then firms can increase actual prices by 3-1 = 2%.
Advantages of Revenue-cap regulation:
Disadvantages of Revenue-cap regulation: