Monopoly

• What is a monopoly

  where a single seller or producer assumes a dominant position in an industry or a sector
• In the Uk, what's the concentration ratio for a monopoly?

  When a firm has more than 25% of the market share.
• Monopoly Graph

  • A monopolist will seek to maximise profits by setting output where MR = MC
  • This will be at output Qm and Price Pm.
  • Compared to a competitive market, the monopolist increases price and reduces output
  • Red area = Supernormal Profit (AR-AC) * Q
  • Blue area = Deadweight welfare loss (combined loss of producer and consumer surplus) compared to a competitive market

  A) MR

  B) D=AR

  C) AC

  D) MC

  E) Pm

  F) Pc

  G) Qc

  H) Qm

  I) P

  J) Q

  K) Supernormal profit

  L) Deadweight welfare loss

  
• How monopolies can develop:

  1. Horizontal Integration. e.g. two banks such as TSB and Lloyds
  2. Vertical Integration. A good example is the oil industry, where the leading firms produce, refine and sell oil.
  3. Legal Monopoly. E.g. Royal Mail or Patents for producing a drug.
  4. Internal Expansion of a firm. Firms can increase market share by increasing their sales and possibly benefiting from economies of scale. E.g. Google by dominating the search engine market.
  5. Being the first firm e.g. Microsoft
• Monopolies and Barriers to entry

  Monopolies also need barriers to entry to protect them from new firms entering the market.

  Barriers to entry can include – brand loyalty through advertising and economies of scale
• Disadvantages of Monopoly

  1. Higher prices. Firms with monopoly power can set higher prices (Pm) than in a competitive market (Pc). (Red area is supernormal profit)
  2. Supernormal Profit. A monopolist makes Supernormal Profit Qm * (AR – AC ) leading to an unequal distribution of income in society.
  3. Higher prices to suppliers – A monopoly may use its market power (monopsony power) and pay lower prices to its suppliers. E.g. supermarkets have been criticised for paying low prices to farmers. This is because farmers have little alternative but to supply supermarkets who have dominant buying power.

  
• Disadvantages of Monopoly

  1. X – Inefficiency. – It is argued that a monopoly has less incentive to cut costs because it doesn’t face competition from other firms. Therefore the AC curve is higher than it should be.
  2. Diseconomies of scale – It is possible that if a monopoly gets too big it may experience diseconomies of scale. – higher average costs because it gets too big and difficult to coordinate.
• Disadvantages of Monopoly

  1. Lack of incentives. A monopoly faces a lack of competition, and therefore, it may have less incentive to work at product innovation and develop better products.
  2. Lack of choice. Affects Consumers. In some markets – clothing, choice is as important as price
• Advantages of Monopoly - Economies of Scale

  • If there are significant economies of scale, a monopoly can benefit from lower average costs. This can lead to lower prices for consumers.

  If a firm is in a competitive market and produces at Q2, its average costs will be AC2.

  A monopoly can increase output to Q1 and benefit from lower long-run average costs (AC1). In industries with high fixed costs, it can be more efficient to have a monopoly than several small firms.

  A) LRAC

  
• Advantages of Monopoly

  1. More profit for research and development – enabling better products in the long-run
  2. Firms who become monopolies need to be successful and efficient.
  3. Domestic monopolies provide international competition.
  4. Monopolies reduce duplication of infrastructure and services.
• Evaluating Monopolies

  • It depends on the industry in question. For example, a monopoly is needed in a natural monopoly like tap water. However, for restaurants, there are no significant economies of scale and it is important to have a choice. Therefore monopoly would be very inappropriate for restaurants.
  • Some industries need a lot of research and development (e.g. building new aeroplanes, research drugs). Therefore, a monopoly may be needed in this industry.
  • A government may be able to regulate monopolies to gain benefits of economies of scale, without the disadvantages of higher prices.
• What is a natural monopoly?

  occurs when the most efficient number of firms in the industry is one.
• What do Fixed costs look like in a natural monopoly?

  A natural monopoly will typically have very high fixed costs meaning that it is impractical to have more than one firm producing the good.
• Natural Monopoly Diagram

  • Suppose the industry demand is 10,000 units.
  • If a firm produces 10,000 units, it will get the lowest possible average costs – £9.
  • If there were three firms producing 3,000 units. The firms would have average costs of £17.
  • Therefore, the optimal number of firms in the industry will be one (one firm producing all 10,000 units)

  A) Economies of Scale

  B) AC

  C) LRAC

  D) D

  E) Q

  
• Difference between monopoly and competitive markets in the long-run

  In the short run, firms in competitive markets and monopolies could make supernormal profit.

  However;

  • In monopolies, there are barriers to entry – which prevent new firms from entering the market
  • In competitive markets barriers to entry are low – so new firms can enter the market causing lower profit.
  • Therefore, in the long-run in competitive markets, prices will fall and profits will fall.
  • However in the long-run in monopoly prices and profits can remain high.
• Efficiency and monopoly

  • Monopolies set a price greater than MC which is allocatively inefficient.
  • By producing at Qm, the monopoly is productively inefficient (not lowest point on AC curve)
  • With less competition, a monopoly has fewer incentives to cut costs and therefore will be x-inefficient.

  
• Welfare loss to society

  • In a competitive market, the output will be at Pc and Qc. (point C)
  • In a monopoly, the output will be QM and PM (point M)– causing a fall in consumer surplus.
  • Monopoly also causes a fall in producer surplus (less is sold). But, some of the consumer surplus is captured by firms (from setting higher price).
  • The blue triangle shows the net loss of consumer and producer surplus to society.

  
• Disadvantages to Monopoly

  1. Allocative inefficiency. A monopoly is allocatively inefficient because in monopoly (at Qm) the price is greater than MC. (P > MC). In a competitive market, the price would be lower and more consumers would benefit from buying the good. A monopoly results in dead-weight welfare loss indicated by the blue triangle. (this is net loss of producer and consumer surplus)
  2. Productive inefficiency. A monopoly is productively inefficient because the output does not occur at the lowest point on the AC curve.