Monopoly
August 21st, 2007 | by Qurratulain |Monopoly is a situation in which a single company or group owns all or nearly all of the market for a given type of product or service. By definition, monopoly is characterized by an absence of competition, which often results in high prices and inferior products. Getting strictly academic, monopoly is a market containing a single firm.
Investopedia Says: Monopoly is the extreme case in capitalism. Most believe that, with few exceptions, the system just doesn’t work when there is only one provider of a good or service because there is no incentive to improve it to meet the demands of consumers. Governments attempt to prevent monopolies from arising through the use of antitrust laws.
Of course, there are gray areas; for instance the granting of patents on new inventions. These give, in effect, a monopoly on a product for a set period of time. The reasoning behind patents is to give innovators some time to recoup what are often large research and development costs. In theory, they are a way of using monopolies to promote innovation. Another example is public monopoly set up by governments to provide essential services. According to some experts, utilities should offer public goods and services such as water and electricity at a price affordable to everyone.
Causes of Monopoly:
How is monopoly position in a market caused? The fastest route for a business to grow and take an increasing share of a particular market is through integration i.e. through agreed mergers or contested take over’s. a horizontal integration occurs when two businesses in same industry at the same stage of production become one.
On the other hand, the vertical Integration involves acquiring a business in the same industry but at different stages of the supply chain – for instance, an oil company owning drilling and extraction businesses together with refining, distribution and retail subsidiaries.
Monopoly power also comes from the ownership of Patents and Copyright protection or the exclusive ownership of assets (e.g. De Beers - diamonds).
The government may also give legal monopoly power to some business through nationalization or government awarded franchises and licenses.
Monopoly power for existing firms within a business can come more organically through the internal growth of a firm, taking advantage for example of internal economies of scale
Potential benefits from monopoly:
The debate on monopoly is endless. The consensus seems to be that the economic case for and against monopoly needs to be judged on the basis of individual cases, particularly when assessing the impact on economic welfare.
The standard economic case against monopoly is that, with the same cost structure, a monopoly supplier will produce at a lower output and charge a higher price than a competitive industry. This leads to a net loss of economic welfare and efficiency because price is driven above the marginal cost, leading to allocative inefficiency.
The diagram below shows how price and output differ between a competitive and a monopolistic industry. Assume that the cost structure for both the competitive firm and the monopoly is the same: indeed we have assumed that output can be supplied at a constant marginal and average cost.
Assuming that the monopolist seeks to maximize profits and that they take the whole of the market demand curve, then the price under monopoly will be higher and the output lower than the competitive market equilibrium. This leads to a deadweight loss of consumer surplus and therefore a loss of static economic efficiency.
Monopoly and Economies of Scale:
Because monopoly producers are often supplying goods and services on a very large scale, they may be better placed to take advantage of economies of scale - leading to a fall in the average total costs of production. These reductions in costs will lead to an increase in monopoly profits but some of the gains in productive efficiency might be passed onto consumers in the form of lower prices. The effect of economies of scale is shown in the diagram above. Economies of scale provide potential gains in economic welfare for both producers and consumers.
Regulation of monopoly:
Because of the potential economic welfare loss arising from the exploitation of monopoly power, the Government regulates some monopolies. Regulators can control annual price increases and introduce fresh competition into particular industries
Monopoly and Innovation:
Are large-scale firms required to create a comparative advantage in global markets? Some economists argue that large-scale firms are required to be competitive in international markets.
An important issue is what happens to the monopoly profits both in the short run and the long run. Undoubtedly some of the profits will be distributed to shareholders as dividends. This raises questions of equity. Some low income consumers might be exploited by the monopolist because of higher prices. And, some of their purchasing power might be transferred via dividends to shareholders in the higher income brackets - thus making the overall distribution of income more unequal.
However some of the supernormal profits might be used to invest in research and development programmes that have the potential to bring dynamic efficiency gains to consumers in the markets. There is a continuing debate about whether competitive or monopolistic markets provide the best environment for high levels of research spending.
Price Discrimination:
Are there potential welfare improvements from price discrimination? Some forms of price discrimination benefit certain consumers.
Domestic monopoly but international competition:
A firm may have substantial domestic monopoly power but face intensive competition from overseas producers. This limits their market power and helps keep prices down for consumers. A good example to use here would be the domestic steel industry. Corus produces most of the steel manufactured inside the UK but faces intensive competition from overseas steel producers.
Contestable markets:
Contestable market theory predicts that monopolists may still be competitive even if they enjoy a dominant position in their market. Their price and output decisions will be affected by the threat of “hit and run entry” from other firms if they allow their costs to rise and inefficiencies to develop.
Price and output under a pure monopoly:
Be careful of saying that “monopolies can charge any price they like” - this is wrong. It is true that a firm with monopoly has price-setting power and will look to earn high levels of profit. However the firm is constrained by the position of its demand curve. Ultimately a monopoly cannot charge a price that the consumers in the market will not bear. A pure monopolist is the sole supplier in an industry and, as a result, the monopolist can take the market demand curve as its own demand curve. A monopolist therefore faces a downward sloping AR curve with a MR curve with twice the gradient of AR. The firm is a price maker and has some power over the setting of price or output. It cannot, however, charge a price that the consumers in the market will not bear. In this sense, the position and the elasticity of the demand curve acts as a constraint on the pricing behaviour of the monopolist. Assuming that the firm aims to maximise profits (where MR=MC) we establish a short run equilibrium as shown in the diagram below.
Assuming that the firm aims to maximise profits (where MR=MC) we establish a short run equilibrium as shown in the diagram below.
The profit-maximising output can be sold at price P1 above the average cost AC at output Q1. The firm is making abnormal “monopoly” profits (or economic profits) shown by the yellow shaded area. The area beneath ATC1 shows the total cost of producing output Qm. Total costs equals average total cost multiplied by the output.
A CHANGE IN DEMAND
A change in demand will cause a change in price, output and profits.
In the example below, there is an increase in the market demand for the monopoly supplier. The demand curve shifts out from AR1 to AR2 causing a parallel outward shift in the monopolist’s marginal revenue curve (MR1 shifts to MR2). We assume that the firm continues to operate with the same cost curves. At the new profit maximising equilibrium the firm increases production and raises price. Total monopoly profits have increased.
Not all monopolies are guaranteed profits - there can be occasions when the costs of production are greater than the average revenue a monopolist can charge for their products. This might occur for example when there is a sharp fall in market demand (leading to an inward shift in the average revenue curve). In the diagram below notice that ATC lies AR across the entire range of output. The monopolist will still choose an output where MR=MC for this reduces their losses to the minimum amount.
How do monopolies continue to earn supernormal profits in the long run - revise barriers to entry. See also the pages on price discrimination
