3.5.5 - The Advantages and Disadvantages of Monopoly Flashcards
What are the two main advantages of monopolies?
Economies of scale
Dynamic Efficiency / Supernormal profit
Why are economies of scale an advantage of monopolies?
The monopolist benefiting from economies of scale leads to reducing long run average cost so consumer costs should fall.
Why is dynamic efficiency an advantage of monopolies?
Due to the supernormal profit that monopolies make in the long run, they can reinvest the profit into R&D to improve their productive efficiency over time, which leads to an increase in dynamic efficiency that competitive markets cannot take advantage of.
What is a natural monopoly?
A monopoly that occurs due to a particular country / location being the only source of supply of a raw material.
What were examples of natural monopolies in the past?
Utility industries such as water, gas and electricity.
Why is competition within utility industries a bad idea?
It’s extremely wasteful, as it requires the duplication of fixed capacity, and therefore each supplier incurs unnecessarily high fixed costs.
What are the main disadvantages of monopolies?
Productive inefficiency
Allocative inefficiency
Why is productive inefficiency a disadvantage of monopolies?
A monopoly may choose to profit-satisfice rather than maximise.
The ATC are at Point D rather than Point C for output Q1 demonstrating a lack of productive efficiency as ATC ≠ MC.
Why is allocative inefficiency a disadvantage of monopolies?
A monopoly will make supernormal profit, meaning P > MC.
When does x-efficiency occur?
When a firm has eliminated all unnecessary costs of production it may have otherwise incurred.
When does x-inefficiency occur?
When a firm has unnecessary costs of production.
Why may a monopoly choose to be x-inefficient rather than x-efficient?
On this graph, Z is off of the ATC, so the firm is still making supernormal profits it has unnecessary production costs. While it is true under traditional economic theory that a firm will profit maximise under any circumstances, a firm may instead choose to profit-satisfice due to the agents having different goals other than profit maximisation. The monopoly can do this as they are protected by barriers to entry which prevent new firms from entering the market. As a result of the barriers to entry, unnecessary costs very often persist in monopoly.
Explain the natural monopoly in the UK water industry?
In 1989, the UK water industry was sold off to privately owned companies, many of whom were UK PLCs. Today however, many of the firms have been bought by foreign owners.
Australian bank Macquarie borrowed £2.8 billion to purchase Thames Water, then offloaded £2 billion of Cayman Islands debt on to Thames Water and therefore it’s customers.
The idea of privatisation should theoretically increase competition and therefore efficiency. However, what the Conservative government failed to recognise was the efficiency only applies to markets that are not a natural monopoly. Water, and other utilities with distribution grids are natural monopolies and as a result, privatisation reduces efficiency overall.
Monopolies cannot gain benefits of economies of scale. T/F
False. They can take advantage of these economies of scale.
How are economies of scale shown on a graph?
A falling long-run average cost curve.
