Monopoly and monopoly power Flashcards
Monopoly power in markets
- Dominant firm
- Price maker
- No substitutes
- Not allocatively efficient P≠MC
- Not productively efficient
- High barriers to entry
Monopoly power in markets
- A pure monopolist is a single supplier that dominates the entire market - the market has 100% concentration ratio
- A working monopoly is any firm with greater than 25% of the industries total sales
- A dominant firm is a firm that has at least 40% market share
- Price setting or price making power is available to any business with a downward sloping demand (AR) curve
- There are assumed to be high entry and exit barriers into a monopolistic market in SR
- Because firms are price makers they will have a downward sloping demand curve (AR)
- If AR if falling, then marginal revenue (MR) is below AR
- Aims to profit maximise operates where MC = MR
- Makes supernormal profits as it produces where AR is greater than AC
- Is a price maker e.g. it sets the price in the market no close substitutes therefore relatively inelastic demand
Sources of monopoly power
Monopolies acquire and maintain power over their markets for a number of reasons
Natural sources:
- Economies of scale at large production levels
- Control of key resources
- High set up or sunk costs
Artificial sources:
- Patents
- Vertical integration
- Product differentiation
- Benefitting from ‘first mover’ advantage
- Limit or predatory pricing
- High marketing expenditure
Monopoly - the diagram
- The monopolist operate at point a where MC = MR
- It can then charge at any price up to the D curve at point b. Here we have a price of P.
- The profit made by the monopolist is the difference between AR and AC shown by the shaded area
- The monopolist is making supernormal profit at this point because AR is greater than AC
- The monopolist continues to make supernormal profit due to barriers to entry
Perfect competition Vs Monopoly
- In PERFECT COMPETITION firms can make supernormal profits in the short run where AR is greater than AC. In the long run new firms enter the industry and compete away this supernormal profit to leave normal profit
- In MONOPOLY firms can make supernormal profits in the short run where the AR is greater than AC. In the long run there are barriers to entry stopping new firms entering the industry. Therefore, the firm makes supernormal profit in both the short run and the long run, this diagram can be used to illustrate both
(In)Efficiency
Allocative
- A monopoly is allocatively inefficient because in monopoly the price is greater than MC (P > MC). In a competitive market the price would be lower and more consumers would benefit. A monopoly results in dead-weight welfare loss indicated by the red triangle
Productive
- Where the output is produced at minimum average total cost
- A monopoly is productively inefficient because output does not occur at the lowest point on the AC curve
Dynamic
- The productive efficiency of a firm over a period of time
- Without drive to innovate products, the dynamic efficiency in competitive market is low
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. If firms costs at any point above AC curve then X inefficiency
Monopoly - inefficiency diagram
- Productive inefficiency occurs as monopolists operate above the lowest point on their LRAC curve at point a.
- Allocative inefficiency occurs as price does not reflect the value that consumers put on the product as P > MC at point b.
- X-inefficiency occurs as there are no incentives to keep costs to a minimum e.g. at point a. This is due to a lack of competition
Innovation
- Innovation is putting new ideas or approach into action
- Innovation is ‘the commercially successful exploitation of ideas’
- Innovation has demand and supply side effect in markets and the economy as a whole
Product innovation
- Small scale and frequent subtle change to the characteristic and performance of a good or a service
Process innovation
- Changes to the way in which production takes place or is organised
- Changes in business models and pricing strategies
Advantages of monopoly
Can achieve economies of scale
- This lowers the average cost of production
- They can therefore charge lower prices to that of firms in perfect competition
Can use retained profits to invest in research and development
- This creates dynamic efficiency as innovation leads to better processes lowering the LRAC curve further
- Better quality products can be developed as monopolies can invest without the threat of competitors
- Natural monopoly - economies of scale
- Domestic monopoly faces global competition
- Monopolistic firms can be regulated - e.g. industry regulator acting as a proxy customer
- Price discrimination may help consumers
Disadvantages of monopoly
- Removes competition due to barriers to entry
- Makes supernormal profits in the long run by charging higher prices than would occur under competitive markets
- This leads to the consumer being exploited
- Is productively inefficient as it does not produce at the lowest point on its LRAC curve
- In allocatively inefficient as it does not produce at the point where P = MC
- Is x-inefficient as no competition means less incentives to control costs
- Can reduce choice and quality as there is no competition
- Service
> Does the lack of competition affect the quality of service to consumers? - Prices
> How high are prices compared to competitive/ contestable market - Welfare
> What are the overall welfare outcomes?
> Is there a net loss of welfare in markets dominated by business with monopoly power?
For monopolies
- Consumer may pay less as monopoly exploits monopsony power over suppliers
- If dynamic efficiency quality of good increase, innovation is faster, specialisation for the country
- Required in order to compete internationally
- Price discrimination increases efficiency
- Welfare loss for consumer provides supernormal profit for firm
- EOS as output increases - could be passed on to consumer
- Employment source
Against monopolies
- Exploited suppliers due to monopsony pushing price down. May need to leave market.
- Government intervention required if inefficient monopoly - Competition and Markets Authority
- Individuals pay higher prices - not allocative
- Power to price discriminate - price differently depending on customer
- Diseconomies of scale larger firms require more government intervention
- Firms socially irresponsible - negative externalities in production
- Welfare loss to consumer
- Less innovation due to lack of competition
Government intervention - Tax on monopoly profits
Reasoning:
- A one off windfall tax on supernormal profits from monopoly power
Evaluation:
- Risks of tax avoidance/ loss of capital investment spending
Government intervention - Liberalization of markets
Reasoning:
- Breaking up monopolies - allow smaller businesses to enter and increased contestability
Evaluation:
- Smaller businesses may struggle to scale up and compete
Government intervention - Introduce price capping policies
Reasoning:
- Encourage cost efficiency + increase consumer surplus
Evaluation:
- Monopolists may find revenue in other ways
Government intervention - Nationalisation
Reasoning:
- Take some monopoly utilities back into public ownership
Evaluation:
- Possible loss of productive efficiency
Consumer surplus
- CS is the difference between the price paid and the amount which consumers would have been willing and able to buy the product at
Producer surplus
- PS is the difference between price taken by the producer and the price they would have been willing and able to supply at
Monopoly undesirable
The main case against monopoly is that it can earn supernormal profits at the expense of economic efficiency
- The monopolist can extract a price from consumers that is above the cost of resources used in making the product
- E.g. consumer surplus turned into additional producer surplus
Consumers needs and wats are not being satisfied as the product is being under-consumed because price is above cost
- Leading to what is known as market failure
Little pressure for a firm with monopoly power to maximise their efficiency or minimise costs of production
- “Managerial slack” or “X-inefficiencies”
- Limited incentives to adopt costs reducing process innovations
Monopoly undesirable in the case for competitiveness
- Competitive markets provide the best means of ensuring that the economy’s resources are put to their best use by encouraging enterprise and efficiency, and widening choice
- Where markets work well, they provide strong incentives for good performance - encouraging firms to improve productivity, to reduce prices and to innovate; whilst rewarding consumers with lower prices, higher quality, and wider choice
- By encouraging efficiency, competition in the domestic market - whether between domestic firms alone or between those and overseas firms - also contributes to our international competitiveness
Monopoly not always undesirable
Research and development spending
- Profits can fund investment and research and development projects
- The positive spill-over effects of research can be seen increased innovation
The exploitation of Economies of scale
- Monopolies can exploit economies of scale
- Gains in productive efficiency might lead to lower prices and improvements in economic welfare
Monopolies and international competitveness
- British economy needs multinational companies operating on a scale large enough to compete effectively in global markets
International competition and market contestability
- A firm may enjoy domestic monopoly power in the home economy, but face intense competition in overseas markets
Social welfare contributions
- Some monopolists invest in “good works”, such as sponsoring arts, museums, research
