Economics - Monopolists

ECONOMICS 1 ESSAY MONOPOLISTS

A pure monopolist is a single supplier of a good or service for which there is no close substitute. In this case the demand curve is fairly inelastic. Examples of monopolies prior to privatisation are British gas, British telecom and British rail. One firm has complete control over the supply of a good or service meaning one firm constitutes the entire industry. A small business or a company selling on a nationwide basis can have a monopoly. Few monopolists are likely to face no competition at all. In reality it is unusual for a firm to have complete control in an industry, as government often intervene to prevent such control. In the UK The Competition Commission states a monopoly exists when one firm has 25% of the market for a product. The more narrowly defined the product is the more number of monopolies there are.

A seller prefers to have a monopoly than to have competition. For a firm to obtain a monopoly there must be barriers to entry that enable firms to receive monopoly profits in the long run. Barriers to entry are difficulties facing potential new competitors in an industry. For monopoly power to continue to exist in the long run there has to be a way the market is closed to entry. Legal means or certain aspects of the industry’s technical or cost structure must prevent entry. Barriers to entry take several forms. A natural barrier is ownership or control of natural resources. If one firm owned the entire supply of raw material that is essential to produce a commodity, then the ownership of that resource is a barrier to entry. It would act as a barrier to entry until an alternative source of the raw material is found or until technology advances so that the raw material is no longer required to produce. An example of control over a raw material is the Aluminium Company of America. This company controlled the world’s bauxite before the Second World War. Bauxite is an essential material in the production of aluminium. If the monopolist owns the resources required to produce a good then it is possible to control the number of operators in their market, through restriction in supply. An example of this is the De Beer Company, they control the world supply of diamonds. Controlling the amount supplied to the market ensures high prices are maintained and helps to maximise profits.

There are also legal barriers to entry. In many industries it is illegal to enter without a licence, which is provided by the government. In the UK you could not operate an unlicensed postal service. There are also laws on competition, trading and the granting of patent rights. A patent is issued to an inventor to protect them from someone else copying their invention for a number of years. Patents were introduced in the UK in 1623 to encourage invention by giving the inventor short term reward. In general the firm holding the patent is protected from competition. The ...

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There are also artificial barriers which can be created through things like advertising and branding. The development of strong brand names is common. In the consumers mind a dominant brand name is associated with a specific firms product. Some examples are Tampax, Hoover and Durex. The brand image is taken to represent high quality. This acts as a barrier to entry as it is difficult and costly to attract consumers away from the strong brand names. The dominant firm may introduce price cuts to deter potential competition. Existing large monopolists may have budgets for advertising which potential new entrants to a market find it difficult to establish. The newcomer faces huge costs in coming up against such firms.

Also due to economies of scale sometimes it’s not profitable for more than one firm to exist in a market. A situation of natural monopoly may arise when economies of scale exist, costs increase less than proportionately to the increase in output. The long run average cost curve continues to fall as output increases making it very difficult for newcomers to compete with price. Within a natural monopoly the firm that is established is able to have very low average cost per unit. If a firm charges the price, which reflects the low average cost per unit, then no rival firm, can threaten its position. It will not be undercut and then is assured of being a monopolist.

Originally utilities such as electricity, gas, water and telecommunications had to be managed by the government to avoid unfair pricing. Privatisation has enabled governments to structure the public/private sector in a way that encourages natural monopolies to behave as if supply was being provided competitively. This model is called the theory of contestable markets, when there are few firms in an industry because there are fewer barriers to entry; firms are forced to price their products more competitively.

The monopolist is a price maker this means the consumer may be at a disadvantage paying higher prices than in a competitive market. It can be argued that monopolists operate on a level where they benefit from economies of scale. Due to unit costs falling, prices may be lower with monopoly than with small firms in a competitive market. The monopoly is the entire industry so the monopoly firm faces the entire market demand curve. The market demand curve is downward sloping, so in order to sell more of a particular product the monopoly firm must lower the price. If all buyers are to be charged the same price, in order for the monopolist to sell more they must lower the price on all units. The monopolist can practice price discrimination. By price discrimination different groups of consumers may be offered different prices for the same product. An example of this would be Scot rail; they charge commuters a higher price in the morning and evening peaks. This means they are discriminating on time of travel although the journey, distance and time are still the same, but off peak prices are lower. As long as each market group is distinct, monopolists are able to practice price discrimination. Some groups are charged more than others but if the groups are separated then the result is an increase in total revenue. This would also mean a decrease in average costs. Higher prices can be charged in markets with inelastic demand than in markets with elastic demand. The marginal revenue curve lies below the average revenue curve on a diagram to reflect the ability to price discriminate.

The monopolist has the power to determine either the level of output to be sold or the price at which the product will be sold. Having decided upon a price for sale the monopolist can only sell whatever the market demand is at that price, as the monopolist faces a normal downward sloping demand curve. Only price or output can be determined not both at the same time, to sell more of a given product the monopolist would have to cut the price.

In this market structure the producer has more power than the consumer. Monopolists act against the interests of the public by restricting output or charging high prices. Comparing monopolies to the market structure of perfect competition, suggests that monopolies lead to a decrease in consumer welfare. The desire to maximise profits would mean prices are set far above average costs. Profit maximisation occurs where marginal cost is equal to marginal revenue. Monopolies can be innovative and use excess profit to develop new and better products. If the monopolists did passed on to the consumer the benefits of economies of scale, by charging lower prices then it may be more beneficial than a market comprised of lots of small firms. There must be a balance of profit maximisation and consumer welfare.