According to Mankiw, one of the Ten Principles of Economics is that rational people think at margin (Mankiw, 2001, P6). In this sense, a monopolist is assumed to be a profit maximiser. From Graph 2, profit maximization point is where marginal revenue equals marginal cost. Thus, an abnormal profit has been created. This means that the monopoly firm is earning more with its resources than its costs and will attract competitors. If the monopolist wants to continue making abnormal profits, there must be strong barriers to entry. The first form of it is government regulations, patents and copyrights. The governments grant a monopoly because, on one side, competition would force the price down, therefore public interests would be reduced. On the other side, inflation would keep low if price is low, it is far better for a country to have low inflation.
The second form of barriers to entry is that the costs of production make a monopoly firm more efficient than other producers. In some cases, it can be also explained as a monopoly has economies of scale. The last type is that a monopoly firm may get key resources which are no close substitutes. For instance, the principle diamond mines are owed by De Beers. The main tour operators in UK own many of the country’s travel agents, making it difficult for new operators to find suitable outlets for their products (Grant, 2003, p112). As a result, potential entrants are prevented from entering the monopoly market. Monopoly therefore provides a constraint on competition among the whole market.
Unlike the firms in the long-run equilibrium position in a perfectly competitive market, a monopoly is allocatively and productively inefficiency (Gillespie, 2007, p164). A monopoly firm can abuse its market power to restrict its output and forces up prices for the consumer relative to a perfect competitive market. Thus, consumers may be forced to pay more than he would in a competitive market as limited substitutes are available in a monopoly situation. In a competitive market, the invisible hand of the market makes total surplus as large as it can be. By contrast, the relative high monopoly price and low quantity outcome in monopoly market has led to the transfer from consumer surplus to producer surplus and result in a welfare loss. The triangle ABC in Graph 3 is a welfare loss area that exists because the firm is allocatively inefficiency.
A monopoly firm is also productively inefficient because it is not producing at the minimum average cost which is the most efficient output level. However, if the firm gives an output at Qc, the price would have to be lowered and much the profit would fall, which means the firm must use more resources to produce the same output as a competitive industry. Productive inefficiency appears in monopoly market mainly due to ‘X-inefficiency’ because monopolists only look at the outputs that are produced with given inputs (Leibenstein, 1966). In addition, the lack of competition in a market may reduce the pressure on firms to innovate and use the most efficient methods. This may lead to cutback in research and development spending. What’s more, due to barriers to entry, firms have an incentive to put large amount of resources to obtain its monopoly position. In this sense, firms may take lots of lawyers and public relations specialists to lobby or even bribe politicians rather than devote to the development of production or services. Costs therefore will drift upwards and resources are wasted.
It also can be argued that there are some advantages and potential benefits of monopoly. Firstly, in a monopoly market where economies of scale are significant, the unit costs of the monopoly firm may be lower than they would be in a competitive market. This is referred to as a natural monopoly. Graph 4 shows this situation, for any given amount of output, a larger number of firms leads to less output per firm and higher average cost. Thus, a natural monopoly is productively efficient than a competitive market. Examples of natural monopoly include water services and electricity. It is very expensive to build transmission networks; therefore it is unlikely that a potential competitor would be willing to enter these monopoly markets. Furthermore, monopolists could make monopoly profits provides dominate firms with investing in more research and development of new products or process, which could bring large efficiency gains.
It is called price discrimination when a firm offers same product but charges different prices to different consumers. Price discrimination enables the firm to make more profits, it removes the allocative inefficiency of a single-price monopoly, but the customers are worse off. However, it is an additional barrier to entry as it aims at killing off potential competitors. A firm must be able to identify different demand conditions among different groups of customers in order to price discriminate effectively. A monopoly firm could also provide some stability of output and price for consumers as the monopolist may have a great deal of experience about estimating market trends and making long-run plans. Although there are arguments in favour of monopoly, competition authorities usually take the view that competitive markets serve the public best.
With problems existing in monopoly markets, government may decide to intervene by providing competition policy with the intention of correcting market failure and increasing economic efficiency. The objective of competition policy is to prevent uncompetitive behaviours. For instance, a monopoly firm may charge a relatively high price and provide poor services; firms fix prices as part of a cartel. A cartel usually occurs in an to deal with uncertainty by making formal agreements with other firms to fix prices. Competition policy therefore tries to create and maintain market structures competitive and control natural monopolies. The policy measures the government use in UK are various, including merger control; making uncompetitive practices illegal; regulations on privatised utilities; removing artificial barriers to entry into market (Grant, 2003, p185). For example, following the recommendations of Competition Commission, the government prevented Sainsbury, Tesco or Asda from taking over Safeway Stores and the stores were finally sold to Morrison. A successful competition policy will put pressure on firms to produce in a more efficient way. It could result in lower prices, higher outputs, higher consumer surplus and more innovation than it would be by doing nothing. However, there is a risk that economic efficiency may be reduced by limitation of firm’s dominance and may lead to increased costs.
Indeed, monopolies may be allocatively and productively inefficiency compared with a competitive market. Monopolies also give great benefits to the community as a whole.
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Gillespie, A. (2007) Foundations of Economics, Oxford, Oxford University.
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Gowland, D.H. & Paterson, A. R.(1993) Microeconomic Analysis, New York, Harvester Wheatshesf.
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Grant, S.J. (2003) AS Economics, Essex, Pearson.
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Mankiw, N.G. (2001) Principles of Economics 2nd Edition, Fort Worth, Harcourt College.
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Gillespie, A. (2007) Foundations of Economics, Oxford, Oxford University.
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Gowland, D.H. & Paterson, A. R.(1993) Microeconomic Analysis, New York, Harvester Wheatshesf.
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Grant, S.J. (2003) AS Economics, Essex, Pearson.
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Grinols, E. (1994) Microeconomics, Geneva, Houghton Mifflin.
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Mankiw, N.G. (2001) Principles of Economics 2nd Edition, Fort Worth, Harcourt College.
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Robinson, E.A.G. (1961) Monopoly, Cambridge, Cambridge University.
