Q. a) Compare monopoly and monopolistic competition (8)
b) Discuss whether a monopoly always disadvantages consumers. (12)
Comparing monopoly and monopolistic competition:
Monopoly and monopolistic competition are two types of imperfect competition market
structures where goods and services are supplied by firms in a particular market under
certain conditions and where customers have limited or no knowledge of the product and
find it difficult to evaluate their choices. This then limits efficient allocation of resources.
The characteristics of these types of markets to compare are summarised below:
Characteristic
Monopoly
Monopolistic
competition
Number of firms
One
Many
Product
differentiation
Unique (no
close
substitutes)
Differentiated
Barriers to entry
Very high
low
Control over price
considerable
limited
Availability of
information
little
some
A monopolistic competition market is where there are many firms and have relative freedom
of entry into an industry but, unlike perfect competition, firms have some control over the
product and its price due to some form of product differentiation (physical or quality). These
types of firms are price makers at least in the short term and consumers face a wide choice
of differentiated products. These firms then use price and non-price competition to try to
increase market power. This advantage due to low barriers to entry and the attractiveness of
supernormal profits makes the market readily contestable so that competitors will compete
out the supernormal profits in the longer run. It is also easy for firms to recoup their capital
expenditure on exit from the market.
A monopoly differs from the above market structure but has two different market forms. The
first is a pure monopoly where there is a single seller in the market, one firm, that is
producing a good or service for the entire market and where long-run average costs are
lower when there is just one firm in the industry. The second type is where a monopolistic
industry exists with many firms but one firm may dominate the market due to it having a very
large or dominant market share (>25% in UK and exceeding 40% is dominant). Barriers to
entry creating obstacles deterring or preventing firms from entering the market to compete
are substantial such as patents and other restrictive methods such as advertising, brand,
collaboration with producers, market conditions, high fixed costs (eg. mining and R&D) and
economies of scale. Exit barriers can also equally restrict entry into the market.
Any decisions made by other firms in a non-pure monopoly do not affect the monopolist's
market share or price from being challenged. Many pure monopolies are state run and have
a legal monopoly in order to achieve social and political objectives. Other pure monopolies
exist due to the fact that they more than one firm would be inefficient eg. the Channel
Tunnel. In monopoly, there is no distinction between the short run and long run due to
barriers to entry that prevent entry of competitors.
Discuss whether a monopoly always disadvantages consumers.
Paraphrase - Monopolies can disadvantage consumers but in certain situations can
advantage consumers.
A monopoly is a firm that has either exclusive possession (pure monopoly) or control
(majority share) of the supply of or trade in a good or a service. Although it appears
overwhelming considered that monopoly structures are disadvantageous to consumers this
is not always the case as discussed forthwith.
Some of the key potential advantages and drawbacks of monopoly power in markets for
consumers relates directly to the efficient allocation of resources which due to the fact that a
monopoly is imperfect competition it fails to do this but at the same time in certain cases it
can be beneficial to consumers.
The main disadvantages to consumers are:
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that monopoly produces a welfare loss or market failure compared to competitive
market conditions.
Prices that a profit maximising monopoly will charge higher than under competitive
conditions, higher than marginal costs, higher than average cost which leads to a
loss of allocative efficiency (price > MC). This may even lead to cost-push inflation.
This links to the question of equity so if you have a monopoly charging higher prices
this can have a regressive effect on the purchasing power (real living standards) of
lower-income households/families particularly large families living on low incomes
unable to save much but facing often times monopoly prices
Absence of genuine competition may lead to X-inefficiencies such as wasteful
advertising spending, organisational slack and low productivity or low-quality
products for consumers, lack of incentive for innovation
Higher prices can limit output and lead to less economies of scale being exploited
If we assume a monopoly aims to maximise profit then it will tend to charge a price
well above cost as in the diagram below the supernormal profit which is well above
the marginal cost of production. Output is lower than the socially efficient point of
view. The monopoly price maximum is constrained by the demand curve level and
the elasticity of demand.
Consumers and society at large suffer a welfare or deadweight loss denoted by the
triangle ABC
Advantages to consumers from monopoly power include the following:
● As monopolies operate on a bigger scale they may well be able to achieve
economies of scale leading to lower prices for consumers
● The monopoly profit may well be used productively to help fund R&D and not
necessarily back to shareholders which can have a positive effect such as
creating better quality products or a range of products to give choice and
other consumer benefits. This can also lead to gains in dynamic efficiency
and continued consumer benefits in the long run.
● Tax revenues from monopoly profits in theory could be used to fund public
expenditure or to decrease deficit to benefit the consumer
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Regulated by the government to set conditions of service quality targets,
standards of service, keep prices down etc.
The monopoly could use its profits from one part of the business to lower
prices to provide accessible services for other people
Monopolies that have achieved significant economies of scale can also be
important on a macroeconomic level to improve a country’s price and
non-price competitiveness that benefits all consumers in the country.
Price discrimination by monopolies can help some lower income families on a
limited budget to access important goods and services at lower prices.
If a monopoly can achieve substantial internal economies of scale, then the
marginal and average costs (AC1 - AC2) of production will be lower in the
long run. As a result, the profit maximising price may be lower than if the
market was less highly concentrated. This then has implications for the level
of consumer welfare.
In conclusion, while monopolies can offer certain advantages to consumers,
such as lower prices, increased innovation, and reliability, these benefits are
often outweighed by the risks of reduced competition, higher prices, and
limited consumer choice. Monopolies can lead to market inefficiencies
(deadweight loss), hinder innovation, and potentially harm consumers by
exploiting their monopoly power. Therefore, it is generally recognized that in
most situations, the disadvantages of monopolies on consumers outweigh
any potential advantages especially as profit maximisation objective tends to
be a dominant objective in business.