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Accounting and Finance
Essential guidance on economics exam technique:
Ten ways to turn a good economics exam paper into a great one
Weesteps to evaluation - maximise your A2 economics marks
Revision materials on the Economics blog:
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A2 Markets & Market Systems
Monopoly & Economic Efficiency
In this note we evaluate the costs and benefits of businesses with industry muscle,
monopoly pricing power in markets. The standard economic and social case against
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monopolistic businesses is no longer straightforward. Markets are changing all of
the time and so are the conditions in which businesses must operate regardless of
whether they have any noticeable market power.
The economic case against monopoly
The usual textbook argument against monopoly power in markets is that existing
monopolists can continue to earn abnormal (supernormal) profits at the expense of
economic efficiency and the welfare of consumers and society.
The standard case against monopoly is that the monopoly price is higher than both
marginal and average costs leading to a loss of allocative efficiency and a failure
of the market mechanism. The monopolist is extracting a price from consumers that
is above the cost of resources used in making the product and, consumers’ needs and
wants are not being satisfied, as the product is being under-consumed.
The higher average cost of production if there are inefficiencies in production also
means that the firm is not making optimum use of its scarce resources. Under these
conditions, there may be an economic case for some form of government intervention
to limit or reduce the scale of monopoly power, for example through the rigorous
application of competition policy or by a process of market deregulation
(liberalisation). X Inefficiencies under Monopoly
X inefficiency is a term first coined by Harvey Libenstein. The lack of real
competition may give a monopolist less of an incentive to invest in new ideas or
consider consumer welfare. It can also be argued that even if the monopolist benefits
from economies of scale, they will have little incentive to control production costs
and 'X' inefficiencies will mean that there will be no real cost savings.
Comparison between Monopoly and Perfect Competition
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A competitive industry will produce in the long run where market demand = market supply.
Consider the diagrams below. Equilibrium output and price is at Q1 and Pcomp on the
left hand diagram and Pcomp and Q1 on the right hand diagram. At this point, Price
= MC and the industry meets the conditions for allocative efficiency.
If the industry is taken over by a monopolist the profit-maximising point (MC=MR)
is at price Pmon and output Q2. The monopolist is able to charge a higher price restrict
total output and thereby reduce economic welfare. The rise in price to Pmon reduces
consumer surplus.
Some of this reduction in consumer welfare is a pure transfer to
the producer through higher profits, but some of the loss is not reassigned to any
other economic agent. This is known as the deadweight welfare loss
and is equal to the area ABC.
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