Monopoly
Questions
1. What is a monopoly?
2. Describe how a monopoly compares to a competitive industry.
3. What is the difference between a ‘pure monopoly’ and a ‘working monopoly’?
4. Must a monopoly be controlled by a single firm?
5. How can monopolies develop?
6. What are the advantages and disadvantages of a monopoly?
7. What are legal and natural monopolies?
8. Can monopolies charge whatever price they wish?
9. List the ways governments intervene to counteract the impact monopolies have on the market?
10. Outline the arguments for non-intervention policies on monopolies.
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Monopoly
Answers
1.
A monopoly is a situation in which a single company owns all or nearly all of the market for a given type of product or
service.
2. See box:
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.
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Monopoly
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.
Source: http://www.tutor2u.net/economics/revision-notes/a2-micro-monopoly-economic-efficiency.html
3. A pure monopoly in an industry has a single seller. It is quite rare for a firm to have a pure monopoly – except when the
industry is state owned and has a legally protected monopoly position. A working monopoly is any firm with greater than
25% of the industries' total sales. In practice, there are many markets where businesses enjoy some degree of monopoly
power even if they do not have a twenty-five per cent market share
4. No. Oligopolistic industry is characterised by the existence of a few dominant firms and a in a duopoly, the majority of market
sales are taken by two dominant firm
5. The Benefits are:

Horizontal Integration. Where 2 firms join at the same stage of production, e.g. 2 banks such as TSB and Lloyds

Vertical Integration. Where a firm gains market power by controlling different stages of the production process. A good
example is the oil industry. Where the leading firms produce, refine and sell oil

Legal Monopoly. E.g. Royal Mail or Patents

Internal Expansion of a firm. Firms can increase market share by increasing their sales and possibly benefiting from
economies of scale

Being the First Firm e.g. Microsoft
6. See box:
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Monopoly
Advantages
Research and Development. Supernormal Profit can be used to fund high cost capital investment spending. Successful research
can be used for improved products and lower costs in the long term. E.g. Telecommunications and Pharmaceuticals.
Economies of scale. Increased output will lead to a decrease in average costs of production. These can be passed on to
consumers in the form of lower prices.
See: Economies of Scale
International Competitiveness. A domestic firm may have Monopoly power in the domestic country but face effective competition
in global markets. E.g. British Steel
A firm may become a monopoly through being efficient and dynamic. A monopoly is thus a sign of success not inefficiency.
Disadvantages
Higher Prices Higher Price and Lower Output than under Perfect Competition. This leads to a decline in consumer surplus and a
deadweight welfare loss
Allocative Inefficiency. 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
Productive Inefficiency A monopoly is productively inefficient because it is not the lowest point on the AC curve.
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.
Supernormal Profit. A Monopolist makes Supernormal Profit Qm * (AR – AC ) leading to an unequal distribution of income.
Higher Prices to Suppliers - A monopoly may use its market power and pay lower prices to its suppliers. E.g. Supermarkets have
been criticised for paying low prices to farmers.
Diseconomies of Scale - It is possible that if a monopoly gets too big it may experience diseconomies of scale. - higher average
costs because it gets too big
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Worse products Lack of competition may also lead to improved product innovation
Source: http://www.economicshelp.org/microessays/markets/monopoly-diagram.html
7. A legal monopoly is a company which the government has granted exclusive rights to offer a particular service in a specific
region. In return, the company agrees to have its policies and prices regulated.
A natural monopoly is a monopoly that exists because the cost of producing the product (i.e., a good or a service) is lower
due to economies of scale if there is just a single producer than if there are several competing producers.
8. While a monopolist can generally charge higher prices than that of a competitive market, they still must charge a price the
consumers are willing to bear.
9. Government intervention:

Tax

Subsidies

Price controls

Nationalisation

Privatisation and deregulation

Breaking up the monopolies

Reducing entry barriers
10. See box:
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Monopoly
Monopolies are often relatively short lived, and even natural monopolies are not necessarily permanent. This is because technological
advances can lead to the development of new forms of competition for an industry, change its cost structure and affect the demand
for its products. For example, canals were once a natural monopoly for bulk transport in parts of Europe and the U.S., but these
monopolies disintegrated during the nineteenth century as a result of the development of railways. Likewise, the advent of cellular
phone technology has greatly weakened the wired telecommunications monopolies that prevailed in many countries.
Advocates of laissez faire capitalism (i.e., an economy in which the government plays no role in regulating business) emphasize this
natural attrition of monopolies as a justification for doing nothing. They also point out that monopolists sometimes find that it is in
their own best interest to limit their monopolistic behaviour in order to deter the entry of competitors. In fact, in some situations a
monopolist might even set production and pricing at levels close to those that would be set by the industry if competition existed.
Some advocates of laissez faire go so far as to claim that the concept of natural monopoly is merely a theoretical construct employed
to justify government intrusions into the private sector in order to gain power and satisfy constituents, intrusions that are usually not
in the best long-term interests of consumers or the economy as a whole.
They also assert that claims of natural monopoly have been wrongly used to justify the creation of government monopolies,
particularly in public utilities. Examples include the nationalized railroads and telephone systems that existed in many countries (but
not the U.S.) through much of the 20th century.
A strong case can certainly be made for having as little government intervention in an economy as possible because of the benefits
of competition (e.g., incentives to produce high quality products at the lowest possible cost). Another reason is that government
itself is a monopoly, and history has demonstrated repeatedly that it can be just as corrupt and abusive as private sector
monopolies.
Source: http://www.bellevuelinux.org/natural_monopoly.html
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