The conventional argument against market power is that monopolists can earn abnormal (supernormal) profits at the expense of efficiency and the welfare of consumers and society.

The case against monopoly

The monopoly price is assumed to be higher than both marginal and average costs leading to a loss of allocative efficiency and a failure of the market. 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 if there are inefficiencies in production means that the firm is not making optimum use of scarce resources. Under these conditions, there may be a case for government intervention for example through competition policy or market deregulation.

Possible X Inefficiencies under Monopoly

The lack of competition may give a monopolist less incentive to invest in new ideas. Even if the monopolist benefits from economies of scale, they have little incentive to control their costs and 'X' inefficiencies will mean that there will be no real cost savings compared to a competitive market.

A competitive industry will produce in the long run where market demand = market supply. Price = MC and the industry meets the conditions for allocative efficiency.

If the industry is taken over by a monopolist then the monopolist is able to charge a higher price restrict total output and thereby reduce welfare because the rise in price reduces consumer surplus.

Some of this reduction in welfare is a pure transfer to the producer through higher profits, but some of the loss is not reassigned to any other agent. This is known as the deadweight welfare loss or the social cost of monopoly

Potential Welfare Benefits from Monopoly

  • A high market concentration does not always signal the absence of competition; sometimes it can reflect the success of firms in providing better-quality products, more efficiently, than their rivals
  • One difficulty in assessing the welfare consequences of monopoly, duopoly or oligopoly lies in defining precisely what a market constitutes! In nearly every industry a market is segmented into different products, and globalization makes it difficult to gauge the degree of monopoly power.

What are the main advantages of a market dominated by a few sellers?

Economies of Scale

A monopolist might be better placed to exploit increasing returns to scale leasing to an equilibrium that gives a higher output and a lower price than under competitive conditions. This is illustrated in the next diagram, where we assume that the monopolist is able to drive marginal costs lower in the long run, finding an equilibrium output of Q2 and pricing below the competitive price.

Possible welfare gains from monopoly

Monopoly Profits, Research and Development and Dynamic Efficiency

  • Patents provide legal protection of an idea or process. Generic patents allow legal copying of a product.
  • As firms are able to earn abnormal profits in the long run there may be a faster rate of technological development that will reduce costs and produce better quality items for consumers.
  • Monopoly power can be good for innovation
  • Despite the fact that the market leadership of firms like Microsoft, Toyota, GlaxoSmithKline and Sony is often criticised, investment in research and development can be beneficial to society because they expand the technological frontier and open new ways to prosperity.
  • Many innovations are developed by firms who then look to apply for patents on 'leading-edge' technologies.

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