A2 Micro: Monopoly Price and Output

Our revised presentation on monopoly price and output is available in three formats

Streamed:

Handout (pdf)

SCORM VLE Import (Zip File)

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 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.

The lack of competition may give a monopolist less incentive to invest in new ideas. It can be argued that 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.

Potential 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

Monopoly Profits, Research and Development and Dynamic Efficiency
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 (R&D) can be beneficial to society because they expand the technological frontier and open new ways to prosperity. Many innovations are developed by firms with patents on the ‘leading-edge’ technologies.

SPEW

Here is a good way to remember some of the issues we have covered regarding monopoly, efficiency and economic welfare

Service - does the lack of competition affect the quality of service to consumers?
Prices - how high are prices compared to competitive / contestable market
Efficiency - productive, allocative and dynamic
Welfare - what are the overall welfare outcomes? Is there a net loss of welfare in markets dominated by businesses with monopoly power?
Acknowledged source: Ruth Tarrant