Monopoly Power and Economic Welfare
- A-Level, IB
- AQA, Edexcel, OCR, IB, Eduqas, WJEC
Last updated 1 Apr 2018
Here is a revision video and presentation on how welfare loss might result from monopoly power.
A monopoly supplier such a regional water utility has significant market power and can therefore set prices above the level we expect to see in a competitive market.
This means that, at the profit-maximising level of output where MR=MC, the monopoly price is above marginal cost. This then leads to a loss of allocative efficiency meaning that scarce resources are not allocated optimally.
High monopoly prices lead to a deadweight loss of consumer welfare because output is lower and price higher than a competitive equilibrium. High prices mean some consumers are priced out of the market because of a fall in effective demand.
The monopolist makes abnormal (supernormal) profit (price > AC) but the loss of consumer surplus is greater than the gain in producer surplus leading to a net loss of welfare measured by community surplus
Evaluating the impact of monopoly on welfare
Challenge the assumptions:
- Are average costs the same with both monopoly and competition?
- Consider the potential for a monopoly supplier to achieve economies of scale
- Is the loss of productive efficiency greater because of possible X-inefficiencies?
- Does a monopoly necessarily charge a single profit-maximising price? Consider the impact on welfare of price discrimination on different groups of consumers
- Not every monopoly charges a price! Consider Google and Facebook – but is it free?
What do we mean by a welfare loss?
- Narrow definition focuses on consumer welfare / consumer surplus
- Wider interpretation considers social welfare – i.e. community surplus which includes producer welfare and also effects on the distribution of income
How are monopoly profits used?
- Research and development spending – possible gains in dynamic efficiency
- Share buy-backs and short term capital gain for shareholders?
- Do businesses with monopoly power pay an equitable amount of corporation tax?
Evaluating monopoly power
- Natural monopoly – falling long run average costs and high MES - more productively efficient to have a monopoly supplier
- Competition in the supply chain – possible to introduce competition at different stages of the supply chain e.g. via competitive tendering, franchises
- “In theory …. But in practice”: Judge a monopoly on a case by case basis using an evidence-based approach to how a monopoly actually behaves in the market
- Contestability – the threat of entry into a market can be a powerful influence on the actual conduct of firms who have monopoly power
- Definition of the market – a business might have monopoly power in the domestic market but face significant international competition