Submitted to:

Ms SAMINA

Submitted by:

IKRAM KHAN

Project name:

THE COST & BENEFIT OF MONOPOLY COMPETITION.

Roll NO:

1023

Subject:

Economic

MONOPOLY:

Monopoly can be considered the opposite of perfect competition. It is a market form in which there is only one seller.

The Costs and Benefits of Monopoly

1-Contestable markets:

Contestable market theory predicts that monopolists may still be competitive even if they enjoy a dominant position in their market. Their price and output decisions will be affected by the threat of "hit and run entry" from other firms if they allow their costs to rise and inefficiencies to develop.

2- Economies of Scale:

If the firm produces in an industry with very high fixed costs, consumers can benefit from a large firm which can exploit economies of scale. Economies of scale lead to lower average costs and therefore the potential of lower prices.

Example: Would you want several firms providing tap water? Would it make sense to have 2-3 companies laying a network of water pipes and sewage systems across the country? No. It is better to have 1 firm. This is an example of an industry which is a natural monopoly.

Industries like car production and airline production also have significant economies of scale so it makes sense for firms to have some degree of market power.

3-Monopoly Firms are Efficient:

An argument popular with economists of the Austrian School of Economics is that firms who gain monopoly power are invariably successful, innovative and efficient. E.g. Google have monopoly power but who can do it any better?

4-Monopoly and Innovation (Research and Development):

Firms with monopoly profit can use their profit to invest in new products and technologies that benefit consumers in the long run. e.g. oil companies who find new sources of oil

An important issue is what happens to the monopoly profits both in the short run and the long run. Undoubtedly some of the profits will be distributed to shareholders as dividends. This raises questions of equity. Some low income consumers might be exploited by the monopolist because of higher prices. And, some of their purchasing power might be transferred via dividends to shareholders in the higher income brackets - thus making the overall distribution of income more unequal.

5-Domestic monopoly but international competition:

A firm may have substantial domestic monopoly power but face intensive competition from overseas producers. This limits their market power and helps keep prices down for consumers. A good example to use here would be the domestic steel industry. Corus produces most of the steel manufactured inside the UK but faces intensive competition from overseas steel producers.

6-Single seller:

In a monopoly there is one seller of the good who produces all the output[Therefore, the whole market is being served by a single firm, and for practical purposes, the firm is the same as the industry.

7-Market power:

Market power is the ability to affect the terms and conditions of exchange so that the price of the product is set by the firm (price is not imposed by the market as in perfect competition). Although a monopoly's market power is high it is still limited by the demand side of the market. A monopoly faces a negatively sloped demand curve not a perfectly inelastic curve. Consequently, any price increase will

result in the loss of some customers.

8-Firm and industry:

In a monopoly, market, a firm is itself an industry. Therefore, there is no distinction between a firm and an industry in such a market.

9-Price Discrimination:

A monopolist can change the price and quality of the product. He sells more quantities charging less price against the product in a highly elastic market and sells less quantities charging high price in a less elastic market.

10-Regulation of monopoly:

Because of the potential economic welfare loss arising from the exploitation of monopoly power, the Government regulates some monopolies. Regulators can control annual price increases and introduce fresh competition into particular industries

11-Competition:

One disadvantage of deregulation is its inability to function properly in a market where a natural monopoly exists. A natural monopoly exists when high barriers make it extremely difficult for new firms to enter a market. In this situation, privatizing a state-owned company can hand the new privately run firm a virtual monopoly in its industry. For many years, the provision of electric power in the United States was considered a natural monopoly.

12-Capital requirements:Production processes that require large investments of capital, or large research and development costs or substantial sunk costs limit the number of firms in an industry. Large fixed costs also make it difficult for a small firm to enter an industry and expand.

13-Control of Natural Resources:A prime source of monopoly power is the control of resources that are critical to the production of a final good.

14-No substitute goods:A monopoly sells a good for which there is no close substitute. The absence of substitutes makes the demand for the good relatively inelastic enabling monopolies to extract positive profits.

15-Technological superiority:A monopoly may be better able to acquire, integrate and use the best possible technology in producing its goods while entrants do not have the size or fiscal muscle to use the best available technology

Effect on society:

1-Marketplace Instability:Deregulation is often followed by the entrance of a large number of new

companies into the marketplace. This provides one of the purported benefits -- in more competitive pricing -- but also can make the marketplace more unstable for all the companies in it. This was the case when U.S. civil aviation was deregulated in 1978. Previously, the federal Civil Aeronautics Board had regulated routes, new

carriers and fares, but once its influence was removed, new routes sprang up across the country and prices tumbled in an era of no-holds-barred competition. This had a serious impact on the largest companies and three major carriers -- Continental, Eastern Airlines and Pan American -- which ended up bankrupt. Their place was taken by a larger number of small airlines.

2-Network Externalities:

The use of a product by a person can affect the value of that product to other people. This is the network effect. There is a direct relationship between the proportion of people using a product and the demand for that product. In other words the more people who are using a product the higher the probability of any individual starting to use the product. This effect accounts for fads and fashion trends.It also can play a crucial role in the development or acquisition of market power. The most famous current example is the market dominance of the Microsoft operating system in personal computers.

3-Elasticity of Demand:

the price elasticity of demand is the percentage change in demand caused by a one percent change in relative price. A successful monopoly would face a relatively inelastic demand curve

4-Monopolist shutdown ruleA monopolist should shutdown when price is less than average variable cost for

every output level. In other words where the demand curve is entirely below the average variable cost curve. Under these circumstances at the profit maximum level of output (MR = MC) average revenue would be lower than average variable costs and the monopolists would be better off shutting down in the short run.

5-Legal barrier:

Legal rights can provide opportunity to monopolies the market in a good. Intellectual property rights, including patents and copyrights, give a monopolist exclusive control over the production and selling of certain goods. Property rights may give a firm the exclusive control over the materials necessary to produce a good.

Summing up