positive and normative economics you will often

8/14/2019 Positive and Normative Economics You Will Often

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positive and normative economics

You will often hear statements about economic issues on the television and written innewspapers and magazines. These statements can be divided into two main groups -positive and normative.

POSITIVE STATEMENTS

Positive statements are objective statements dealing with matters of fact or they questionabout how things actually are. Positive statements are made without obvious value-judgements and emotions. They may suggest an economic relationship that can be testedby recourse to the available evidence.

Positive economics can be described as what is, what was, and what probably will beeconomics. Statements are based on economic theory rather than raw emotion. Oftenthese statements will be expressed in the form of a hypothesis that can be analysed and

evaluated.

Examples:

A rise in interest rates will cause a rise in the exchange rate and an increase in thedemand for imported productsLower taxes may stimulate an increase in the active labour supplyA national minimum wage is likely to cause a contraction in the demand for low-skilledlabourThe UK economy now has lower unemployment than GermanyThe American stock market has boomed in recent years

NORMATIVE STATEMENTS

Normative statements are subjective - based on opinion only - often without a basis infact or theory. They are value-laden, emotional statements that focus on "what ought tobe".

It is important to be able to distinguish between these types of statements - particularlywhen heated arguments and debates are taking place. Most economists tend to adopt apositive approach.

Examples:

The decision to grant independence for the Bank of England is unwise and should bereversedA national minimum wage is totally undesirable as it does not help the poor and causeshigher unemployment and inflationThe national minimum wage should be increased to? 5 as a method of reducing povertyProtectionism is the only proper way to improve the living standards of workers whosejobs are threatened by cheap imports


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Monopoly

From Wikipedia, the free encyclopedia

Jump to: navigation,searchThis article is about the economic term. For the board game, seeMonopoly (game). Forother uses, see Monopoly (disambiguation).

This article needs additional citations for verification.Please help improve this articleby addingreliable references. Unsourced material may bechallengedand removed. (August 2009)

Competition lawBasic concepts

History of competition law

Monopolyo Coercive monopoly

o Natural monopoly

Barriers to entry

Market power

SSNIP test

Relevant market

Merger controlAnti-competitive practices

Monopolization

Collusiono Formation ofcartels

o Price fixing

o Bid rigging

Product bundling and tying

Refusal to dealo Group boycott

o Essential facilities

Exclusive dealing

Dividing territories Conscious parallelism

Predatory pricing

Misuse of patents andcopyrights

Enforcement authorities and

organizations

International CompetitionNetwork

List of competition regulatorsThis box:viewtalkedit
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In economics, a monopoly (from Greekmonos / (alone or single) +polein / (to sell)) exists when a specific individual or an enterprise has sufficient control over aparticular product or service to determine significantly the terms on which otherindividuals shall have access to it.[1][clarification needed] Monopolies are thus characterized by alack of economic competition for thegood orservice that they provide and a lack of

viable substitute goods.[2]

The verb "monopolize" refers to theprocess by which a firmgains persistently greater market share than what is expected underperfect competition.

A monopoly must be distinguished from monopsony, in which there is only one buyerofa product or service ; a monopoly may also have monopsony control of a sector of amarket. Likewise, a monopoly should be distinguished from a cartel (a form ofoligopoly), in which several providers act together to coordinate services, prices or saleof goods. Monopolies can form naturally or through vertical orhorizontal mergers. Amonopoly is said to be coercivewhen the monopoly firm actively prohibits competitorsfrom entering the field.

In many jurisdictions, competition lawsplace specific restrictions on monopolies.Holding a dominant position or a monopoly in the market is not illegal in itself, howevercertain categories of behavior can, when a business is dominant, be considered abusiveand therefore be met with legal sanctions. A government-granted monopoly orlegalmonopoly, by contrast, is sanctioned by the state, often to provide an incentive to investin a risky venture or enrich a domestic constituency. The government may also reservethe venture for itself, thus forming a government monopoly.

Contents

[hide]

1 Market structures 2 Characteristics 3 Sources of monopoly power 4 Monopoly versus competitive markets

o 4.1 Monopoly and efficiency

o 4.2 Natural monopoly

o 4.3 Government-granted monopoly

5 Breaking up monopolies 6 Law 7 Historical monopolies

o 7.1 Examples of legal (and or) illegal monopolies 8 How to counter monopolies? 9 See also 10 Notes and references 11 Further reading 12 External links

o 12.1 Criticism

[edit] Market structures
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wikipedia.org/wiki/Monopoly#See_also%23See_alsohttp://en.wikipedia.org/wiki/Monopoly#Notes_and_references%23Notes_and_referenceshttp://en.wikipedia.org/wiki/Monopoly#Further_reading%23Further_readinghttp://en.wikipedia.org/wiki/Monopoly#External_links%23External_linkshttp://en.wikipedia.org/wiki/Monopoly#Criticism%23Criticismhttp://en.wikipedia.org/w/index.php?title=Monopoly&action=edit&section=1


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In economics, monopoly is a pivotal area to the study ofmarket structures, which directlyconcerns normative aspects of economic competition, and sets the foundations for fieldssuch as industrial organizationand economics of regulation. There are four basic types ofmarket structures under traditional economic analysis: perfect competition, monopolisticcompetition, oligopoly and monopoly. A monopoly is a market structure in which a

single supplier produces and sells the product. If there is a single seller in a certainindustry and there are no close substitutes for the goods being produced, then the marketstructure is that of a "pure monopoly". Sometimes, there are many sellers in an industryand/or there exist many close substitutes for the goods being produced, but neverthelessfirms retain some market power. This is called monopolistic competition, whereas inoligopoly the main theoretical framework revolves around firm's strategic interactions.

In general, the main results from this theory refer to compare price-fixing methods acrossmarket structures, analyze the impact of a certain structure on welfare, and play withdifferent variations of technological/demand assumptions in order to assess itsconsequences on the abstract model of society. Most economic textbooks follow the

practice of carefully explaining theperfect competition model, only because of itsusefulness to understand "departures" from it (the so called imperfect competitionmodels).

The boundaries of what constitutes a market and what doesn't, is a relevant distinction tomake in economic analysis. In a general equilibrium context, a good is a specific conceptentangling geographical and time-related characteristics (grapes sold in October of 2009in Moscow is a different good fromgrapes sold in October of 2009 in New York). Moststudies of market structure relax a little their definition of a good, allowing for moreflexibility at the identification of substitute-goods. Therefore, one can find an economicanalysis of the market ofgrapes in Russia, for example, which is not a market in the strict

sense of general equilibrium theory.

[edit] Characteristics

Single Seller: In a monopoly there is one seller of the monopolized good whoproduces all the output.[3] Therefore, the whole market is being served by a singlefirm, and for practical purposes, the firm is the same as the industry. In acompetitive market (that is, a market with perfect competition) there are aninfinite number of sellers each producing an infinitesimally small quantity ofoutput.

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 imposedby the market as in perfect competition).[4][5]Although a monopoly's market poweris high it is still limited by the demand side of the market. A monopoly faces anegatively sloped demand curve not a perfectly inelastic curve. Consequently, anyprice increase will result in the loss of some customers.

[edit] Sources of monopoly power

Monopolies derive their market power from barriers to entry - circumstances that preventor greatly impede a potential competitor's entry into the market or ability to compete inthe market. There are three major types of barriers to entry; economic, legal anddeliberate.[6]
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Economic Barriers:Economic barriers include economies of scale, capitalrequirements, cost advantages and technological superiority.[7]

Economies of scale: Monopolies are characterized by declining costs over arelatively large range of production.[8] Declining costs coupled with large start up

costs give monopolies an advantage over would be competitors. Monopolies areoften in a position to cut prices below a new entrant's operating costs and drivethem out of the industry.[8] Further the size of the industry relative to the minimumefficient scale may limit the number of firms that can effectively compete withinthe industry. If for example the industry is large enough to support one firm ofminimum efficient scale then other firms entering the industry will operate at asize that is less than MES meaning that these firms cannot produce at an averagecost that is competitive with the dominant industry.Capital requirements: Production processes that require large investments ofcapital, or large research and development costs or substantial sunk costs limit thenumber of firms in an industry.[9] Large fixed costs also make it difficult for a

small firm to enter an industry and expand.

[10]

Technological Superiority: A monopoly may be better able to acquire, integrateand use the best possible technology in producing its goods while entrants do nothave the size or fiscal muscle to use the best available technology.[8] In plainEnglish one large firm can sometimes produce goods cheaper than several smallfirms.[11]No Substitute Goods:A monopoly sells a good for which there is no closesubstitutes. The absence of substitutes makes the demand for the good relativelyinelastic enabling monopolies to extract positive profits.

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. Legal Barriers: Legal rights can provide opportunity to monopolize the market

in a good. Intellectual property rights, including patents and copyrights, give amonopolist exclusive control over the production and selling of certain goods.Property rights may give a firm the exclusive control over the materials necessaryto produce a good.

Deliberate Actions: A firm wanting to monopolize a market may engage invarious types of deliberate action to exclude competitors or eliminate competition.Such actions include collusion, lobbying governmental authorities, and force.

In addition to barriers to entry and competition, barriers to exit may be a source of marketpower. Barriers to exit are market conditions that make it difficult or expensive for a firmto leave the market. High liquidation costs are a primary barrier to exit.[12] Market exitand shutdown are separate events. The decision whether to shut down or operate is notaffected by exit barriers. A firm will shut down if price falls below minimum averagevariable costs.

[edit] Monopoly versus competitive markets

While monopoly and perfect competition mark the extremes of market structures[13]thereare many point of similarity. The cost functions are the same.[14]Both monopolies andperfectly competitive firms minimize cost and maximize profit. The shutdown decisions
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are the same. Both are assumed to face perfectly competitive factors markets. There aredistinctions, some of the more important of which are as follows:

Market Power - market power is the ability to control the terms and condition ofexchange. Specifically market power is the ability to raise prices without losing all one's

customers to competitors. Perfectly competitive (PC) firms have zero market power whenit comes to setting prices. All firms in a PC market are price takers. The price is set by theinteraction of demand and supply at the market or aggregate level. Individual firmssimply take the price determined by the market and produce that quantity of output thatmaximize the firm's profits. If a PC firm attempted to raise prices above the market levelall its "customers" would abandon the firm and purchase at the market price from otherfirms. A monopoly has considerable although not unlimited market power. A monopolyhas the power to set prices or quantities although not both.[15] A monopoly is a pricemaker.[16] The monopoly is the market[17] and prices are set by the monopolist based onhis circumstances and not the interaction of demand and supply. The two primary factorsdetermining monopoly market power are the firm's demand curve and its cost structure.[18]

Product differentiation: There is zero product differentiation in a perfectly competitivemarket. Every product is perfectly homogeneous and a perfect substitute. With amonopoly there is high to absolute product differentiation in the sense that there is noavailable substitute for a monopolized good. The monopolist is the sole supplier of thegood in question.[19] A customer either buys from the monopolist on her terms or doeswithout.

Number of competitors: PC markets are populated by an infinite number of buyers andsellers. Monopoly involves a single seller.[19]

Barriers to Entry - Barriers to entry are factors and circumstances that prevent entry intomarket by would be competitors and impediments to competition that limit new firmsfrom operating and expanding within the market. PC markets have free entry and exit.There are no barriers to entry, exit or competition. Monopolies have relatively highbarriers to entry. The barriers must be strong enough to prevent or discourage anypotential competitor from entering the market.

PED; the price elasticity of demand is the percentage change in demand caused by a onepercent change in relative price. A successful monopoly would face a relatively inelasticdemand curve. A low coefficient of elasticity is indicative of effective barriers to entry. APC firm faces what it perceives to be perfectly elastic demand curve. The coefficient ofelasticity for a perfectly competitive demand curve is infinite.

Excess Profits- Excess or positive profits are profit above the normal expected return oninvestment. A PC firm can make excess profits in the short run but excess profits attractcompetitors who can freely enter the market and drive down prices eventually reducingexcess profits to zero.[20]A monopoly can preserve excess profits because barriers toentry prevent competitors from entering the market.

Profit Maximization - A PC firm maximizes profits by producing where price equalsmarginal costs. A monopoly maximizes profits by producing where marginal revenueequals marginal costs.[21] The rules are equivalent. The demand curve for a PC firm isperfectly elastic - flat. The demand curve is identical to the average revenue curve and theprice line. Since the average revenue curve is constant the marginal revenue curve is also
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constant and equals the demand curve, Average revenue is the same as price (AR = TR/Q= P x Q/Q = P). Thus the price line is also identical to the demand curve. In sum, D = AR= MR = P.

P-Max quantity, price and profit: if a monopolist took over a perfectly competitive

industry he would raise prices cut production and realize positive economic profits.[22]

The most significant distinction between a PC firm and a monopoly is that the monopolyfaces a downward sloping demand curve rather than the "perceived" perfectly elasticcurve of the PC firm.[23]Practically all the variations above mentioned relate to this fact.If there is a downward sloping demand curve then by necessity there is a distinctmarginal revenue curve. The implications of this fact are best made manifest with a lineardemand curve, Assume that the inverse demand curve is of the form x = a - by. Then thetotal revenue curve is TR = ay - by2 and the marginal revenue curve is thus MR = a - 2by.From this several things are evident. First the marginal revenue curve has the same yintercept as the inverse demand curve. Second the slope of the marginal revenue curve is

twice that of the inverse demand curve. Third the x intercept of the marginal revenuecurve is half that of the inverse demand curve. What is not quite so evident is that themarginal revenue curve lies below the inverse demand curve at all points.[23] Since allfirms maximize profits by equating MR and MC it must be the case that at the profitmaximizing quantity MR and MC are less than price which further implies that amonopoly produces less quantity at a higher price than if the market were perfectlycompetitive.

A company with a monopoly does not undergo price pressure from competitors, althoughit may face pricing pressure from potential competition. If a company raises prices toohigh, then others may enter the market if they are able to provide the same good, or a

substitute, at a lower price.

[24]

The idea that monopolies in markets with easy entry neednot be regulated against is known as the "revolution in monopoly theory".[25]

A monopolist can extract only one premium, [clarification needed] and getting into complementarymarkets does not pay. That is, the total profits a monopolist could earn if it sought toleverage its monopoly in one market by monopolizing a complementary market are equalto the extra profits it could earn anyway by charging more for the monopoly productitself. However, the one monopoly profit theorem does not hold true if customers in themonopoly good are stranded or poorly informed, or if the tied good has high fixed costs.

A pure monopoly follows the same economic rationality of firms under perfectcompetition, i.e. to optimize a profit function given some constraints. Under theassumptions of increasing marginal costs, exogenous inputs' prices, and controlconcentrated on a single agent or entrepreneur, the optimal decision is to equate themarginal cost andmarginal revenue of production. Nonetheless, a pure monopoly can-unlike a competitive firm- alter the market price for her own convenience: a decrease inthe level of production results in a higher price. In the economics' jargon, it is said thatpure monopolies "face a downward-sloping demand". An important consequence of suchbehavior is worth noticing: typically a monopoly selects a higher price and lower quantityof output than a price-taking firm; again, less is available at a higher price.[26]

There are important points for one to remember when considering the monopoly modeldiagram (and its associated conclusions) displayed here. The result that monopoly pricesare higher, and production output lower, than a competitive firm follow from a
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requirement that the monopoly not charge different prices for different customers. Thatis, the monopoly is restricted from engaging inprice discrimination (this is called firstdegree price discrimination, where all customers are charged the same amount). If themonopoly were permitted to charge individualized prices (this is calledthird degree pricediscrimination), the quantity produced, and the price charged to the marginalcustomer,

would be identical to a competitive firm, thus eliminating the deadweight loss; however,all gains from trade (social welfare) would accrue to the monopolist and none to theconsumer. In essence, every consumer would be just indifferent between (1) goingcompletely without the product or service and (2) being able to purchase it from themonopolist.

As long as theprice elasticity of demand for most customers is less than one in absolutevalue, it is advantageous for a firm to increase its prices: it then receives more money forfewer goods. With a price increase, price elasticity tends to rise, and in the optimum caseabove it will be greater than one for most customers.

[edit] Monopoly and efficiency

This section does not cite any references or sources.Please help improve this articleby adding citations to reliable sources. Unsourced material maybe challengedand removed. (October 2009)

Surpluses and deadweight loss created by monopoly price setting

According to the standard model,[citation needed] in which a monopolist sets a single price for

all consumers, the monopolist will sell a lower quantity of goods at a higher price thanwould firms underperfect competition. Because the monopolist ultimately forgoestransactions with consumers who value the product or service more than its cost,monopoly pricing creates a deadweight lossreferring to potential gains that went neitherto the monopolist or to consumers. Given the presence of this deadweight loss, thecombined surplus (or wealth) for the monopolist and consumers is necessarily less thanthe total surplus obtained by consumers under perfect competition. Where efficiency isdefined by the total gains from trade, the monopoly setting is less efficient than perfectcompetition.

It is often argued that monopolies tend to become less efficient and innovative over time,

becoming "complacent giants", because they do not have to be efficient or innovative tocompete in the marketplace. Sometimes this very loss of psychological efficiency can
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raise a potential competitor's value enough to overcome market entry barriers, or provideincentive for research and investment into new alternatives. The theory ofcontestablemarkets argues that in some circumstances (private) monopolies are forced to behave asifthere were competition because of the risk of losing their monopoly to new entrants.This is likely to happen where a market'sbarriers to entry are low. It might also be

because of the availability in the longer term of substitutes in other markets. For example,acanal monopoly, while worth a great deal in the late eighteenth centuryUnitedKingdom, was worth much less in the late nineteenth century because of the introductionofrailways as a substitute.

[edit] Natural monopoly

A natural monopoly is a firm which experiences increasing returns to scale over therelevant range of output.[27] A natural monopoly occurs where the average cost ofproduction declines throughout the relevant range of product demand. The relevantrange of product demand is where the average cost curve is below the demand curve.[28]

When this situation occurs it is always cheaper for one large firm to supply the marketthan multiple smaller firms, in fact, absent government intervention in such markets willnaturally evolve into a monopoly. An early market entrant who takes advantage of thecost structure and can expand rapidly can exclude smaller firms from entering and candrive or buy out other firms. A natural monopoly suffers from the same inefficiencies asany other monopoly. Left to its own devices a profit seeking natural monopoly willproduce where marginal revenue equals marginal costs. Regulation of natural monopoliesis problematic. Breaking up such monopolies is counter productive[citation needed]. The mostfrequently used methods dealing with natural monopolies is government regulations andpublic ownership. Government regulation generally consists of regulatory commissionscharged with the principal duty of setting prices.[29]To reduce prices and increase output

regulators often use average cost pricing. Under average cost pricing the price andquantity are determined by the intersection of the average cost curve and the demandcurve.[30]This pricing scheme eliminates any positive economic profits since price equalsaverage cost. Average cost pricing is not perfect. Regulators must estimate average costs.Firms have a reduced incentive to lower costs. And regulation of this type has not beenlimited to natural monopolies.[30]

[edit] Government-granted monopoly

A government-granted monopoly (also called a "de jure monopoly") is a form ofcoercivemonopoly by which a government grants exclusive privilege to a private individual or

firm to be the sole provider of a good or service; potential competitors are excluded fromthe market by law,regulation, or other mechanisms of government enforcement.Copyright,patents and trademarksare examples of government-granted monopolies.

[edit] Breaking up monopolies

When monopolies are not broken through the open market, sometimes a government willstep in, either to regulate the monopoly, turn it into a publicly owned monopolyenvironment, or forcibly break it up (see Antitrust law and trust busting). Public utilities,often being naturally efficient with only one operator and therefore less susceptible toefficient breakup, are often strongly regulated or publicly owned. AT&T and Standard

Oil are debatable examples of the breakup of a private monopoly: When AT&T was
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broken up into the "Baby Bell" components, MCI,Sprint, and other companies were ableto compete effectively in the long distance phone market.

[edit] Law

Main article: Competition law

The existence of a very high market share does not always mean consumers are payingexcessive prices since the threat of new entrants to the market can restrain a high-market-share firm's price increases. Competition law does not make merely having a monopolyillegal, but rather abusing the power a monopoly may confer, for instance throughexclusionary practices.

First it is necessary to determine whether a firm is dominant, or whether it behaves "to anappreciable extent independently of its competitors, customers and ultimately of itsconsumer."[31]As with collusive conduct, market shares are determined with reference to

the particular market in which the firm and product in question is sold.

Under EU law, very large market shares raises a presumption that a firm is dominant, [32]

which may be rebuttable.[33] If a firm has a dominant position, then there is "a specialresponsibility not to allow its conduct to impair competition on the common market".[34]

The lowest yet market share of a firm considered "dominant" in the EU was 39.7%.[35]

Certain categories of abusive conduct are usually prohibited under the country'slegislation, though the lists are seldom closed.[36] The main recognized categories are:

Limiting supply Predatory pricing Price discrimination Refusal to deal and exclusive dealing Tying (commerce) andproduct bundling

Despite wide agreement that the above constitute abusive practices, there is some debateabout whether there needs to be a causal connection between the dominant position of acompany and its actual abusive conduct. Furthermore, there has been some considerationof what happens when a firm merely attempts to abuse its dominant position.

barriers to entry

Barriers to entry are designed to block potential entrants from entering a marketprofitably. They seek to protect the monopoly power of existing (incumbent) firms in anindustry and therefore maintain supernormal (monopoly) profits in the long run. Barriers

to entry have the effect of making a market less contestable
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The economist Joseph Stigler defined an entry barrier as "A cost of producing (at some orevery rate of output) which must be borne by a firm which seeks to enter an industry butis not borne by firms already in the industry"

This emphasises the asymmetry in costs between the incumbent firm (already inside themarket) and the potential entrant. If the existing businesses have managed to exploit someof the economies of scale that are available to firms in a particular industry, they havedeveloped a cost advantage over potential entrants. They might use this advantage to cutprices if and when new suppliers enter the market, moving away from short run profitmaximisation objectives - but designed to inflict losses on new firms and protect theirmarket position in the long run.

EXAMPLES OF BARRIERS TO ENTRY

Patents

Giving the firm the legal protection to produce a patented product for a number of years(see below)

Limit Pricing

Firms may adopt predatory pricing policies by lowering prices to a level that would forceany new entrants to operate at a loss

Cost advantages

Lower costs, perhaps through experience of being in the market for some time, allows theexisting monopolist to cut prices and win price wars

Advertising and marketing

Developing consumer loyalty by establishing branded products can make successful entryinto the market by new firms much more expensive. This is particularly important inmarkets such as cosmetics, confectionery and the motor car industry.

Research and Development expenditure

Heavy spending on research and development can act as a strong deterrent to potentialentrants to an industry. Clearly much R&D spending goes on developing new products(see patents above) but there are also important spill-over effects which allow firms toimprove their production processes and reduce unit costs. This makes the existing firmsmore competitive in the market and gives them a structural advantage over potential rivalfirms.

Presence of sunk costs

Some industries have very high start-up costs or a high ratio of fixed to variable costs.Some of these costs might be unrecoverable if an entrant opts to leave the market. Thisacts as a disincentive to enter the industry.


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International trade restrictions

Trade restrictions such as tariffs and quotas should also be considered as a barrier to theentry of international competition in protected domestic markets.

Sunk Costs

Sunk Costs are costs that cannot be recovered if a businesses decides to leave an industryExamples include: " Capital inputs that are specific to a particular industry and whichhave little or no resale value " Money spent on advertising / marketing / research whichcannot be carried forward into another market or industry When sunk costs are high, amarket becomes less contestable. High sunk costs (including exit costs) act as a barrier toentry of new firms (they risk making huge losses if they decide to leave a market).

A good example of substantial sunk costs occurred in 2001 when British Telecomannounced it was scrapping its loss-making joint venture with US telecoms firm AT&T.

The closure was estimated to lead to the loss of 2,300 jobs - almost 40% of Concert'sworkforce. And, it will cost BT $2bn (?1.4bn) in impairment charges and restructuringcosts, and AT&T $5.3bn._______________________________________________________________________

_

Q : WHAT ARE THE ECONOMIC ARGUMENTS IN FAVOUR AND AGAINSMONOPOLY MARKET?

A2 Markets & Market SystemsMonopoly & Economic EfficiencyIn this note we evaluate the costs and benefits of businesses with industry muscle, monopoly pricingpower in markets. The standard economic and social case against monopolistic businesses is no longstraightforward. Markets are changing all of the time and so are the conditions in which businesses moperate regardless of whether they have any noticeable market power.The economic case against monopolyThe usual textbook argument against monopoly power in markets is that existing monopolists cancontinue to earn abnormal (supernormal) profits at the expense of economic efficiency and the welfaconsumers and society.The standard case against monopoly is that the monopoly price is higher than both marginal and avercosts leading to a loss of allocative efficiency and a failure of the market mechanism. The monopolisextracting a price from consumers that is above the cost of resources used in making the product andconsumers needs and wants are not being satisfied, as the product is being under-consumed.The higher average cost of production if there are inefficiencies in production also means that the firmnot making optimum use of its scarce resources. Under these conditions, there may be an economic cfor some form of government intervention to limit or reduce the scale of monopoly power, for exampthrough the rigorous application of competition policy or by a process of market deregulation(liberalisation).X Inefficiencies under MonopolyX inefficiency is a term first coined by Harvey Libenstein. The lack of real competition may give amonopolist less of an incentive to invest in new ideas or consider consumer welfare. It can also beargued that even if the monopolist benefits from economies of scale, they will have little incentive to


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control production costs and 'X' inefficiencies will mean that there will be no real cost savings.Comparison between Monopoly and Perfect CompetitionA competitive industry will produce in the long run where market demand = market supply. Considediagrams below. Equilibrium output and price is at Q1 and Pcomp on the left hand diagram and Pcomand Q1 on the right hand diagram. At this point, Price = MC and the industry meets the conditions fo

allocative efficiency.

If the industry is taken over by a monopolist the profit-maximising point (MC=MR) is at price Pmon

output Q2. The monopolist is able to charge a higher price restrict total output and thereby reduceeconomic welfare. The rise in price to Pmon reduces consumer surplus. Some of this reduction inconsumer welfare is a pure transfer to the producer through higher profits, but some of the loss is notreassigned to any other economic agent. This is known as the deadweight welfare loss and is equal toarea ABC.


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A similar result is seen in the next diagram which makes the working assumption of constant long runaverage and marginal costs under both competition and monopoly. The deadweight loss of economicwelfare under monopoly (whose profit maximising price is P1 and Q1) is shown by the triangle ABCThe competitive price and output is Pc and Qc respectively.

Potential Benefits from MonopolyA high market concentration (fewness of sellers) does not always signal the absence of competition;sometimes it can reflect the success of leading firms in providing better quality products, moreefficiently, than their smaller rivalsIt is important in essays and data questions when you are analyzing imperfectly competitive marketswhere the concentration ratio is high to mention some of the potential advantages of suppliers havingmonopoly power.One difficulty in assessing the welfare consequences of monopoly, duopoly or oligopoly lies in definprecisely what a market actually constitutes! In nearly every industry the market is segmented intodifferent products, and the impact of globalisation makes it difficult to gauge the true degree ofmonopoly power that might exist in an industry at any moment in time. Increasingly markets where amonopoly appears to exist are actually becoming more contestable because of the effects of growinginternational competition.So what are the main advantages of a market dominated by a few sellers?Economies of Scale

A monopolist might be better positioned to exploit economies of scale leasing to an equilibrium whicgives a higher output and a lower price than under competitive conditions. This is illustrated in the nediagram, 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.


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Monopoly Profits, Research and Development and Dynamic EfficiencyAs firms are able to earn abnormal profits in the long run there may be a faster rate of technologicaldevelopment that will reduce costs and produce better quality products for consumers. This is becausthe monopolist will invest profits into research and development to promote dynamic efficiency.Monopoly power can be good for innovation, according to research by Professor Federico Etro,published in the April 2004 edition of the Economic Journal. Despite the fact that the market leadershof firms like Microsoft is often criticised, their investments in research and development (R&D) can

beneficial to society because they expand the technological frontier and open new ways to prosperityMany technological innovations are developed by firms with patents on the leading-edge technologieThese firms perpetuate their leadership and their market power through innovations. Etro's researchargues that providing that a market is characterised by free entry, then the market leader will actuallyhave more incentives than any other firm to invest in R&D.Baumol Oligopoly and InnovationWilliam Baumol an economist from Princeton University in the USA published a book in 2002 TheFree Market Innovation Machine in which he analysed the conditions best suited for markets andcountries to achieve a faster pace of innovation. Baumol argues that the structure that fosters productinnovation best is oligopoly. The Baumol hypothesis is that oligopolists compete by making theirproducts differ slightly from their rivals. Highly innovative firms are often quick to license new

technology or to become members of technology-sharing consortia.Natural MonopolyA natural monopoly occurs in an industry where LRAC falls over a wide range of output levels such there may be room only for one supplier to fully exploit all of the internal economies of scale, reach tminimum efficient scale and therefore achieve productive efficiency.The major utilities such as gas, electricity and water are often put forward as examples of industries wstrong "natural tendencies" towards being a natural monopoly in part because of the huge fixed costsbuilding and maintaining nationwide networks of cables and pipes. In fact we can make an importantdistinction between the supply and distribution of services such as gas and electricity. The retail markfor the supply of gas and electricity to homes and businesses is also fully competitive. However, thebusinesses which transport gas and electricity to the final consumer are closer to being natural

monopolies. The industry regulator Ofgem regulates these companies through price controls andmonitoring of quality of service.
http://www.blackwellpublishing.com/journal.asp?ref=0013-0133http://www.blackwellpublishing.com/journal.asp?ref=0013-0133


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The natural monopoly through the exploitation of economies of scale can in theory undercut any actuor potential rivals purely on the grounds of cost. If the monopolist loses market share (for example bythe competition authorities acting to split up an existing monopoly) there is the risk that smaller-scalesuppliers will produce at higher average total cost which would represent a waste of scarce resourcesForcing such a company to price at marginal cost would also inflict inevitable losses and threaten the

long term financial viability of the supplier.

Author: Geoff Riley, Eton College, September 2006

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positive and normative economics you will often

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