1.5.

Theory of the Firm: Monopoly

IB Definition: A monopoly is a market with a single supplier of a good or

service that has no clear substitutes and in which natural or legal barriers
to entry prevent competition (Pure Monopoly). Another definition of a
monopoly is when one firm control 25% or more of the market share of the
industry it operates in (Working Monopoly).

Monopoly along the market structures spectrum

Formation of monopolies
Monopolies can form for a variety of reasons, including the following:
1. If a firm has exclusive ownership of a scarce resource, such as Microsoft
owning the Windows operating system brand, it has monopoly power over
this resource and is the only firm that can exploit it.
2. Governments may grant a firm monopoly status, such as with the Post
Office, which was given monopoly status by Oliver Cromwell in 1654.
The Royal Mail Group finally lost its monopoly status in 2006, when the
market was opened up to competition.
3. Producers may have patents over designs, or copyright over ideas,
characters, images, sounds or names, giving them exclusive rights to sell a
good or service, such as a song writer having a monopoly over their own
material. (Intellectual property rights)
4. A monopoly could be created following the merger of two or more firms.
Given that this will reduce competition, such mergers are subject to close
regulation and may be prevented if the two firms gain a combined market
share of 25% or more. (Merger and Acquisitions)

Source:
http://www.economicsonline.co.uk/Business_economics/Monopoly.html

1
Characteristics of Monopoly

1. One seller (pure monopoly)/ one seller controls 25% or more of the
industrys market share (working monopoly)
2. Monopolies can maintain supernormal profit in the long run. As with all
firms, profits are maximized when MC = MR. In general, the level of profit
depends upon the degree of competition in the market, which for a pure
monopoly is zero. At profit maximization, MC = MR, and output is Q and
price P. Given that price (AR) is above ATC at Q, supernormal profits are
possible (area PABC).

3: Firm is a price maker i.e. it has market power

4: Barriers to entry exist and are usually high
5: A monopoly is a profit maximiser i.e. produces where MC = MR
6: Product is unique (pure monopoly) or it has no close substitutes
7: Asymmetric information i.e. specialised information about production
techniques unavailable to other potential producers
8: Price discrimination: in a monopoly the firm can change the price and
quantity of the good or service. In an elastic market the firm will sell a high
quantity of the good if the price is less. If the price is high, the firm will sell a
reduced quantity in an elastic market.(price the products differently in
different markets) Reason: to separate the market for different consumers
with different purchasing power (different elasticities)

2
As a conclusion, there are restrictive practices: the arrangements that tries to
prevent competition in the market (unfair)
Efficiency of monopoly:
No productive efficiency: Q line cuts ATC at a value higher than its minimum
Not allocatively efficiency: Wont be allocatively efficient(MC not= MR)
However, state monopolies can be instructed to be allocatively efficient

Downward sloping: pricing power as consumers have no choice

Firm=market

Barriers to entry

1. Natural barriers to entry a natural monopoly exists when the

technology for producing a good or service enables one firm to meet the
entire market demand at a lower price than two or more firms could.
E.g. one electric power distributor can meet the market demand for
electricity at a lower cost than two or more firms could
2. Legal barriers to entry a legal monopoly is a market in which
competition and entry are restricted by the concentration of ownership
of a natural resource or by the granting of a public franchise,
government license, patent or copyright.
(a) Concentration of ownership of a natural resource and vertical
integration - Control over supplies and distribution can be
important. For example many major oil companies are vertically
integrated. They control, oil extraction refining and retail outlets
maintain their market power. Vertical integration gives a business
control over different stages of the supply chain.
(b) Public franchise exclusive right granted to a firm to supply a
good or service e.g. MTR subway rail system in Hong Kong
(c) Government license controls entry into particular occupations
such as the accountancy profession
(d) Patent exclusive right granted to the inventor of a good or
service. Patents are legal property rights to prevent the entry of
rivals. They are generally valid for 17-20 years and give the owner
an exclusive right to prevent others from using patented products,
inventions, or processes. The owners of patents can sell licenses to
other businesses to produce versions of their patented product
this can prove to be lucrative.
(e) Copyright exclusive right granted to the author or composer of a
literary, musical, dramatic or artistic work
3. Brand loyalty & advertising customer loyalty given to first entrant
into the industry. Developing consumer loyalty by establishing branded

3
 products can make successful entry into the market by new firms much
more expensive and less successful. Advertising can also cause an
outward shift of the demand curve and also make demand less sensitive
to price.
4. Brand proliferation - In many industries multi-product firms engaging
in brand proliferation can give a false appearance of competition to the
consumer. This is common in markets such as detergents, confectionery
and household goods it is an essential part of non-price competition.
5. Cost of entry set up costs required for a firm to enter a market
6. Learning curve effects incumbents operating in an industry benefit
from knowledge which allows them to produce at a lower cost per unit
7. Reputational effects based on history of retaliation against new
entrants and/or the resources available to incumbents to retaliate.

See -
http://web.sis.edu.hk/Departments/EcoBus/microeconomics_11/media/monop
power.html

Task 1: Questions on monopoly

1: Monopoly arises in which of the following situations?

a) Coca-Cola cuts its price below that of Pepsi-Cola in an attempt to increase
its market share No: - Competition (more than 1 firm)
- Close substitutes
b) A single firm, protected by a barrier to entry, produces a personal service
that has no close substitutes Yes: one firm, (strong) barrier to entry,
homogenous products
c) A barrier to entry exists but some close substitutes for the good exists No:
close substitues, not high barrier
d) A firm offers discounts to students and seniors Yes: (price discrimination/
separate markets) No: oligopolies can offer discounts as well
e) A firm can sell any quantity it chooses at the going price No: perfect
competition
f) The government issues Tiger Woods, Inc. an exclusive license to produce
golf balls Yes: government mandate
g) A firm experiences economies of scale even when it produces the quantity
that meets the entire market demand Yes: the products are produced at a
minimal cost but it satisfies the entire market demand (natural
monopoly)

4
2: In each of the following cases, state whether the monopolist would increase or
decrease output:

(a) Marginal revenue exceeds marginal cost at the output produced: increase
(b) Marginal cost exceeds marginal revenue at the output produced: decrease

Case 1: Debswana in Botswana: joint venture between DeBeers Diamond

Company and the Botswana Government
- Ownership
- De Beers = 49%
- Botswana Gov: 51%

Case 2: Uranium minr in Kasungi Malaum: joint venture between Paladin, an

Australian mining firm and Malaun Government
- Ownership
- Paladin: 85%
- Malaun Gov: 15%

***Need to consider the competition info

- Joint venture:
1. The government wants to be involved in the profit shares with the use of
tis own resources
2. Minimal shares: the government wants to have a representational
ownership and get involved in the operations involving national safety like
uranium business

The monopolist's demand curve

In our analysis of perfect competition, we showed how there is a distinction
between the demand curve of the individual firm and that of the market as a
whole - the existence of many firms each competing against each other means
that each one has no influence over price, and has to take the price that is
determined in the market through the intersection of the demand and supply
curves. The demand curve for each firm is therefore horizontal: an infinite
amount is demanded at one price, with nothing at all being demanded at a higher
price and with the charging of a lower price being inconsistent with the goal of
profit maximization.

5
However, under monopoly there is only one firm in the industry; thus there is no
difference between the demand curve for the industry and the demand
curve for the firm. As the monopolist is subject to the normal law of demand,
the monopolist's demand curve will be downward sloping so that to sell more,
price would have to be lowered (see figure 1). In comparison to other types of
market, the monopolist's demand curve is likely to be relatively inelastic as close
substitutes may not be available if price is raised. Indeed, the availability or non-
availability of close substitutes is one of the key factors determining the
monopolist's power in the market.

Figure 1 Monopolist's demand curve

The demand curve shown in Figure 1 presents the monopolist with a choice. The
monopolist can either choose to make the price or the quantity, but cannot do
both; for example, if the monopolist chooses to set a price of OP1, the market
dictates that only a quantity of OQ1 could be sold; however, if the monopolist
chooses to set a quantity of OQ2 to be sold, clearly the demand curve tells us that
this could only be achieved at a price of OP2.

Marginal revenue and average revenue under monopoly

The table below assumes that the monopolist faces a normal demand schedule,
and from this the revenue curves are derived. Try calculating the figures for total,
average and marginal revenue and once you have had a go, follow the link to
check your answers.

6
Task 2: Complete the table below
Output Price Total revenue Marginal revenue Average revenue

1 20 20 20 20

2 18 36 16 18

3 16 48 12 16

4 14 56 8 14

MR= change in revenue (falling back due to downward sloping demand)

AR= average of old + new figures
From the table two points can be seen:

a) As price has to be lowered to increase sales, marginal revenue is not equal to

price as in perfect competition: the additional revenue gained from each extra
sale is always less than price or average revenue, and thus the MR curve will
always be below the AR curve in monopoly.
b) As price is identical to average revenue, the demand curve is also the curve
relating average revenue to the quantity produced.
The information in this table can now be shown in diagrammatic form to show
the relationship between the average and marginal revenue curves (figure 2).

Figure 2 Marginal and average revenue curves

Price, Marginal revenue and PED

7
Task 3: Calculate total revenue, marginal revenue and price elasticity of demand
in the table below

Point Price QD Total Marginal Price

revenue revenue elasticity of
demand
A 20 0 0 ---- ----
B 18 1 18 18 ----
C 16 2 32 14 -9
D 14 3 42 10 -4
E 12 4 48 6 -2.33
F 10 5 50 2 -1.5
G 8 6 48 -2 -1
H 6 7 42 -6 -0.67
0I 4 8 32 -10 -0.45
J 2 9 18 -14 -0.25
K 0 10 0 -18 -0.11

Plot of AR and MR: Monopolist will not price their product at a price at a price
where MR is negative, this corresponds to where the good is inelastic
Elastic

Unitary elastic

Inelastic

***MR and AR relationship:

- MR begins at same point on the vertical axis
- MR has twice the slope of AR
- Monopolist will price the products at elastic range
Reason: Distance of Y-axis and Q(MR)= Distance of Y-axis and Q(AR)
Possible Market Graph

Task 4: Plot average revenue (price) and marginal revenue on a diagram.

Identify the relationship between total revenue and price elasticity of demand

8
Remember: If a price fall increases total revenue, demand is elastic, but if a price
fall decreases total revenue, demand is inelastic.

Interpretation: The relationship between marginal revenue and elasticity

implies that a monopoly never profitably produces an output in the inelastic
range of its demand curve.

Profit maximisation

A monopoly maximizes profits where MR=MC. It sets a price of Pm and quantity

Qmax.

So a monopolist can earn supernormal profit in both the short-run and long-run;
this is mainly due to the fact that the barriers to entry will maintain the firms
market power and restrict competitive forces.

9
Task 5: The following table gives the total costs and total revenue schedule for a
monopolist.

Quantity Total Cost Total Revenue Marginal Marginal

Revenue Cost
0 144 0 -- --
1 160 90 90 16
2 170 160 70 10
3 194 210 50 24
4 222 240 30 28
5 260 250 10 38
6 315 240 -10 55
7 375 210 -30 60

(a) Calculate the marginal revenue and marginal cost, and sketch the demand
curve.
(b) Determine the profit-maximising price and quantity, and calculate the
resulting profit. Between 4 and 5: MC=MR

Task 6: Fill in the missing data on a monopolist in the following table:

Quantity Price Total Marginal Marginal Average Profit

Revenue Revenue Cost Total
Cost
1 11 11 0 -- 18.00 -7
2 10 20 9 4 11.00 -2
3 9 27 7 1 7.67 4
4 8 32 5 4 6.75 5

10
5 7 35 3 6 6.60 2
6 6 36 1 9 7.00 -6
7 5 35 -1 14 8.00 -21

(a) At what quantity will the monopolist produce in order to maximise profits?
What will be the price at this level of output? What will be the profits? Q=4
Price=8
(b) What quantity maximises total revenue? What is the elasticity of demand at
that point? Why is this not the profit-maximising quantity?

Market Power: The power to raise price above marginal cost- without fear that
other firms will enter the firm

The Monopolists Profit

Example of how a patent allows a monopolist to profit maximize

11
Task 7: A Publisher faces the following demand Schedule for the next novel by
one of its popular authors:

Price Quantity Demanded

$100 0
90 100,000
80 200,000
70 300,000
60 400,000
50 500,000
40 600,000
30 700,000
20 800,000
10 900,000
0 1,000,000

The author is paid $2 million to write the book, and the marginal cost of
publishing the book is a constant $10 per book.

(a) Compute total revenue, total cost and profit at each quantity. What quantity
would a profit-maximising publisher choose? What price would it charge?

12
(b) Compute marginal revenue. How does marginal revenue compare to the
price.

(c) Graph the marginal revenue, marginal cost and demand curves. At what
quantity do the marginal revenue and marginal cost curves cross?

(d) On your graph, shade in the deadweight loss

(e) if the author were paid $3 million instead of $2 million to write the book, how
would this affect the publishers decision regarding the price to charge?

(f) Suppose that the publisher were not profit maximising but were concerned
with maximising economic efficiency. What price would it charge for the book?
How much profit would it make at this price?

Other possible equilibrium positions

Maximising sales revenue is an alternative to profit maximisation and occurs

when the marginal revenue, MR, from selling an extra unit is zero.

Revenue maximization graph

The condition for revenue maximisation is, therefore, to produce up to the point
where MR = 0. This is also at the same level of output where PED = 1, namely at
the mid-point of the average revenue/demand curve.

13
Sales volume maximization
Sales maximisation is another possible goal and occurs when the firm sells as
much as possible without making a loss.
Not-for-profit organisations may choose to operate at this level of output, as may
profit making firms faced with certain situations, or employing certain strategies.
An example of this would be predatory pricing where, so long as costs are
covered, a firm may reduce price to drive rivals out of the market.

14
Sales maximisation means achieving the highest possible sales volume, without
making a loss. To the right of Q, the firm will make a loss, and to the left of Q sales
are not maximised.

Loss-minimizing equilibrium

A monopolist can be a loss making one if the Average Cost lies above Average
Revenue. In this case the firm costs are greater than its revenue so it makes a
loss. The red and blue combined add up to cost. The red box represents revenue
and the blue box, loss. The cost is found by drawing a vertical line from where
Quantity meets the Average Cost curve to the price line.

15
16
Natural Monopoly

A natural monopoly is a type of monopoly that may arise when there are
extremely high fixed costs of distribution, such as exist when large-scale
infrastructure is required to ensure supply. Examples of infrastructure include
cables and grids for electricity supply, pipelines for gas and water supply, and
networks for rail and underground. These costs are also sunk costs, and they
deter entry and exit.
Exam definition: monopoly that argues that because one firm can meet the
entire market demand and of a lower price than two or more firms

Very high fixed costs need to be spread over a large output for a firm to be
competitive i.e. economies of scale

In the case of natural monopolies, trying to increase competition by encouraging

new entrants into the market creates a potential loss of efficiency. The efficiency
loss to society would exist if the new entrant had to duplicate all the fixed factors
- that is, the infrastructure.

It may be more efficient to allow only one firm to supply to the market because
allowing competition would mean a wasteful duplication of resources.

- Argument for government intervention to achieve allocative efficiency

- Price ceiling and price floor

Economies of scale
With natural monopolies, economies of scale are very significant so that
minimum efficient scale is not reached until the firm has become very large in
relation to the total size of the market.
Minimum efficient scale (MES) is the lowest level of output at which all scale
economies are exploited. If MES is only achieved when output is relatively high, it
is likely that few firms will be able to compete in the market. When MES can only
be achieved when one firm has exploited the majority of economies of scale
available, then no more firms can enter the market.

Utility companies
Natural monopolies are common in markets for essential services that require
an expensive infrastructure to deliver the good or service, such as in the cases of
water supply, electricity, and gas, and other industries known as public utilities.
Because there is the potential to exploit monopoly power, governments tend
to nationalize or heavily regulate them.

17
Regulators
If public utilities are privately owned, as in the UK, since privatization during the
1980s, they usually have their own special regulator to ensure that they do not
exploit their monopoly status.
Examples of regulators include Ofgem, the energy regulator, and Ofcom, the
telecoms and media regulator. Regulators can cap prices or the level of return
gained.

Railways as a natural monopoly

Railways are often considered a typical example of a natural monopoly. The
very high costs of laying track and building a network, as well as the costs of
buying or leasing the trains, would prohibit, or deter, the entry of a competitor.
To society, the costs associated with building and running a rival network would
be wasteful.

Avoiding wasteful duplication

The best way to ensure competition, without the need to duplicate the
infrastructure, is to allow new train operators to use the existing track; hence,
competition has been introduced, without duplication of costs. This is
called opening-up the infrastructure.
This approach is frequently adopted to deal with the problem of privatizing
natural monopolies and encouraging more competition, such as:
1. Telecoms, the network is provided by BT
2. Gas, the network is provided by National Grid (previously Transco)
With a natural monopoly, average total costs (ATC) keep falling because of
continuous economies of scale. In this case, marginal cost (MC) is always below
average total cost (ATC) over the whole range of possible output.

18
Profits
In order to maximize profits the natural monopolist would charge Q, and make
super-normal profits. If unregulated, and privately owned, the profits are likely
to be excessive. In addition, the natural monopolist is likely to be allocatively and
productively inefficient.

19
Losses
To achieve allocative efficiency, the regulator will have to impose an excessive
price-cap (at P1). The output needed to be allocatively efficient, at Q1, is so high
that the natural monopolist is forced to make losses, given that ATC is above AR
at Q1. Allocative efficiency is achieved when price (AR) = marginal cost (MC),
at A, but at this price, the natural monopolist makes a loss.
A public utilitys losses could be dealt with in a number of ways, including:
1. Subsidies from the government.
2. Price discrimination, whereby splitting the market into two or more sub-
groups, and charging different prices to each sub-group can derive
additional revenue.
Source:
http://www.economicsonline.co.uk/Business_economics/Natural_monopolies.ht
ml

Monopoly and Efficiency

In contrast to a competitive firm, the monopoly charges a price above the

marginal cost. From the standpoint of consumers, this high price makes

20
monopoly undesirable. However, from the standpoint of the owners of the firm,
the high price makes monopoly very desirable.

Because a monopoly sets its price above marginal cost, it places a wedge between
the consumers willingness to pay and the producers cost. This wedge causes the
quantity sold to fall short of the social optimum.

The monopolist produces less than the socially efficient quantity of output. The
deadweight loss caused by a monopoly is similar to the deadweight loss caused
by a tax. The difference between the two cases is that the government gets the
revenue from a tax, whereas a private firm gets the monopoly profit.

Monopoly is also productively inefficient i.e. it will not produce at the point
where MC cuts ATC at the lowest point.

Despite being productively and allocatively inefficient, monopolies can still

be desirable

Monopolies can be defended on the following grounds:

21
 1. They can benefit from economies of scale, and may be natural
monopolies, so it may be argued that it is best for them to remain
monopolies to avoid the wasteful duplication of infrastructure that would
happen if new firms were encouraged to build their own infrastructure.
2. Domestic monopolies can become dominant in their own territory and then
penetrate overseas markets, earning a country valuable export revenues.
This is certainly the case with Microsoft.
3. According to Austrian economist Joseph Schumpeter, inefficient firms,
including monopolies, would eventually be replaced by more efficient and
effective firms through a process called creative destruction.
4. It has been consistently argued by some economists that monopoly power
is required to generate dynamic efficiency, that is, technological
progressiveness. This is because:
1. High profit levels boost investment in R&D.
2. Innovation is more likely with large enterprises and this innovation
can lead to lower costs than in competitive markets.
3. A firm needs a dominant position to bear the risks associated with
innovation.
4. Firms need to be able to protect their intellectual property by
establishing barriers to entry; otherwise, there will be a free
rider problem.
5. Why spend large sums on R&D if ideas or designs are instantly
copied by rivals who have not allocated funds to R&D?
6. However, monopolies are protected from competition by barriers to
entry and this will generate high levels of supernormal profits.
7. If some of these profits are invested in new technology, costs are
reduced via process innovation. This makes the monopolists supply
curve to the right of the industry supply curve. The result is lower
price and higher output in the long run.

Source:
http://www.economicsonline.co.uk/Business_economics/Monopoly.html

Policies to regulate monopolies

Monopoly power can be controlled, or reduced, in several ways, including price

controls and prohibiting mergers. It is widely believed that the costs to society

22
arising from the existence of monopolies and monopoly power are greater than
the benefits and that monopolies should be regulated.

Options available to regulators include:

1. Regulators can set price controls and formulae, often called price capping.
This means forcing the monopolist to charge a price, often below profit
maximizing price. For example, in the UK the RPI X formula has been
widely used to regulate the prices of the privatized utilities. In the formula,
the RPI (Retail Price Index) represents the current inflation rate and X is a
figure which is set at the expected efficiency gain, which the regulator
believes would have existed in a competitive market. However, there is a
dilemma with price controls because price-capping results in lower prices,
but lower prices also deter entry into the market. The formula for water
is RPI + K + U, where K is the price limit, and U is any unused 'credit' from
previous years. For example, if K is 3% in 2010, but a water company only
'uses' 2%, it can add on the unused 1% to K in 2011. Regulators may
remove price caps if they judge that competition in the market has
increased sufficiently, as in the case of OFCOM who removed BT's price cap
in 2006.
2. An alternative to price-cap regulation is rate-of-return regulation. Rate of
return regulation, which was developed in the USA, is a method of
regulating the average price of private or privatized public utilities, such
as water, electricity and gas supply. The system, which employs accounting
rules for the calculation of operating costs, allows firms to cover these
costs, and earn a fair rate of return on capital invested. The fair rate is
based on typical rates of return, which might be expected in a competitive
market.
3. Regulators can prevent mergers or acquisitions, or set conditions for
successful mergers.
4. Breaking-up the monopoly, such as forcing Microsoft to split into two
separate businesses one for the operating system and one for software
sales. In 2004, the UK telecom's regulator Ofcom recommended that BT is
split into two businesses: retail and wholesale.
5. A less popular option would be to bring the monopoly under public control,
in other words to nationalize it.
6. Regulators can also force firms to unbundle their products and open-up
their infrastructure. Bundling means selling a number of products together
in a single bundle. For example, Microsoft
sells PowerPoint, Access, Excel and Word as one product rather than
separate ones. Unbundling makes it easier for firms to enter the market, as
in the case of UK telecoms, when BT was forced to apply local loop
unbundling, which enabled new broadband operators to enter the market.

23
 7. Regulators can use yardstick competition, such as setting punctuality
targets for train operators based on the highly efficient Bullet trains of
Japan.
8. It is also possible to split up a service into regional sections to compare the
performance of one region against another. In the UK, this is applied to
both water supply and rail services.

Source:
http://www.economicsonline.co.uk/Business_economics/Monopoly.html

Regulating a natural monopoly

When demand and cost conditions create natural monopoly, government

agencies regulate the monopoly.

Regulating a natural monopoly in the public interest sets output where MB = MC

and the price equal to marginal cost. This regulation is the marginal cost-pricing
rule, and it results in an efficient use of resources.

24
Regulating Natural Monopoly
With price equal to marginal cost, ATC exceeds price and the monopoly incurs an
economic loss. If the monopoly receives a subsidy to cover its loss, taxes must be
imposed on other economic activity, which create deadweight loss. Where
possible, a regulated natural monopoly might be permitted to price discriminate
to cover the loss from.

Average-cost pricing

Another alternative is to produce the quantity at which price equals average total
cost and to set the price equal to average total cost the average cost pricing
rule.

Output where MB = MC and P = MC is the marginal cost pricing rule, and it results
in an efficient use of resources. With price equal to marginal cost, ATC exceeds
price and the monopoly incurs an economic loss. If the monopoly receives a
subsidy to cover its loss, taxes must be imposed on other economic activity,
which create deadweight loss.

25
Evaluation of monopolies

The advantages of monopolies

Monopolies can be defended on the following grounds:
1. They can benefit from economies of scale, and may be natural
monopolies, so it may be argued that it is best for them to remain
monopolies to avoid the wasteful duplication of infrastructure that would
happen if new firms were encouraged to build their own infrastructure.
2. Domestic monopolies can become dominant in their own territory and then
penetrate overseas markets, earning a country valuable export revenues.
This is certainly the case with Microsoft.
3. According to Austrian economist Joseph Schumpeter, inefficient firms,
including monopolies, would eventually be replaced by more efficient and
effective firms through a process called creative destruction.
4. It has been consistently argued by some economists that monopoly power
is required to generate dynamic efficiency, that is, technological
progressiveness. This is because:
1. High profit levels boost investment in R&D.
2. Innovation is more likely with large enterprises and this innovation
can lead to lower costs than in competitive markets.
3. A firm needs a dominant position to bear the risks associated with
innovation.

26
 4. Firms need to be able to protect their intellectual property by
establishing barriers to entry; otherwise, there will be a free
rider problem.
5. Why spend large sums on R&D if ideas or designs are instantly
copied by rivals who have not allocated funds to R&D?
6. However, monopolies are protected from competition by barriers to
entry and this will generate high levels of supernormal profits.
7. If some of these profits are invested in new technology, costs are
reduced via process innovation. This makes the monopolists supply
curve to the right of the industry supply curve. The result is lower
price and higher output in the long run.
8. Monopoly markup: Inelastic demand mark-up will be high
(price above in MC)
AR>MC
D>S
MB>MC
Two things that increase markup:
1. Necessity (relative demand)
2. Third parties were paying for the product for the consumers
consumer is insensitive to the price change
Linked back to allocative efficiency, markup is as allocative inefficiency (

5. ***Comparison between perfect competition and natural monopoly:

- A greater consumer surplus in a competitive market
- While in monopoly the consumer surplus triangle would be broken up
into three components: deadweight loss, profit and consumer surplus
(much smaller)

- Supernormal profit (benefit from consumers)

The disadvantages of monopoly to the consumer

Monopolies can be criticized because of their potential negative effects on the
consumer, including:
1. Restricting output onto the market.
2. Charging a higher price than in a more competitive market.
3. Reducing consumer surplus and economic welfare.
4. Restricting choice for consumers.
5. Reducing consumer sovereignty.

27
Higher prices
The traditional view of monopoly stresses the costs to society associated with
higher prices. Because of the lack of competition, the monopolist can charge a
higher price (P1) than in a more competitive market (at P).
The area of economic welfare under perfect competition is E, F, B. The loss of
consumer surplus if the market is taken over by a monopoly is P P1 A B. The new
area of producer surplus, at the higher price P1, is E, P1, A, C. Thus, the overall
(net) loss of economic welfare is area A B C.
The area of deadweight loss for a monopolist can also be shown in a more simple
form, comparing perfect competition with monopoly.

Alternative diagram
The following diagram assumes that average cost is constant, and equal to
marginal cost (ATC = MC). Under perfect competition, equilibrium price and
output is at P and Q. If the market is controlled by a single firm, equilibrium for
the firm is where MC = MR, at P1 and Q1. Under perfect competition, the area
representing economic welfare is P, F and A, but under monopoly the area of
welfare is P, F, C, B. Therefore, the deadweight loss is the area B, C, A.

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The wider and external costs of monopolies
Monopolies can also lead to:
1. A less competitive economy in the global marketplace.
2. A less efficient economy.
1. Less productively efficient
2. Less allocatively efficient
3. The economy is also likely to suffer from X inefficiency, which is the loss of
management efficiency associated with markets where competition is
limited or absent.
4. Less employment in the economy, as higher prices lead to lower output
and les need to employ labour.

Besides, many monopolies are born of a corrupted government. Monopoly

runners use the supernormal to benefit themselves.

Setback of eliminating monopolies:

Example: elimination of monopolies in pharmaceutics
The competition will drive the price of existing drugs down to MC, but it costs
about 1 billion to produce the first pill. The R&D cost are not included in the MC.

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If P=MC, firm cannot recover from their R&D costs. As a result, monopolistic
pharmaceutic firms would loss the incentive to produce more new drugs.

Static and dynamic efficiency

Role of patents: the patent leads to static inefficiency at output is less than the
socially-efficient level (firm is profit-maximizing to cover the high fixed costs)
Yet a patent can lead to dynamic efficiency at output is equal or more than the
socially-efficient level (firm is bringing the price to a socially-optimal level

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Source:
http://www.economicsonline.co.uk/Business_economics/Monopoly.html
Task 8: Arguments for and against breaking up a monopoly

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ai. Economies of scale refers to a situation in a long run that when the output is
increased, the average cost of production is decreased
ii. Investment refers to a fund being added to a business or firm to expand the
capabilities of the business.
b. Allocative efficiency refers to a situation where price=MC. With the initiative of
any producers to maximize profit, the equilibrium point would be MC=MR. In
such cases, there would be a difference between the profit maximizing point and
the allocative efficiency. As a result, there would be an allocative inefficiency.
c. Negative production externality
d. Regulation argument: 1. Existence of substantial economies of scale, benefit
industry in the long run. BAA will have a higher SNP allowing if to invest in
infrastructure
2. With two or more firms it could lead to even higher price and less potential for
future investment (lower economies of scale)
Break-up argument:
1. profit making- benefits may not be passed onto consumers of more
competitive prices or facilities
2. Firm losses the incentive to improve the service- no efficiency in evidence of
the case study
3. Productively and allocatively inefficient
4. Doubling price of landing fees at the airports i.e. exploiting market power
(P>MC)

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Task 9: Anti-monopoly legislation in China

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