Monopolies

Economics: Edexcel A A Level, topic 6.1.9

Monopoly

A pure monopoly is where one firm dominates a market for a good or service.

Monopolies are price-setters. They choose the price at which the product is sold.
Monopolies can get monopoly power legally:
E.g a patent can stop other firms from entering a market.
E.g a convincing advertising campaign that suggests a particular brand of drink is better than others can lead to a higher market share.
E.g an industry may not have many firms competing within it.

The monopoly demand curve is downward sloping.
It will aim to maximise profits and so produce where marginal cost (MC) is equal to marginal revenue (MR).
Here, supernormal profits are made.
These profits are made in the long run also.
The supernormal profits can be reinvested and dynamic efficiency can be achieved in the long run.

The monopoly is not productively efficient because marginal cost is not equal to average cost.
The equilibrium price in the long run is above marginal cost. So it is not allocatively efficient either.
Pm is above Pc.

Monopoly power may arise because of:
Limited competition in the market - when there are only a few firms in a market, they will usually have some pricing power.
Differences in products and advertising - firms may gain price-making power if consumers want their products more than others.
Barriers to entry stopping new competitors from joining the market.

Where firms are price setters in the market, we assume they will aim to maximise profit by setting the output and quantity where marginal revenue equals marginal cost.
This is profit maximising as if the firm produced any more then the cost of producing each extra unit would be greater than the extra amount earned by selling that unit.

Monopolies have benefits as well as disadvantages.

A monopoly can benefit from economies of scale.
E.g a firm could bulk buy on raw materials because they have a large market, reducing cost per unit.
Dynamic efficiency can be achieved if a firm wants to reinvest its profits.
Monopolies can create employment and jobs, like businesses in other industries.
The ability to invest lots of profits in R&D and intellectual property can benefit the firm and society with new advances e.g Bell Labs in the USA invested heavily in Telecoms.

Consumers have fewer products to choose from.
There is no guarantee that a monopoly will reinvest their profits and achieve dynamic efficiency.
By the same logic, firms may not actually improve overall efficiency, even though they have the ability to do so.