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 rule

A 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