4.3. MONOPOLY - PART 1
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A monopoly is able to restrict output. As output is reduced the market decides who receives the good by raising the price (which can be found by looking at the demand curve). Consumers have no alternative firms to buy from, so if they want the good then they have to purchase it from this firm at the higher price. If a firm in perfect competition chose to raise their price then consumers could choose to shop elsewhere. This is because the goods are homogenous meaning that it makes no difference where the consumer buys the goods from.
In perfect competition, where prices and quantities reflect supply and demand, the price would be P1 and the quantity would be Q1. A monopoly can choose what level of output they want to produce. A monopolist may choose to reduce the output they produce to Qmon. The market will then decide at what price Qmon should sell for. By looking at the demand curve you can see that consumers are willing to pay more than P1 and will pay Pmon. The motivation behind the reduction in output is to increase the level of profit for a firm. There is an optimal quantity of output that a profit maximising monopoly should produce and you will learn about if you study Economics at A2.
A monopoly is only able to control either output or prices; it can never control both.
A monopoly is only able to control either output or prices; it can never control both.
By reducing the quantity of output produced the consumer surplus falls.
In perfectly competitive market the price a quantity will be determine by supply and demand and thus be the equilibrium price, P1, and quantity, Q1. This means that consumer surplus in competitive markets (which is the sum of the excess of what a consumers would have been prepared to pay for a good over what they actually pay) is the area AP1E. The producer surplus (which is the difference between what a supplier is willing to accept for a good and what they actually receive for the good) is the area BP1E.
Monopolists reduce the output produced, which changes the level of producer and consumer surplus. The level of consumer surplus now is APmonC and the level of producer surplus is BPmonCD. But we need to see whether the level of economic welfare has changed? Economic welfare is the total benefit to society from an economic transaction i.e. producer surplus, consumer surplus and government welfare. The increase in price level means that an area of consumer surplus has been converted into producer surplus; this area is PmonCFP1. This has no effect on the level of economic welfare because no welfare has been lost; all that has happened is that welfare has gone from the consumer to the producer. However, area CED has been totally lost and this area is known as the deadweight welfare loss. Society now has a lower level of economic welfare; they have lost out.
In perfectly competitive market the price a quantity will be determine by supply and demand and thus be the equilibrium price, P1, and quantity, Q1. This means that consumer surplus in competitive markets (which is the sum of the excess of what a consumers would have been prepared to pay for a good over what they actually pay) is the area AP1E. The producer surplus (which is the difference between what a supplier is willing to accept for a good and what they actually receive for the good) is the area BP1E.
Monopolists reduce the output produced, which changes the level of producer and consumer surplus. The level of consumer surplus now is APmonC and the level of producer surplus is BPmonCD. But we need to see whether the level of economic welfare has changed? Economic welfare is the total benefit to society from an economic transaction i.e. producer surplus, consumer surplus and government welfare. The increase in price level means that an area of consumer surplus has been converted into producer surplus; this area is PmonCFP1. This has no effect on the level of economic welfare because no welfare has been lost; all that has happened is that welfare has gone from the consumer to the producer. However, area CED has been totally lost and this area is known as the deadweight welfare loss. Society now has a lower level of economic welfare; they have lost out.
Monopoly Negatives
Along with the restriction of output and the raising of the price, there are many other negative associated with monopoly, such as:
Along with the restriction of output and the raising of the price, there are many other negative associated with monopoly, such as:
- A reduction in choice. If you only have one person to buy from then you have no choice. If goods were homogenous this wouldn’t matter because who ever you buy from you will get the same good but in reality all goods are slightly different meaning choice is restricted if there is only a monopoly. Also, the lack of competition results in there being no incentive to create choice within their products.
- They could be productively inefficient. Because there are no other competitors there is no incentive to reduce costs in the factory and come up with more efficient ways of using resources.
- There may be a lack of innovation. If there are no competitors it may be the case that there is no incentive to keep pushing the boundaries in the hope of creating a better and better product. This could mean that technological progress is slow.
MONOPOLY POSITIVES
But there are benefits of monopolies such as:
But there are benefits of monopolies such as:
- Economies of scale. As a firm exploits it monopoly power, it can grow and reap the rewards of economies of scale. This would result in lower costs that can be passed onto consumers; but this may not be the case as the monopoly will want to maximise profit, so the outcome depends on how the monopoly chooses to react.
- They can increase choice. There is usually more choice between the BBC channels compared with the choice between BBC 1 and ITV 1. For example, on a Saturday evening both BBC 1 and ITV 1 have similar shows such as X factor and Strictly Come Dancing and then later on they tend to play a film.
- Dynamic efficiency. A firm that has barriers to entry can protect their inventions and innovations meaning that they receive all of the benefit from conducting research and development. This would encourage a firm to increase their spending on R&D, which can result in better quality products.
- Avoidance of duplication of infrastructure. This is especially the case for a natural monopoly where competition would be wasteful. For example, if all electricity wires had to be owned by the companies whose electricity is traveling through them then we would have multiple wires doing the same job, which would be a waste of resources.
- Exports. If the firm was a leader in its field then it could exports its goods abroad, which would favour the balance of payment and help create jobs for an economy.
- National security. You may always be able to rely on this firm for production.
- Segment the market. They may segment the market in such a way that more people are able to use the good or service. A bus firm may use its revenue from peak times to subsidise times where the service is less busy meaning that there is always a good service. Also they could use the revenue gained from adults to reduce the fares for children.