positive and normative economics

You will often hear statements about economic issues on the television and written in
newspapers 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 question
about how things actually are. Positive statements are made without obvious value-
judgements and emotions. They may suggest an economic relationship that can be tested
by recourse to the available evidence.

Positive economics can be described as “what is, what was, and what probably will be”
economics. Statements are based on economic theory rather than raw emotion. Often
these 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 the
demand for imported products
Lower taxes may stimulate an increase in the active labour supply
A national minimum wage is likely to cause a contraction in the demand for low-skilled
labour
The UK economy now has lower unemployment than Germany
The American stock market has boomed in recent years

NORMATIVE STATEMENTS

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

It is important to be able to distinguish between these types of statements - particularly

when heated arguments and debates are taking place. Most economists tend to adopt a
positive approach.

Examples:

The decision to grant independence for the Bank of England is unwise and should be
reversed
A national minimum wage is totally undesirable as it does not help the poor and causes
higher unemployment and inflation
The national minimum wage should be increased to? 5 as a method of reducing poverty
Protectionism is the only proper way to improve the living standards of workers whose
jobs are threatened by cheap imports
Monopoly
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Competition law
Basic concepts
• History of competition law
• Monopoly
o Coercive monopoly
o Natural monopoly
• Barriers to entry
• Market power
• SSNIP test
• Relevant market

• Merger control
Anti-competitive practices
• Monopolization
• Collusion
o Formation of cartels
o Price fixing
o Bid rigging
• Product bundling and tying
• Refusal to deal
o Group boycott
o Essential facilities
• Exclusive dealing
• Dividing territories
• Conscious parallelism
• Predatory pricing

• Misuse of patents and

copyrights
Enforcement authorities and
organizations
• International Competition
Network

• List of competition regulators

This box: view • talk • edit
In economics, a monopoly (from Greek monos / μονος (alone or single) + polein / πωλειν
(to sell)) exists when a specific individual or an enterprise has sufficient control over a
particular product or service to determine significantly the terms on which other
individuals shall have access to it.[1][clarification needed] Monopolies are thus characterized by a
lack of economic competition for the good or service that they provide and a lack of
viable substitute goods.[2] The verb "monopolize" refers to the process by which a firm
gains persistently greater market share than what is expected under perfect competition.

A monopoly must be distinguished from monopsony, in which there is only one buyer of
a product or service ; a monopoly may also have monopsony control of a sector of a
market. Likewise, a monopoly should be distinguished from a cartel (a form of
oligopoly), in which several providers act together to coordinate services, prices or sale
of goods. Monopolies can form naturally or through vertical or horizontal mergers. A
monopoly is said to be coercive when the monopoly firm actively prohibits competitors
from entering the field.

In many jurisdictions, competition laws place specific restrictions on monopolies.

Holding a dominant position or a monopoly in the market is not illegal in itself, however
certain categories of behavior can, when a business is dominant, be considered abusive
and therefore be met with legal sanctions. A government-granted monopoly or legal
monopoly, by contrast, is sanctioned by the state, often to provide an incentive to invest
in a risky venture or enrich a domestic constituency. The government may also reserve
the 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

In economics, monopoly is a pivotal area to the study of market structures, which directly
concerns normative aspects of economic competition, and sets the foundations for fields
such as industrial organization and economics of regulation. There are four basic types of
market structures under traditional economic analysis: perfect competition, monopolistic
competition, 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 certain
industry and there are no close substitutes for the goods being produced, then the market
structure is that of a "pure monopoly". Sometimes, there are many sellers in an industry
and/or there exist many close substitutes for the goods being produced, but nevertheless
firms retain some market power. This is called monopolistic competition, whereas in
oligopoly the main theoretical framework revolves around firm's strategic interactions.

In general, the main results from this theory refer to compare price-fixing methods across
market structures, analyze the impact of a certain structure on welfare, and play with
different variations of technological/demand assumptions in order to assess its
consequences on the abstract model of society. Most economic textbooks follow the
practice of carefully explaining the perfect competition model, only because of its
usefulness to understand "departures" from it (the so called imperfect competition
models).

The boundaries of what constitutes a market and what doesn't, is a relevant distinction to
make in economic analysis. In a general equilibrium context, a good is a specific concept
entangling geographical and time-related characteristics (grapes sold in October of 2009
in Moscow is a different good from grapes sold in October of 2009 in New York). Most
studies of market structure relax a little their definition of a good, allowing for more
flexibility at the identification of substitute-goods. Therefore, one can find an economic
analysis of the market of grapes 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 who
produces all the output.[3] Therefore, the whole market is being served by a single
firm, and for practical purposes, the firm is the same as the industry. In a
competitive market (that is, a market with perfect competition) there are an
infinite number of sellers each producing an infinitesimally small quantity of
output.
• 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).[4][5] 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.

[edit] Sources of monopoly power

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

Economies of scale: Monopolies are characterized by declining costs over a

relatively large range of production.[8] Declining costs coupled with large start up
costs give monopolies an advantage over would be competitors. Monopolies are
often in a position to cut prices below a new entrant's operating costs and drive
them out of the industry.[8] Further the size of the industry relative to the minimum
efficient scale may limit the number of firms that can effectively compete within
the industry. If for example the industry is large enough to support one firm of
minimum efficient scale then other firms entering the industry will operate at a
size that is less than MES meaning that these firms cannot produce at an average
cost that is competitive with the dominant industry.
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.[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, 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.[8] In plain
English one large firm can sometimes produce goods cheaper than several small
firms.[11]
No Substitute Goods:A monopoly sells a good for which there is no close
substitutes. The absence of substitutes makes the demand for the good relatively
inelastic 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 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.
• Deliberate Actions: A firm wanting to monopolize a market may engage in
various 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 market
power. Barriers to exit are market conditions that make it difficult or expensive for a firm
to leave the market. High liquidation costs are a primary barrier to exit.[12] Market exit
and shutdown are separate events. The decision whether to shut down or operate is not
affected by exit barriers. A firm will shut down if price falls below minimum average
variable costs.

[edit] Monopoly versus competitive markets

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

Market Power - market power is the ability to control the terms and condition of
exchange. 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 when
it comes to setting prices. All firms in a PC market are price takers. The price is set by the
interaction of demand and supply at the market or aggregate level. Individual firms
simply take the price determined by the market and produce that quantity of output that
maximize the firm's profits. If a PC firm attempted to raise prices above the market level
all its "customers" would abandon the firm and purchase at the market price from other
firms. A monopoly has considerable although not unlimited market power. A monopoly
has the power to set prices or quantities although not both.[15] A monopoly is a price
maker.[16] The monopoly is the market[17] and prices are set by the monopolist based on
his circumstances and not the interaction of demand and supply. The two primary factors
determining monopoly market power are the firm's demand curve and its cost structure.[18]

Product differentiation: There is zero product differentiation in a perfectly competitive

market. Every product is perfectly homogeneous and a perfect substitute. With a
monopoly there is high to absolute product differentiation in the sense that there is no
available substitute for a monopolized good. The monopolist is the sole supplier of the
good in question.[19] A customer either buys from the monopolist on her terms or does
without.

Number of competitors: PC markets are populated by an infinite number of buyers and

sellers. Monopoly involves a single seller.[19]

Barriers to Entry - Barriers to entry are factors and circumstances that prevent entry into
market by would be competitors and impediments to competition that limit new firm’s
from 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 high
barriers to entry. The barriers must be strong enough to prevent or discourage any
potential competitor from entering the market.

PED; 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. A low coefficient of elasticity is indicative of effective barriers to entry. A
PC firm faces what it perceives to be perfectly elastic demand curve. The coefficient of
elasticity for a perfectly competitive demand curve is infinite.

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

Profit Maximization - A PC firm maximizes profits by producing where price equals

marginal costs. A monopoly maximizes profits by producing where marginal revenue
equals marginal costs.[21] The rules are equivalent. The demand curve for a PC firm is
perfectly elastic - flat. The demand curve is identical to the average revenue curve and the
price line. Since the average revenue curve is constant the marginal revenue curve is also
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 monopoly
faces a downward sloping demand curve rather than the "perceived" perfectly elastic
curve 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 distinct
marginal revenue curve. The implications of this fact are best made manifest with a linear
demand curve, Assume that the inverse demand curve is of the form x = a - by. Then the
total 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 y
intercept 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 revenue
curve is half that of the inverse demand curve. What is not quite so evident is that the
marginal revenue curve lies below the inverse demand curve at all points.[23] Since all
firms maximize profits by equating MR and MC it must be the case that at the profit
maximizing quantity MR and MC are less than price which further implies that a
monopoly produces less quantity at a higher price than if the market were perfectly
competitive.

A company with a monopoly does not undergo price pressure from competitors, although
it may face pricing pressure from potential competition. If a company raises prices too
high, 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 need
not be regulated against is known as the "revolution in monopoly theory".[25]

A monopolist can extract only one premium,[clarification needed] and getting into complementary
markets does not pay. That is, the total profits a monopolist could earn if it sought to
leverage its monopoly in one market by monopolizing a complementary market are equal
to the extra profits it could earn anyway by charging more for the monopoly product
itself. However, the one monopoly profit theorem does not hold true if customers in the
monopoly 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 perfect
competition, i.e. to optimize a profit function given some constraints. Under the
assumptions of increasing marginal costs, exogenous inputs' prices, and control
concentrated on a single agent or entrepreneur, the optimal decision is to equate the
marginal cost and marginal revenue of production. Nonetheless, a pure monopoly can
-unlike a competitive firm- alter the market price for her own convenience: a decrease in
the level of production results in a higher price. In the economics' jargon, it is said that
pure monopolies "face a downward-sloping demand". An important consequence of such
behavior is worth noticing: typically a monopoly selects a higher price and lower quantity
of 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 model
diagram (and its associated conclusions) displayed here. The result that monopoly prices
are higher, and production output lower, than a competitive firm follow from a
requirement that the monopoly not charge different prices for different customers. That
is, the monopoly is restricted from engaging in price discrimination (this is called first
degree price discrimination, where all customers are charged the same amount). If the
monopoly were permitted to charge individualized prices (this is called third degree price
discrimination), the quantity produced, and the price charged to the marginal customer,
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 the
consumer. In essence, every consumer would be just indifferent between (1) going
completely without the product or service and (2) being able to purchase it from the
monopolist.

As long as the price elasticity of demand for most customers is less than one in absolute
value, it is advantageous for a firm to increase its prices: it then receives more money for
fewer goods. With a price increase, price elasticity tends to rise, and in the optimum case
above 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 article by adding citations to reliable sources. Unsourced material may
be challenged and 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 than
would firms under perfect competition. Because the monopolist ultimately forgoes
transactions with consumers who value the product or service more than its cost,
monopoly pricing creates a deadweight loss referring to potential gains that went neither
to the monopolist or to consumers. Given the presence of this deadweight loss, the
combined surplus (or wealth) for the monopolist and consumers is necessarily less than
the total surplus obtained by consumers under perfect competition. Where efficiency is
defined by the total gains from trade, the monopoly setting is less efficient than perfect
competition.

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 to
compete in the marketplace. Sometimes this very loss of psychological efficiency can
raise a potential competitor's value enough to overcome market entry barriers, or provide
incentive for research and investment into new alternatives. The theory of contestable
markets argues that in some circumstances (private) monopolies are forced to behave as
if there were competition because of the risk of losing their monopoly to new entrants.
This is likely to happen where a market's barriers to entry are low. It might also be
because of the availability in the longer term of substitutes in other markets. For example,
a canal monopoly, while worth a great deal in the late eighteenth century United
Kingdom, was worth much less in the late nineteenth century because of the introduction
of railways as a substitute.

[edit] Natural monopoly

A natural monopoly is a firm which experiences increasing returns to scale over the
relevant range of output.[27] A natural monopoly occurs where the average cost of
production “declines throughout the relevant range of product demand.” The relevant
range 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 market
than multiple smaller firms, in fact, absent government intervention in such markets will
naturally evolve into a monopoly. An early market entrant who takes advantage of the
cost structure and can expand rapidly can exclude smaller firms from entering and can
drive or buy out other firms. A natural monopoly suffers from the same inefficiencies as
any other monopoly. Left to its own devices a profit seeking natural monopoly will
produce where marginal revenue equals marginal costs. Regulation of natural monopolies
is problematic. Breaking up such monopolies is counter productive[citation needed]. The most
frequently used methods dealing with natural monopolies is government regulations and
public ownership. Government regulation generally consists of regulatory commissions
charged 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 and
quantity are determined by the intersection of the average cost curve and the demand
curve.[30] This pricing scheme eliminates any positive economic profits since price equals
average 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 been
limited to natural monopolies.[30]

[edit] Government-granted monopoly

A government-granted monopoly (also called a "de jure monopoly") is a form of coercive

monopoly 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 from
the market by law, regulation, or other mechanisms of government enforcement.
Copyright, patents and trademarks are examples of government-granted monopolies.

[edit] Breaking up monopolies

When monopolies are not broken through the open market, sometimes a government will
step in, either to regulate the monopoly, turn it into a publicly owned monopoly
environment, 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 to
efficient 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
broken up into the "Baby Bell" components, MCI, Sprint, and other companies were able
to 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 paying
excessive 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 monopoly
illegal, but rather abusing the power a monopoly may confer, for instance through
exclusionary practices.

First it is necessary to determine whether a firm is dominant, or whether it behaves "to an

appreciable extent independently of its competitors, customers and ultimately of its
consumer."[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 special
responsibility 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's
legislation, 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) and product bundling

Despite wide agreement that the above constitute abusive practices, there is some debate
about whether there needs to be a causal connection between the dominant position of a
company and its actual abusive conduct. Furthermore, there has been some consideration
of 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 market
profitably. They seek to protect the monopoly power of existing (incumbent) firms in an
industry and therefore maintain supernormal (monopoly) profits in the long run. Barriers
to entry have the effect of making a market less contestable
The economist Joseph Stigler defined an entry barrier as "A cost of producing (at some or
every rate of output) which must be borne by a firm which seeks to enter an industry but
is not borne by firms already in the industry"

This emphasises the asymmetry in costs between the incumbent firm (already inside the
market) and the potential entrant. If the existing businesses have managed to exploit some
of the economies of scale that are available to firms in a particular industry, they have
developed a cost advantage over potential entrants. They might use this advantage to cut
prices if and when new suppliers enter the market, moving away from short run profit
maximisation objectives - but designed to inflict losses on new firms and protect their
market 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 force
any new entrants to operate at a loss

Cost advantages

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

Advertising and marketing

Developing consumer loyalty by establishing branded products can make successful entry
into the market by new firms much more expensive. This is particularly important in
markets 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 potential
entrants 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 to
improve their production processes and reduce unit costs. This makes the existing firms
more competitive in the market and gives them a structural advantage over potential rival
firms.

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. This
acts as a disincentive to enter the industry.
International trade restrictions

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

Sunk Costs

Sunk Costs are costs that cannot be recovered if a businesses decides to leave an industry
Examples include: " Capital inputs that are specific to a particular industry and which
have little or no resale value " Money spent on advertising / marketing / research which
cannot be carried forward into another market or industry When sunk costs are high, a
market becomes less contestable. High sunk costs (including exit costs) act as a barrier to
entry 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 Telecom
announced 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's
workforce. And, it will cost BT $2bn (?1.4bn) in impairment charges and restructuring
costs, and AT&T $5.3bn.
_______________________________________________________________________
_

Q : WHAT ARE THE ECONOMIC ARGUMENTS IN FAVOUR AND AGAINS

MONOPOLY MARKET?

A2 Markets & Market Systems

Monopoly & Economic Efficiency

In this note we evaluate the costs and benefits of businesses with industry muscle, monopoly pricing
power in markets. The standard economic and social case against monopolistic businesses is no longer
straightforward. Markets are changing all of the time and so are the conditions in which businesses must
operate regardless of whether they have any noticeable market power.
The economic case against monopoly
The usual textbook argument against monopoly power in markets is that existing monopolists can
continue to earn abnormal (supernormal) profits at the expense of economic efficiency and the welfare of
consumers and society.
The standard case against monopoly is that the monopoly price is higher than both marginal and average
costs leading to a loss of allocative efficiency and a failure of the market mechanism. The monopolist is
extracting a price from consumers that is above the cost of resources used in making the product and,
consumers’ 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 firm is
not making optimum use of its scarce resources. Under these conditions, there may be an economic case
for some form of government intervention to limit or reduce the scale of monopoly power, for example
through the rigorous application of competition policy or by a process of market deregulation
(liberalisation).
X Inefficiencies under Monopoly
X inefficiency is a term first coined by Harvey Libenstein. The lack of real competition may give a
monopolist less of an incentive to invest in new ideas or consider consumer welfare. It can also be
argued that even if the monopolist benefits from economies of scale, they will have little incentive to
control production costs and 'X' inefficiencies will mean that there will be no real cost savings.
Comparison between Monopoly and Perfect Competition
A competitive industry will produce in the long run where market demand = market supply. Consider the
diagrams below. Equilibrium output and price is at Q1 and Pcomp on the left hand diagram and Pcomp
and Q1 on the right hand diagram. At this point, Price = MC and the industry meets the conditions for
allocative efficiency.

If the industry is taken over by a monopolist the profit-maximising point (MC=MR) is at price Pmon and
output Q2. The monopolist is able to charge a higher price restrict total output and thereby reduce
economic welfare. The rise in price to Pmon reduces consumer surplus. Some of this reduction in
consumer welfare is a pure transfer to the producer through higher profits, but some of the loss is not
reassigned to any other economic agent. This is known as the deadweight welfare loss and is equal to the
area ABC.
A similar result is seen in the next diagram which makes the working assumption of constant long run
average and marginal costs under both competition and monopoly. The deadweight loss of economic
welfare under monopoly (whose profit maximising price is P1 and Q1) is shown by the triangle ABC.
The competitive price and output is Pc and Qc respectively.

Potential Benefits from Monopoly

A 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, more
efficiently, than their smaller rivals
It is important in essays and data questions when you are analyzing imperfectly competitive markets
where the concentration ratio is high to mention some of the potential advantages of suppliers having
monopoly power.
One difficulty in assessing the welfare consequences of monopoly, duopoly or oligopoly lies in defining
precisely what a market actually constitutes! In nearly every industry the market is segmented into
different products, and the impact of globalisation makes it difficult to gauge the true degree of
monopoly power that might exist in an industry at any moment in time. Increasingly markets where a
monopoly appears to exist are actually becoming more contestable because of the effects of growing
international 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 which
gives a higher output and a lower price than under competitive conditions. This is illustrated in the next
diagram, 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.
Monopoly Profits, Research and Development and Dynamic Efficiency
As firms are able to earn abnormal profits in the long run there may be a faster rate of technological
development that will reduce costs and produce better quality products for consumers. This is because
the 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 leadership
of firms like Microsoft is often criticised, their investments in research and development (R&D) can be
beneficial to society because they expand the technological frontier and open new ways to prosperity.
Many technological innovations are developed by firms with patents on the leading-edge technologies.
These firms perpetuate their leadership and their market power through innovations. Etro's research
argues that providing that a market is characterised by free entry, then the market leader will actually
have more incentives than any other firm to invest in R&D.
Baumol – Oligopoly and Innovation
William Baumol an economist from Princeton University in the USA published a book in 2002 “The
Free Market Innovation Machine” in which he analysed the conditions best suited for markets and
countries to achieve a faster pace of innovation. Baumol argues that the structure that fosters productive
innovation best is oligopoly. The Baumol hypothesis is that oligopolists compete by making their
products differ slightly from their rivals. Highly innovative firms are often quick to license new
technology or to become members of technology-sharing consortia.
Natural Monopoly
A natural monopoly occurs in an industry where LRAC falls over a wide range of output levels such that
there may be room only for one supplier to fully exploit all of the internal economies of scale, reach the
minimum efficient scale and therefore achieve productive efficiency.
The major utilities such as gas, electricity and water are often put forward as examples of industries with
strong "natural tendencies" towards being a natural monopoly in part because of the huge fixed costs of
building and maintaining nationwide networks of cables and pipes. In fact we can make an important
distinction between the supply and distribution of services such as gas and electricity. The retail market
for the supply of gas and electricity to homes and businesses is also fully competitive. However, the
businesses 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 and
monitoring of quality of service.
The natural monopoly through the exploitation of economies of scale can in theory undercut any actual
or potential rivals purely on the grounds of cost. If the monopolist loses market share (for example by
the competition authorities acting to split up an existing monopoly) there is the risk that smaller-scale
suppliers will produce at higher average total cost which would represent a waste of scarce resources.
Forcing 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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