Monopolies and the allocation of resources

  • the meaning of monopoly and monopoly power
  • the causes of monopoly
  • whether monopoly leads to resource misallocation or whether there may be circumstances in which the benefits of monopoly exceed the costs
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The meaning of Monopoly

  • Pure Monopoly 
    - market structre with only one firm
    - completey protected by barriers to entry
    - no competition at all 
  • Monopoly power/ Market power
    - Many firms posses a degree of monopoly power
    - This power gives the firm the ability to influence the market - by setting a price and using persuasive advertising to get consumers to buy the good
  • Oligopoly
    - An industry dominated by a few large firms is often loosely called a monopoly - example of highly imperfect competition  
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Causes of monopoly

  • Monopoly power is strongest when a fir produces an essential good for which there are no substitutes
  • OR when demand is relatively inelastic 
  • Natural monopoly occurs when there is room in the market for only one firm benefitting from full economies of scale
  • Utility industries such as water, gas, electricity - natural monopolies - competition considered as wasteful 
  • Geographical - single grocery store in an isolated village 
  • Government created monopolies - protected from competition by the law eg gambling casinos 
  • Control of market outlets and raw materials - breweries and oil companies denying competitors access to the pubs and petrol stations they own
  • Advertising as a barrier to entry - large firms can prevent small firms entering the market through saturation advertising 
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Monopoly and resource allocation

  • They restrict consumer choice
  • They incur unnecessarily high costs and are productively inefficient because they don't face competition 
  • Consumers suffer because producer sovereignity replaces Consumer sovereignity - monopoly does not respond to consumers' wishes. preferring instead an 'easy life'
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Monopoly can be justified

  • By achieving economies of scale, a monopoly can produce at a lower average cost and be more productively efficient than a smaller firm in a competitive industry
  • Limited maximum size to the market - there is only room in the market for one firm benefitting to the full from economies of scale; a natural monopoly 
  • A monopoly may be innovative because the firm can enjoy the fruits of successful innovation in the firm of monopoly profit
  • By contrast, a competitive firm may lack the incentive to innovate if competitors can instantly copy any successful innovation
  • This is the justification of patent legislation, which gives firms an exclusive right to exploit their innovations for a number of years
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Government policy and monopoly

  • If the benefits of monopoly exceed the costs, the government may decide to allow the monopoly to survive
  • If the costs of monopoly exceed the benefits, the government may try and break up an established monopoly and prevent the formation of new monopolies 
  • Even if the monpoly is allowed, there still is a case for government intervention to regulate the monpoly in order to prevent the firms abusing market power
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