Effect of Monopoly Power
The Effect of Monopoly Power
If a firm has monopoly power then it will face little competition. Therefore it will be a price maker and its demand curve will be inelastic. If it was to increase prices demand would only fall by a small %. Therefore a monopoly is likely to cause the following effects.
Increase in Prices and decline in consumer surplus. (diagram of monopoly - demand is inelastic)
The monopolist is able to reduce quantity supplied to increase the price.
Less Choice for Consumers.
Monopoly firms will be able to increase their revenue and make higher profit.
With supernormal profit the monopolies will have less incentive to cut costs and produce at the lowest point on the AC curve. Therefore they will be productively inefficient.
With higher prices and less choice for consumers. Monopolies will cause allocative inefficiency.
If monopolies get too big they may experience diseconomies of scale. (higher average costs from increased output)
Monopolies are able to use their monopoly power to pay lower prices to their suppliers. E.g Supermarkets are able to pay low prices to farmers.(the farmers don’t have any alternatives to sell their produce.)
Advantages of Monopolies
In monopoly firms make high levels of profit. Therefore they can spend this profit on investing in Research and Development. This can lead to the development of the new products that can benefit consumers
Economies of Scale. Monopolies can produce a large output. Therefore they can benefit from lower average costs. This can be passed onto consumers into the form of lower prices. Economies of scale are particularly important in industries with high fixed costs, e.g. car industry and airplane travel.
( diagram of LRAC curve sloping diagram)
Monopolies may not be inefficient. Firms may become monopolies because they are successful and produce goods efficiently.
Domestic monopolies may be necessary to compete on an international scale.
Conclusion
Monopolies are generally seen as undesirable because they lead to higher prices and are more likely to be inefficient. However monopolies may be the best outcome for some industries with substantial economies of scale, and/or industries which require substantial profit for research and development.
-By: Richard Pettinger 12/10/05
