Monopoly

Monopoly

The market structure of perfect competition was at the most competitive end of the spectrum, with numerous firms all-competing wildly. Now we jump to the other extreme. In the market structure of monopoly, there is only one firm in the whole market. In fact, that single supplier constitutes the entire industry.

As with perfect competition, we need to look at the assumptions that need to be made, but in this case there are not so many. Effectively, the monopolist can more or less do what it wants.

  1. Numbers: As we have said, there is only one firm, but the number of buyers can be numerous.
  2. Ease of entry: The complete opposite of perfect competition. With monopoly, there are lots of barriers to entry and exit. It is because of these barriers, usually imposed by the monopolist, which stop other firms trying to compete. For details of these barriers, see the first QuickLearn.
  3. Knowledge: Not such an issue with monopoly. In a sense, the monopolist knows everything that is going on in the industry because it is the industry!
  4. Product: One firm means one product, so I suppose it is homogenous as in perfect competition.
  5. Maximising assumption: Again, we assume that the monopolist aims to maximise its profit.
  6. Mobility of factors: There is only one firm, so factors don't need to be mobile between firms; they always stay with the one firm! Factors might be mobile between industries, but we are not concerned with that at the moment.
  7. Price makers: Firms in perfectly competitive markets are price takers. This means that they have absolutely no control over the price they charge. Monopolists are price makers. It is the only firm in the industry, so they make the price; they decide what the price is going to be.

Pure monopolies are almost as rare as perfectly competitive markets. The Post Office has a pure monopoly in the market for sending letters. Otherwise, there are many monopolistic markets, put no pure monopolies.

The recently privatised utilities used to be monopolies. British Telecom used to be the only company that supplied telephone services. It still has some monopolistic power, but the industry is now much more competitive, especially with the threat from mobile phones. Water, gas and electricity all used to be pure, state run, monopolies as well. There is now a lot of competition in the markets for gas and electricity, but although the Water industry has been split up, some would say that the resulting firms are now regional monopolies. This means that they have monopoly power over the area they serve, but not, any longer, over the whole of the UK. See the Learn-It on privatisation for more detail.

Before we move on to the diagrams, I must give you a definition for a natural monopoly. This is where the market structure of monopoly is the 'natural' state of affairs in an industry. This tends to happen in industries where the sunk costs are absolutely huge. The utilities are considered to be natural monopolies, despite the advent of competition.

Consider trying to compete with the electricity board in the old days. You would have to find the money to build a national grid! If things did not work out, there wouldn't be many firms willing to buy the grid from you! Of course, even today with competition in the market for electricity, the government couldn't get around this problem. There is still only one national grid. The companies compete to supply customers with the same electricity using the same distribution system.

A separate section for the cost curves and the revenue curves have not been produced. A monopolist is the only firm in the industry, so its average cost curve is the standard U-shaped curve (a bit like for a firm in perfect competition) and the marginal cost curve cuts the average cost curve at its lowest point, as you would expect. The average revenue curve (the demand curve) will be downward sloping, assuming the good in question is normal, and the corresponding marginal revenue curve will be below the average revenue, downward sloping and falling twice as fast. See the topic on 'Costs and revenues' for details.

Equilibrium output

The diagram above shows the equilibrium output for the monopolist. Notice that I haven't distinguished between the short run and the long run. There is no need. A monopolist can make profit in the short and long run. It can also makes losses (see the next diagram), although the firm might pull out rather than keep making losses into the long run.

If the industry's demand curve is downward sloping (which is usual) then so will the monopolist's. Remember that the monopolist is the industry. If the firm wants to increase sales, it must lower the price. If they want to increase the price they must accept lower sales. In other words, they cannot set both price and quantity.

To find the equilibrium price and quantity, we must, again, apply the maximising condition, MC = MR. This occurs at point A. To find the quantity demand/supplied, we simply drop a line vertically, giving Q1. To find the price, we must draw a line vertically upwards until it hits the average revenue curve and then draw a line horizontally to the y-axis, giving P1. Remember that the AR curve is the price curve, so it is from this curve that we read the price.

In this diagram the monopolist is earning super normal profit. This is because at output Q1, AR > AC. Profit per unit at Q1 is the distance BC, and total profit is represented by the red box, BCDP1.

Loss-making monopoly

This diagram shows how a monopolist might make a loss. It is the same diagram except the average cost curve is very high and, more importantly, above the average revenue curve. In this situation, the firm is bound to make a loss, but it will still minimise its losses by producing at the level of output where MC = MR. This occurs at point E, giving a price of P2 (read off the AR curve) and quantity Q2. The loss per unit is FG and the red box, FGHP2, represents the total loss.

You may be asking yourself, 'how would a monopolist, with no competition, make a loss?' Good question! How many times have you seen a really great product (potentially) on the program 'Tomorrow's World' and then never seen it on the market? It is feasible that a firm could get a patent for a new invention, but the production costs turn out to be very high, and certainly higher than the expected revenue given a realistic price.

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