When a company lowers its price, is that genuine competition that benefits consumers or an attempt to monopolise the market? If a company gains market share, is that a result of improved efficiency or merely a competitive threat in the long run? When a company develops innovative products that competitors cannot easily duplicate, is that monopolization? If several companies look to limit excess output because of difficult trading conditions – is this necessarily collusive behaviour that competition policy should look to stop?
The economic case against monopoly
- A profit-maximising firm will produce at the productively and allocatively efficient level of output in a perfectly competitive industry
- The conventional argument against market power is that monopolists can earn abnormal (supernormal) profits at the expense of efficiency and the welfare of consumers and society.
- The monopoly price is assumed to be higher than both marginal and average costs leading to a loss of allocative efficiency and a failure of the market. 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 if there are inefficiencies in production means that the firm is not making optimum use of scarce resources. Under these conditions, there may be a case for government intervention for example through competition policy or market deregulation.
X Inefficiencies under Monopoly
- The lack of competition may give a monopolist less incentive to invest in new ideas. Even if the monopolist benefits from economies of scale, they have little incentive to control their costs and 'X' inefficiencies will mean that there will be no real cost savings compared to a competitive market.
- 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 welfare because the rise in price to Pmon reduces consumer surplus.
- Some of this reduction in welfare is a pure transfer to the producer through higher profits, but some of the loss is not reassigned to any other agent. This is known as the deadweight welfare loss or the social cost of monopoly and is equal to the area ABC.
A similar result is seen in the next diagram which makes the assumption of constant long-run average and marginal costs under both competition and monopoly. The deadweight loss of 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 does not always signal the absence of competition; sometimes it can reflect the success of firms in providing better-quality products, more efficiently, than their rivalsOne difficulty in assessing the welfare consequences of monopoly, duopoly or oligopoly lies in defining precisely what a market constitutes! In nearly every industry a market is segmented into different products, and globalization makes it difficult to gauge the degree of monopoly power.