The debate about monopoly will never be settled!
The standard economic case against monopoly is that, with the same cost structure, a monopoly supplier will produce at a lower output and charge a higher price than a competitive industry. This leads to a net loss of economic welfare and efficiency because price is driven above marginal cost - leading to allocative inefficiency.
The diagram below shows how price and output differ between a competitive and a monopolistic industry. We have assumed that the cost structure for both the competitive firm and the monopoly is the same - indeed we have assumed that output can be supplied at a constant marginal and average cost.
Assuming that the monopolist seeks to maximise profits and that they take the whole of the market demand curve, then the price under monopoly will be higher and the output lower than the competitive market equilibrium.
This leads to a deadweight loss of consumer surplus and therefore a loss of static economic efficiency.
CAN MONOPOLY BE DEFENDED?
Monopoly and Economies of Scale
Because monopoly producers are often supplying goods and services on a very large scale, they may be better placed to take advantage of economies of scale - leading to a fall in the average total costs of production. These reductions in costs will lead to an increase in monopoly profits but some of the gains in productive efficiency might be passed onto consumers in the form of lower prices. The effect of economies of scale is shown in the diagram above.
Economies of scale provide potential gains in economic welfare for both producers and consumers.
Regulation of monopoly
Because of the potential economic welfare loss arising from the exploitation of monopoly power, the Government regulates some monopolies. Regulators can control annual price increases and introduce fresh competition into particular industries
Monopoly and Innovation (Research and Development)
How are the supernormal profits of monopoly used? Is consumer surplus of equal value to producer surplus?
Are large-scale firms required to create a comparative advantage in global markets? Some economists argue that large-scale firms are required to be competitive in international markets.
However some of the supernormal profits might be used to invest in research and development programmes that have the potential to bring dynamic efficiency gains to consumers in the markets. There is a continuing debate about whether competitive or monopolistic markets provide the best environment for high levels of research spending.
Are there potential welfare improvements from price discrimination? Some forms of price discrimination benefit certain consumers.
Domestic monopoly but international competition
A firm may have substantial domestic monopoly power but face intensive competition from overseas producers. This limits their market power and helps keep prices down for consumers. A good example to use here would be the domestic steel industry. Corus produces most of the steel manufactured inside the UK but faces intensive competition from overseas steel producers.
Contestable markets!
Contestable market theory predicts that monopolists may still be competitive even if they enjoy a dominant position in their market. Their price and output decisions will be affected by the threat of "hit and run entry" from other firms if they allow their costs to rise and inefficiencies to develop.