Question

13. Some markets are much more monopolistic than others.

a. Why are some markets characterised by monopolistic market structures? (7.5 marks)

b. Compare and contrast the equilibrium outcomes under monopoly and perfect competition (7.5 marks)

c. What are the welfare implications associated with monopolies? (7.5 marks)

d. What policies can governments use to limit the degree of monopoly power? (7.5 marks)

Answer 1

a. Reasons why some markets are characterised by monopolistic structures:

1. Economies of Scale: because products made in larger quantities become cheaper and products made in smaller quantities are more expensive, This create barriers to entry when average total costs are high and results in a monopoly.

2. Sometimes an industry is a natural monopoly when a single firm can supply a good or service to an entire market at a lower cost than could two or more firms.

3. In many cases, monopolies arise because the government has given one person or firm the exclusive right to sell some good or service. The patent and copyright laws are two important examples of how government creates a monopoly to serve public interest.

b. A significant difference between the two is that while under perfect competition price equals marginal cost at the equilibrium output, under monopoly equilibrium price is greater than mar­ginal cost. Under perfect competition average revenue curve is a horizontal straight line and therefore marginal revenue curve coincides with average revenue curve and as a result marginal revenue and average revenue are equal to each other at all levels of output.

Therefore, at the equilib­rium output marginal cost not only equals marginal revenue but also equals average revenue, that is, price. On the other hand, average revenue curve confronting a monopolistic firm slopes downward and marginal revenue curve therefore lies below it.

Consequently, under monopoly, average revenue (or price) is greater than marginal revenue at all levels of output. Hence, at the equilibrium output of the monopolist where marginal cost equals mar­ginal revenue, price stands higher than marginal cost. Thus, under perfectly competitive equilib­rium, price = MR = MC. In monopoly equilibrium, price > MC.

A second important difference between the two is that while under perfect competition, equi­librium is possible only when marginal cost is ris­ing at the point of equilibrium, but monopoly equi­librium can be reached whether marginal cost is rising, remaining constant or falling at the equi­librium output.

This is so because the second order condition of equilibrium, namely, MC curve should cut MR curve from below at the equilibrium point, can be satisfied in monopoly in all the three cases, whether MC curve is rising, remaining constant or falling, whereas in perfect competi­tion the second order condition is fulfilled only when MC curve is rising.

c. The monopolist is able to charge a higher price, restrict total output and thereby reduce welfare of consumers. 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.

d. The government may wish to regulate monopolies to protect the interests of consumers. For example, monopolies have the market power to set prices higher than in competitive markets. The government can regulate monopolies through:

• Price capping – limiting price increases
• Regulation of mergers
• Breaking up monopolies
• Investigations into cartels and unfair practises
• Nationalisation – government ownership.