Question: Using an example of your choice, define the term monopoly and assess the benefits of a monopoly.
A monopoly is a single seller in a market, or the most dominant firm in a market with a minimum market share of 25%. An example of a monopoly is Google in the market for search engines. Google satisfies all the assumptions of a monopoly. Firstly, Google is the most dominant search engine with roughly 70% market share. Other search engines like Yahoo have only a small market share. Also, the market for search engines has high entry barriers. Start-up costs are low as it only takes a computer and the right programme to create a search engine but, because Google is such a strong brand, a new search engine must spend heavily on advertising to compete with Google. Moreover, Google is essentially a price-maker. Although Google does not charge money to use its service it does command high prices from its advertizers. Additionally, Google makes super-normal profits. Google’s profits in 2011 were roughly £5 billion.
In the long-run, a monopoly maximizes profit at MR = MC, sets a price P*, produces Q* and makes super-normal profit because AR > AC.
A monopoly may be beneficial for consumers/society, but it may also be costly; the overall benefit of a monopoly to society depends on the individual circumstances.
For example, A monopoly may be allocatively inefficient because they restrict output to raise prices; If P > MC then the monopoly does not produce what consumers want or the desired quantities. However, if the monopoly is in a perfectly contestable market then the threat of potential competition makes the monopoly act as if there were actual competition so it sets P=MC and the monopoly is allocatively efficient.
Furthermore, a monopoly could be Pareto inefficient because they usually lead to market failure and a welfare loss. Monopolies restrict output to raise prices, this causes a loss of both consumer surplus and producer surplus. On the other hand, monopolies earn super-normal profit so they have the potential to be dynamically efficient by investing in R&D to produce new and better products for consumers. In our example, Google is dynamically efficient. Google always invests in new technology to innovate and provide something new and better for consumers. For instance, in 2012, Google developed the technology to allow its users to drag photos into its search engine to find similar photos online. Google also innovated by developing Google Maps.
Moreover, monopolies could become X-inefficient. A monopoly that faces no current or potential competition may suffer X-inefficiency because its workers put in less effort and the monopoly’s costs consequently rise. But, monopolies could be regulated by competition authorities. A regulator could impose a price cap of RPI-X on the monopoly, forcing the monopoly to act as if there were competition in the industry.