In the board game Monopoly, each player plays to buy all the houses/stations/streets and become a monopoly. A monopoly is basically a firm that owns the whole market. A monopoly sets its own price and earns super-normal profit in the long-run.
Monopolies are usually allocatively, productively and Pareto inefficient.
1) A Single Seller.
A monopoly is the only firm in the market, or it is the most dominant firm with at least 25% market share.
A firm is a price-maker if it has the power to set its price. A monopoly is a price-maker because it owns the market and faces a downward sloping demand curve, it can restrict output to raise price.
3) Monopoly Maximizes Profit at .
4) Barriers to Entry/Exit are significant.
A monopoly may set up entry barriers to protect itself from potential entrants and allow it to maintain its market share/power and profit.
Long-Run Equilibrium A monopoly maximizes profit at , sets a price P*, produces Q* and makes super-normal profit because .
1) Allocatively Inefficient.
Monopolies are allocatively inefficient because they earn super-normal profit by restricting output to raise price. As they do not produce what consumers want or the desired quantities.
2) Productively Inefficient.
Monopolies are productively inefficient because they do not produce at the lowest point on their AC curve.
3) Pareto Inefficient.
Monopolies are Pareto inefficient because they cause a welfare loss. Market failure happens because the price mechanism breaks down and resources are allocated by the monopoly and not free markets. The monopoly restricts output to raise price and maximize profit. Because the monopoly only produces Q* and not Q’ there is lost consumer surplus and lost producer surplus, a welfare loss, and society loses out.
Monopolies could be X-inefficient. A monopoly in an uncompetitive and incontestable market has no current or potential threat to its market power and super-normal profit. Workers and managers will put in less effort at work because they know the monopoly will not go bankrupt if they do not minimize costs since profits are high. So the monopoly may be disincentivized to minimize costs, will use its technology inefficiently, squander resources, let costs spiral upwards and become X-inefficient.
5) Dynamic Efficiency.
Monopolies may be dynamically efficient, that is, invest in Research and Development (R&D), innovate and produce new and better products/technologies for consumers. A monopoly does this to stay ahead of any potential competition. Consumers and society benefit because new and better quality goods are invented. Microsoft devotes a lot of resources to R&D to produce new and better quality products/technologies for example, Windows 7. Similarly, Apple innovated to develop the iPod.
Short-Run Equilibrium A monopoly could make a loss in the short-run if at . The monopoly leaves the industry straight away in the short-run If due to the shut-down rule. If , the monopoly will stay in the industry in the short-run because it can cover its variable costs and make some contribution to fixed costs. Eventually the monopoly leaves in the long-run because losses are unsustainable. After the monopoly leaves, the industry is lost to society as no other firm produces in that industry.
Natural Monopoly A natural monopoly exists if an industry can only support one firm.
An example of a natural monopoly is London Underground. Only one set of railway lines can be laid so only one firm can operate them.
Natural monopolies usually exist in the rail and utility industries. A large start-up investment in the infrastructure is required before a firm can operate for example, railway tracks, gas lines, water pipe networks and the electricity grid. This initial investment is very costly so fixed costs are very high. AC and MC begin high then continue to fall. AC remains above MC. A natural monopoly will produce at MR = MC and make super-normal profit.
A large level of output is required for a firm to exploit economies of scale. More competition is a wasteful duplication of resources and too inefficient, competition is not possible in the long-run. If a 2nd firm enters the market then each produces Q2 and average costs are so high that both firms make a loss.
If the government wants the natural monopoly to be allocatively efficient by producing at P1 = MC then the firm must be subsidised because it makes a loss.
Benefits and Costs of A Monopoly A monopoly may be beneficial for consumers/society, but it may be costly. Below is a summary of the costs and benefits of a monopoly:
An Example of Monopoly: Google Monopolies do not really exist anymore (apart from natural monopolies and monopolies resulting from patents) but a close approximation is Google in the market for search engines.