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Monopoly Case - Large Firms Adopt Undesirable Practices

Essay by   •  May 19, 2011  •  Case Study  •  1,192 Words (5 Pages)  •  1,260 Views

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Large firms adopt undesirable practices. Discuss whether there is any truth in this.

A monopoly is a market structure whereby there is only a single supplier in the market. A pure monopoly is when only one producer exists in the industry. In reality, this situation rarely exists because there is always some form of substitute available. Monopoly exists, therefore, where one firm dominates the market. An oligopoly which is almost similar, is a market strucuture where a few firms (4-10) control at leats 60% cncentration ratio of the market share. Firms may be investigated for examples of monopoly power when market share exceeds 25%. Monopoly power refers to cases where firms influence the market in some way through their behaviour and it is always determined by the degree of concentration in the industry.Large firms become monopolistic in the long run because they enjoy economies of scale. They are identified by many characteristics for example; influencing prices, influencing output, erecting barriers to entry, pricing strategies to prevent or stifle competition and may not pursue profit maximisation which therefore encourages unwanted entrants to the market .

A monopoly has extensive power over the price it may want to charge its customers. The monopolist is sometimes referred to as a price maker. It must be noted, however, that a monopolist does not charge the highest possible price. Instead it charges the price for which its profits are the largest by setting output where MR=MC unlike in perfect competition where a lower price is set at a greater output where MC=AC. Given the barriers to entry, the monopolist will get abnormal profits in the long run because entry to the market is restricted. AR (D) curve for a monopolist is likely to be relatively price inelastic. Output assumed to be at profit maximising output, although not all monopolists may aim for profit maximisation. The diagram below shows the efficiency of the monopolist and oligopolistic market structures.

The higher price and reduced quantity (Qmon) means that consumer surplus is reduced as prices increase, shown by the grey shaded area. Consumer surplus is the diffrence between the price a consumer is willing to pay and the price he actually pays. This diffrence is shown by the diffrence between the demend curve (AR) and the market price (Pm). For a competitive market in equilibrium, price would be equal to the MC of production making it allocatively efficient because it is producing goods that society wants at the right price. A monopoly on the other hand, is allocatively inefficient because from the graph we can clearly see that the price (PM) is greater than M.C. Since that is not the case in the monopoly market structure shown above, then it is considered to be allocatively inefficient. In conclusion, consumers face higher prices and less choice in monopoly conditions compared to more competitive environments. Consumers are therefore exploited because they have no close substitutes that they can turn to. The monopolist will benefit from additional producer surplus because of producing a lower output of quantnity (Qmon). Producer surplus is the diffrence between the price a firm receives and the price it is willing to sell it at. For monopolies as illustrated above, additional producer surplus is gained making it productively inefficient (because A.C is not at its lowest point) thus output is reduced. The value of the blue-shaded triangle represents the total welfare loss to society which is sometimes referred to as the 'deadweight welfare loss'. The consumer's welfare is disregarded because the detriment in consumer surplus is forgone, in exchange for higher profits for the monopolistic firm. The lack of competition gives monopolies less incentives to create new ideas or consider consumer welfare. This is known as x-inefficiency.

A monopolist is better positioned to exploit economies of scale leasing to an equilibrium which

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