Monopolies

Essay 1

A monopoly is a firm that is the only seller of a good or service that does not have a close substitute, e.g. Australia post, BHP and government authorities that sell water and electricity (Hubbard 2010, 224). The main reason why economists argue against the existence of monopolies is because it causes economic inefficiency - allocative, productive and dynamic inefficiency (Hubbard 2010, 233-234).

Allocative efficiency is when production in the economy reflects consumer preferences. (Hubbard 2010, 9). In a monopoly, sufficient resources are not allocated to their best use to produce the amount of goods that society would prefer. Monopolies do not produce in large quantities because then they would have to lower price to sell their products, which would lessen their profits (Anne Garnett, personal communication).

The monopolist is the only firm so the demand curve of the firm becomes the demand curve of the industry. It can set either price or output, not both. To maximise profits, the monopolist will produce where marginal cost equals marginal revenue. Panel (a) of figure 1 shows the equilibrium position of the monopolist where output is at OQ and price at OP (Parry 2004, 123).

Panel (b) compares the monopolist industry with a competitive industry. In a competitive industry, equilibrium occurs where demand equals supply. The MC of the monopolist becomes the supply curve of the competitive industry. Price will be OPc and quantity will be OQc. Thus monopolies produce less and sell at a higher price compared to a competitive industry, leading to a misallocation of resources. “Because the monopolist produces where price exceeds marginal cost, society values the additional output of this product more than it does the alternative products which resources could otherwise produce” (Parry 2004, 124). Too little of the product is produced.

Because a monopoly raises the market price, it reduces consumer surplus and increases producer surplus. By...