MONOPOLY AND MONOPOLY POWER: AQA Economics Specification Topic 4.1

Topic 4.1 - Individuals, firms, markets and market failure

Snapshot of the AQA syllabus topic area we’ll be covering in this post.

MONOPOLY AND MONOPOLY POWER: Perfect competition, imperfectly competitive markets and monopoly

AQA students must understand the following content [taken from the syllabus]

• The formal diagrammatic analysis of the monopoly model.

• That monopoly power is influenced by factors such as barriers to entry, the number of competitors, advertising and the degree of product differentiation.

• The advantages and disadvantages of monopoly.

INFORMATION YOU NEED TO KNOW

[NOTE: supporting diagrams and questions at the end]

Introduction: Monopoly and Monopoly Power

Market structures have a significant impact on how companies behave and perform in the field of economics. A monopoly is one of these market structures, where one company controls the market with little or no competition. The notion of monopoly, its diagrammatic analysis, the variables affecting monopoly power, and the benefits and drawbacks of this market structure will all be covered in this article.

The definitions of monopoly and monopoly power are slightly different.

A monopoly (in the pure sense) is when a firm controls 100% of the market - the firm is the market.

A monopoly power is when a firm has monopoly-like power in the market due to a high proportion of the market share.

The strict definition of a monopoly power could potentially vary around the world. In the UK, the commonly accepted definition of a monopoly is a firm with at least 25% market share - for example, Tesco supermarket.

The conditions of a pure monopoly are:

• The firm is the market (there is only 1 firm in a pure monopoly)

• Price making power (producer sovereignty)

• High barriers to entry

1. The Diagrammatic Analysis of the Monopoly Model [see diagram at the end]:

The diagram of the monopoly model shows the relationship between price, quantity, and demand in a diagram. A monopolistic firm has the power to set prices based on its own output and market conditions, in contrast to competitive markets where enterprises are price takers. A downward-sloping demand curve for the monopolist indicates that it must cut the price in order to increase sales.

The diagram shows the monopolist is a profit maximiser, setting their output at the point MR=MC (marginal revenue = marginal cost).

The respective price is then determined from the profit maximising level of output. The price will generally lead to supernormal profits being made.

The monopoly diagram can also be used to express the potential market failure arising from monopoly. There is a deadweight loss which results from the monpolist transfering consumer welfare (consumer surplus) to itself (producer surplus in the form of excess profit).

2. Factors Contributing to Monopoly Power:

Several variables that affect monopoly power affect the firm's capacity to sustain its leading position in the market. These components consist of:

Barriers to Entry: Monopolies frequently develop as a result of obstacles that restrict the entry of new competitors, such as patents, exclusive access to resources, or expensive start-up costs.

b. Number of Competitors: A monopolist's market position is strengthened by the absence of direct competitors and near substitutes.

Monopolies may use advertising and product differentiation methods to build brand loyalty and foster the idea of uniqueness.

3. Advantages of Monopoly:

a. Economies of Scale: Monopolies can benefit from scale economies, which lowers the cost per unit of production in the long run. Competitive firms are unlikely to be able to price compete with a monopoly power.

b. Research and Development: Monopolies frequently have more money to invest in R&D, which promotes creativity and advances in technology. This is a type of ‘dynamic efficiency’ - a crucial advantage for a monopoly which you should definitely mention in your exam given the chance.

c. Market Stability: Monopolies can ensure long-term investments and reduce price swings in specific industries. For example, Royal Mail is a monopoly in the market for postal services - Royal Mail’s monopoly position allows for more consistent pricing and investment into the industry. This allows for a better postal service overall.

4. Disadvantages of Monopoly:

a. Lack of competition: Monopolies limit consumer choice and may result in higher pricing and a smaller selection of products.

b. Reduced Economic Efficiency: Monopolies may lack the motivation to function as efficiently as possible in the absence of competition, which leads to inefficiencies and lower production. This means monopolies are allocatively and productively inefficient. A monopoly may also be X-inefficient - this is because they are disincentivised from cost minimising due to the lack of competition in the market

c. Potential for Exploitation: Monopolies may abuse their market dominance by setting exorbitant prices and engaging in anti-competitive behaviour such as predatory and limit pricing techniques.

Predatory pricing is where firms deliberately set their prices unreasonably low in order to force competition out of business.

Limit pricing is where firms deliberately set their prices unreasonably low in order to prevent new competition from entering the market in the first place.

Conclusion:

The monopoly market structure is one in which a single company has a dominant position. Understanding the effects of such market arrangements on consumer welfare, competition, and market efficiency requires an understanding of the diagrammatic analysis of monopoly, the factors determining monopoly power, and the benefits and drawbacks of monopolies. In order to maintain a balance between safeguarding consumer interests and promoting a vibrant, competitive corporate climate, policymakers are essential.

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SUPPORTING DIAGRAMS

a monopoly has price setting power - this makes it unlike a competitive market where the AR and MR curve would be the same and perfectly horizontal - in a monopoly market, the AR and MR curves are different - notice also that the AR curve is downward sloping - this means the monopolist can change the price at the cost of demand - for example, if the monopoly firm raises the price, they will experience lower demand - this is unlike the perfectly competitive market where there is only 1 price in the market

monopolies are assumed to be rational and in the pursuit of profit maximisation (MR=MC) - in the monopoly market structure, profit maximisation should also lead to supernormal profits being made (where price exceeds the cost per unit) - Box A is the total supernormal profit that’s made by the monopoly firm - this is unlike a perfectly competitive market where only normal profits can be made in the long run

monopoly market failure can be expressed using a market diagram - monoplies often exhibit market failure due to a deadweight loss - this is because the price in a monopoly market is higher and output is lower when compared to a competitive market - Point ABC is the welfare loss triangle that illustrates the degree of market failure in the industry

monopolies are usually assumed to be X-inefficient - this means their average total costs curves are not operating at their lowest potential - this is because there is a lack of incentive to invest into cost minimising strategies - this is because a monopoly firm has very few, if any, competitors

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SUPPORTING QUESTION

Question:

In 2020, Amazon ranked as the top U.S. company in retail ecommerce sales, capturing 38.7% of the market.

To what extent do you agree that Amazon should be considered a monopoly power, and is its dominance beneficial to households?

Answer:

Although Amazon is frequently referred to as an important player in the field of e-commerce, assessing whether it has monopoly power requires further investigation. Amazon does not strictly fit the definition of a monopoly in terms of having exclusive control over a market, despite having a sizable market share and a substantial impact on online shopping. Due to its size, market presence, and entry hurdles, it does, however, display monopoly power traits.

On the one hand, Amazon’s market share in the USA exceeds 25%, which in most cases would classify it as a monopoly power within the market of online retail. Compared to other companies, Amazon also has significant cost advantages as it’s able to invest heavily into new technologies. For example, Amazon has been known to invest into the field of robotics which helps the company reduce its cost operations. A competitive firm making normal profits would not have the investment funding to achieve these goals. One could argue that Amazon’s actions have raised the barrier to entry in the ecommerce industry as newcomers are highly unlikely to be able to compete on cost. Hence, it might be fair to say that Amazon deserves the label of ‘monopoly power’.

On the other hand, Amazon is well-known to have low, fair prices and this is one reason they have been so successful in the business. The traditional model of a monopoly market would surely predict Amazon prioritising higher prices and lower output in order to increase profits. Customer service is also another known area where Amazon excels (their brand logo is even a smiley face). This is another reason why one might argue that Amazon, despite their high market share, does not act as if they were a monopoly power.

On the whole, it is likely that Amazon is a technical monopoly power operating within a competitive oligopoly market. The retail industry is a highly competitive business, where product pricing is an important element of the customer journey. At this stage in its growth, the company management have most likely decided to increase the company’s market share and brand image, with the view of prioritising its longer-term profits at the expense of short-term profits.

Analysing the advantages for households is a more complex process. The advantages of Amazon's dominance include lower pricing, convenience, and a wide range of products. Amazon is also a massive employer which has provided households with good incomes. The convenience of online purchasing, quick delivery options, and affordable prices have also historically benefited customers. Additionally, the Amazon platform has benefited small businesses. This is because small companies and independent vendors are better able to reach a larger audience of consumers using Amazon’s website.

On the other hand, worries have been expressed regarding possible detrimental effects on market dynamics and competitiveness. Some contend that Amazon's market dominance can harm small firms in the long run as they’re forced to submit to Amazon’s strict rules and pricing policies. In some cases the Amazon platform might limit consumer options, and hinder competition. For example, a consumer purchasing a product directly from Amazon as opposed to an independent business may receive better customer service or warranties. Unfair practices such as predatory and limt pricing, data privacy, and the impact of Amazon's own product lines which drive out competitors are all causes for concern in the long run.