Characteristics of a monopoly
A firm is a pure monopoly if it is the only supplier of a particular good or service. Let us look at the characteristics of a monopoly.
1. No competition – being the only supplier of a good or service, a monopoly faces no competition from other firms.
2. Abnormal profits – Because there is no competition, the monopolist is able to permanently earn high profits, often known as abnormal profits.
3. Price makers – Because the monopolist produces all of a particular good or service for a market, it can raise the price of its product by supplying less of it.
4. High barriers to entry – It is very difficult to enter and exit the industry. It could be due to high capital investment required. Sometimes other firms are prevented from entry by a firm acquiring parents to be the only producer of a particular product, since they researched and developed it.
5. Imperfect information
Under monopoly there is no perfect information. For example, a firm may hide the price it charges to one group of consumers from another group which is charged a different price.
6. Non-homogenous products
Monopolists usually produce products which is difficult for other firms to copy. The product is unique to the monopolist.
In the UK gas, electricity and water supply, telecommunications and the railway track are all monopolies. These industries are often referred to as natural monopolies because economies of scale are so large that any new entrant would find it impossible to match the costs and prices of the established firm. There are many industries in the world economy which possess most if not all of the characteristics identified.
Some monopolies, such as the water companies have considerable monopoly power because there are no good substitutes for their product. BP does not possess a monopoly in oil production or supply but might be said to possess a local monopoly if it had the only petrol station in a village.
A monopoly is able to maintain its position as the sole supplier of a good or service because it is able to establish high barriers to entry. Barriers to entry include legal barriers such as patents, marketing barriers such as advertising, restrictive practices and access to specific technology or raw materials.
A monopoly firm is the same as the industry as it is the only firm that is operational in the industry. The industry faces a downward sloping demand curve, meaning the monopolist also faces a downward sloping demand curve. The monopolist can therefore only set the level of price or output.
If it wishes to sell more units it must lower price or if it wishes to increase price then it must reduce output as shown in the following diagram(Figure 1).
A monopolist is assumed to profit maximise, in other words, aims to achieve an output equal to the point where MC=MR. Figure 2 shows:
• the equilibrium profit maximising level of output at Q1, where MC=MR
• the monopolist is able to supply Q1 at a price of P1
• super-normal profits of P1C1BA will be made. The super-normal profit per unit (AB) is the difference between the average revenue received (P1) and average cost of C1.
The price is determined by establishing the output level where MC = MR and then identifying the average revenue for this — ie the monopolist sets price using the AR or demand curve.
Figure 3 shows a loss making monopolist. A monopolist may decide to remain operational whilst it makes a loss in the short-run as long as it is covering its variable costs and therefore making a contribution to its fixed costs. The monopolist may feel that in the long run super-normal profits might be achieved.
Advantages of monopoly
1. Monopoly avoids duplication and hence wastage of resources.
2. A monopoly enjoys economics of scale as it is the only supplier of product or service in the market. The benefits can be passed on to the consumers.
3. Due to the fact that monopolies make lot of profits, it can be used for research and development and to maintain their status as a monopoly.
4. Monopolies may use price discrimination which benefits the economically weaker sections of the society.
5. Monopolies can afford to invest in latest technology and machinery in order to be efficient and to avoid competition.
6. Source of revenue for the government- the government gets revenue in form of taxation from monopoly firms.
Disadvantages of monopoly
1. Poor level of service.
2. No consumer sovereignty. A monopoly market is best known for consumer exploitation. There are indeed no competing products and as a result the consumer gets a raw deal in terms of quantity, quality and pricing.
3. Consumers may be charged high prices for low quality of goods and services.
4. Lack of competition may lead to low quality and out dated goods and services.