2019 May (Monopoly/ Natural Monopoly) Paper 1 TZ1

 2019 May (Monopoly/ Natural Monopoly) 

Paper 1 TZ1

1 (b) Evaluate the view that monopoly is an undesirable market structure as it fails to achieve productive & allocative efficiency.

 

Definitions

 

Monopoly – Industry served by one firm.

 

Barriers of Entry – obstacles that prevent other firms from entering a particular industry

 

Allocative Efficiency – optimal quantity of goods produces based on society’s preferences (P = MC)

 

Productive Efficiency – production of goods at their lowest cost

 

Natural Monopoly – most efficient number of firms is one

Diagram of Monopoly

A monopoly due to barriers of entry can keep competitors out of the market/industry allowing it to charge higher prices and producing less output. A monopolist given a choice will produce at profit max which is where its MR = MC (marginal revenue = marginal costs) at this point the price is greater than the MC (allocative efficiency = P = MC) and the price is greater than the minimum of the ATC (productive efficiency = P = minimum of the ATC) This is undesirable as prices are higher than society would like them to be and less output is produced causing a (DWL) dead weight loss or welfare loss to society.

 

In some instances monopolistic firms are desirable in that the industry they are in (electricity, transportation, water) would be better served by one firm being the producer and distributer of the service/good. Natural monopolies exist when an industry is most efficient with only one firm taking advantage of the economies of scale available. Ex. Industries with high sunk costs. Natural Monopolies tend to be forced/regulated to lower prices and produce higher output due to the fact government protection in keeping competitors at bay from entering the industries and competing with the firms. As natural monopolies take advantage of these EOS they could focus more financing toward research and development in the hopes of implementing more innovative techniques to lower costs and maintain economic profits. Of course natural monopolies could also use the government protection to be the only supplier of the good and produce low quality products and services and in extreme cases with no competition workers can become apathetic producing less output and lower qualities with no desire to maximize profits (x-inefficiency). Think of a firm with management so comfortable with the prevailing profits due to lack of competition that they hire more middle management to lighten their work load to make their work life easier will increasing costs to the company. The number of workers has increases with higher costs but output hasn’t increased.

 

John Hicks, who won the Nobel Prize for economics in 1972, wrote in 1935: “The best of all monopoly profits is a quiet life.” He did not mean the comment in a complimentary way. He meant that monopolies may bank their profits and slack off on trying to please their customers.

When AT&T provided all of the local and long-distance phone service in the United States, along with manufacturing most of the phone equipment, the payment plans and types of phones did not change much. The old joke was that you could have any color phone you wanted, as long as it was black. However, in 1982, government litigation split up AT&T into a number of local phone companies, a long-distance phone company, and a phone equipment manufacturer. An explosion of innovation followed. Services like call waiting, caller ID, three-way calling, voice mail through the phone company, mobile phones, and wireless connections to the internet all became available. Companies offered a wide range of payment plans, as well. It was no longer true that all phones were black. Instead, phones came in a wide variety of shapes and colors. The end of the telephone monopoly brought lower prices, a greater quantity of services, and also a wave of innovation aimed at attracting and pleasing customers.