Monopolies and the Allocation of Resources

Monopolies and the Allocation of Resources

1. For markets to function well there must be a high level of competition

   • However, often there is a concentration of power on just a small number of firms, this can lead to market failure
     • A 'pure' monopoly exists when just one firm supplies the market

2. Problems of monopolies...

   • Firms can earn higher profits in spite of not producing goods and services that consumers value most
     • No incentive to produce products most valued by consumers as the firm has a high level of control
       • Consumers don't have the option to switch to an alternative so resources are not allocated according to consumer wants
         • The market has failed
   • Goods and services made are determined by the firms and not the conmsumers
     • Consumer sovereignty has been partially replaced by producer sovereignty
   • Firms not obliged to produce at lowest possible cost
     • Monopolists can restrict output in order to raise prices
       • No incentive to cut costs as there are no competitors forcing them to
         • Monopoly firms are unlikely to be productively efficient, hence a market failure
   • They may be less efficient
     • If they believe they have a protected market they may be less inclined to spend money on research and improved management
       • These inefficiencies can lead to a waste of scarce resources

3. Benefits of monopolies...

   • 1 Research and Development
     • large firms with large profits are in the position to allocate some profits to fund capital investment spending and research and development projects
       • Positive spillover effects including a faster pace of innovation and the development of improved products for consumers
         • e.g. in telecommunications and pharmaceuticals
   • 2 Exploitation of economies of scale
     • Because monopoly producers supply goods and services on a large scale they may achieve economies of scale.
       • This leads to a fall in average costs of production
         • Gains in productive efficiency may be passed onto the consumer through lower prices
           • Some economists believe that in some industries allowing a single firm to dominate due to the possibility of significant economies of scale would be a good thing
             • This is the 'natural monopoly' situation
   • 3 Monopolies and international competitiveness
     • The UK economy needs multinational companies operating on a scale large enough to compete in global markets
       • A firm can enjoy domestic monopoly power but still face competition in overseas markets
         • e.g. Corus, the UK/Dutch owned steel manufacturer

4. Causes for markets becoming more competitive in recent years

   • Technological change
     • rise of e-commerce and the internet
   • Globalisation
     • fresh low-cost competition from emerging market economies such as China and India
   • Deliberate government poloicies
     • want to open up markets and give new businesses the right to compete (e.g. in postal services, car retailing and telecommunications)