Topic Videos

Monopoly Power and Economic Welfare

Level:
A-Level, IB
Board:
AQA, Edexcel, OCR, IB, Eduqas, WJEC

Last updated 1 Apr 2018

Here is a revision video and presentation on how welfare loss might result from monopoly power.

Monopoly Power and Economic Welfare

Key notes:

A monopoly supplier such a regional water utility has significant market power and can therefore set prices above the level we expect to see in a competitive market.

This means that, at the profit-maximising level of output where MR=MC, the monopoly price is above marginal cost. This then leads to a loss of allocative efficiency meaning that scarce resources are not allocated optimally.

High monopoly prices lead to a deadweight loss of consumer welfare because output is lower and price higher than a competitive equilibrium. High prices mean some consumers are priced out of the market because of a fall in effective demand.

The monopolist makes abnormal (supernormal) profit (price > AC) but the loss of consumer surplus is greater than the gain in producer surplus leading to a net loss of welfare measured by community surplus

Evaluating the impact of monopoly on welfare

Challenge the assumptions:

  1. Are average costs the same with both monopoly and competition?
  2. Consider the potential for a monopoly supplier to achieve economies of scale
  3. Is the loss of productive efficiency greater because of possible X-inefficiencies?
  4. Does a monopoly necessarily charge a single profit-maximising price? Consider the impact on welfare of price discrimination on different groups of consumers
  5. Not every monopoly charges a price! Consider Google and Facebook – but is it free?

What do we mean by a welfare loss?

  • Narrow definition focuses on consumer welfare / consumer surplus
  • Wider interpretation considers social welfare – i.e. community surplus which includes producer welfare and also effects on the distribution of income

How are monopoly profits used?

  • Research and development spending – possible gains in dynamic efficiency
  • Share buy-backs and short term capital gain for shareholders?
  • Do businesses with monopoly power pay an equitable amount of corporation tax?

Evaluating monopoly power

  1. Natural monopoly – falling long run average costs and high MES - more productively efficient to have a monopoly supplier
  2. Competition in the supply chain – possible to introduce competition at different stages of the supply chain e.g. via competitive tendering, franchises
  3. “In theory …. But in practice”: Judge a monopoly on a case by case basis using an evidence-based approach to how a monopoly actually behaves in the market
  4. Contestability – the threat of entry into a market can be a powerful influence on the actual conduct of firms who have monopoly power
  5. Definition of the market – a business might have monopoly power in the domestic market but face significant international competition
Larry Elliott writing recently in the Guardian

Daily Email Updates

Subscribe to our daily digest and get the day’s content delivered fresh to your inbox every morning at 7am.

Signup for emails

© 2002-2025 Tutor2u Limited. Company Reg no: 04489574. VAT reg no 816865400.