Essay Example on The concept of monopoly power and the way abuse of monopoly power








The purpose of this essay is to explore the concept of monopoly power and the way abuse of monopoly power can lead to market failure However to fully understand how a Monopoly works I will explain certain key factors that determine a monopolistic market Following that I will explain how a monopoly will abuse its power to maximise its profits and how this causes market failure Consequently this will lead us to the second part which is to evaluate what the government can do to regulate the problem and how it should be addressed as well as what the effect and side effects of regulation can be Market failure is when misallocation of resources happens while at least one individual could be better off without making the other worse off Pareto Inefficient The main feature of a Monopoly Market is the lack of competition in the Market as well as the ability of a single firm to determine the market price The lack of competition exists due to high barriers to entry These are obstacles faced by firms who want to enter the market as they see that the monopoly is enjoying abnormal profits Some examples of barriers to entry are economies of scale ownership of unique resources high costs of setting up and brand loyalty which are mainly found in natural monopolies

On the other hand there are also artificial barriers to entry which include predatory pricing advertising and patents Corporate Finance Institute N D Because of lack of competition the monopolist is able to determine the price at which it will maximize profits with its only limiting factor being demand One of the determining factors of how a monopoly will seek to maximize profits is Marginal Revenue that is the additional revenue earned by producing an additional unit This can be easily calculated as it will always have a slope which is double that of the Demand curve It is also important to note that Marginal Revenue follows the law of Diminishing Marginal Utility That means that as we increase output the price people are willing to pay for the product will decrease hence marginal revenue will eventually hit 0 and even become negative This is to justify the negative gradient to the MR curve The next key factor is Marginal Costs which is the cost of producing an additional unit Marginal costs follow the law of Marginal Diminishing Returns which means that as we increase production the cost associated with building a additional unit will be increasing hence the upwards sloping convex shape In this market the supply curve is also the MC curve since the amount produced by the firm is only determined by the whole demand curve Marginal costs are also associated with the average cost of producing a unit these can vary since they are directly related to economies of scale

The two curves will always intersect when AC is minimum since at the point where MC is greater than AC AC will start to rise A monopolist will seek to maximize their profits just like any other entrepreneur This happens if production stops at the point where the MC is equal to MR This is because at any point beyond that MC will be greater than MR Meaning that the production of these units will not be profitable and there will be incentive not to produce them On the other hand at any point prior to that MR is greater than MC so there will be potential profits and incentive to produce more This is true for any other firm too however because of its power and the huge demand it has to face the monopolist will set the price higher than its MR Whereas a competitive market price would have been set at P MR The above will result in allocative inefficiency and welfare loss as there will be a fall in consumer surplus which is the difference between WTP and market price Additionally there will be a loss in producer surplus which is the difference between the money a producer receives total revenue and the marginal costs

This happens because there are units that could have potentially been exchanged in the market but are not produced and consequently keep prices higher This is marked by the triangle on the graph also known as Deadweight loss and it represents all the additional units that could have been potentially produced and sold since WTP MC Following that they can increase the price and maximize profits while keeping a low quantity resulting in a Pareto inefficient market which is by definition a type of market failure since either the supplier or the consumers or in fact both parties can be made better off without the other being made worse off H 2016 One may ask why would a monopolist incur a loss on itself by reducing PS the answer is that PS is not equal to profit since there are also fixed costs which are not accounted for in PS

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