Efficiency & Monopoly

The two main types of monopoly are the natural and the pure monopoly. The former is where one firm can produce a certain level of output at a lower total cost than any combination of multiple firms. The latter occurs when it would be inefficient to have different companies compete in order to provide the same good/service, for example the national grid.

As monopolists are assumed to be profit maximizing they produce at an output level where MC=MR. Due to lack of competition the price is usually set higher than it would be in a perfectly competitive market, thus reducing consumer surplus.

In terms of static efficiency, monopolies do not produce at an allocatively efficient, resulting in a loss of welfare, or a productively efficient output level, as resources are underutilized and they produce below the MC=AR level. As monopolies have entry/exit barriers to protect them and gains abnormal profits, it does not have to behave efficiently or minimize costs. Yet, this sometimes does occur, most notably in the Thames Water Utilised Industries where drastic job cuts of up to 25% have been suggested.


Thames Water Cuts 25% of Jobs - find out why


However, Schumberg argues that dynamic efficiency brought about by monopolies would be more important. It is in the interest of monopolies to spend money, derived from the abnormal profits they earn, on Research & Development as it can take advantage from spin-offs, brand image etc. without any other companies benefiting due to the high exit/entry barriers and high sunk costs, such as advertising.


Conversely, a monopoly does not necessarily consist of one firm, as a number of firms may collude together or form a cartel, usually practicing price fixing. The threat of these mega-mergers has been scrutinized closely by the Competition Commission and the World Trade Organisation.

“The increasing number and size of cross-border mergers raises concerns about whether national competition authorities can maintain competitive markets.” – WTO

WTO Against Globalisation - for more details click here.

X-inefficiency is another issue, as it tends to increase average costs increasing inefficiency. X-inefficiency is usually caused by overinvestment and lack of motivation due to lack of competition. Its effects may also be more severe depending on its scale, and may range from bankruptcy to banking system failures.



Exam Questions

ECN5 - Jan/2008
In the summer of 2006, several UK water companies imposed hosepipe bans which restricted the amount of water that households could consume.

(a) Explain the costs and benefits that might result from new infrastructure projects, such as the building of new reservoirs in areas suffering from water shortages. (20 marks)

(b) Evaluate the view that shortages in markets, such as those for water and health care, can best be prevented by the operation of market forces rather than by government intervention in markets. (30 marks)




-MS-

A2 Economics through Diagrams

Monopoly Diagram

Monopsony Diagram


Trade Union Diagram


Lorenz Curve (Gini Coefficient)


Profit Maximising


Oligopoly (Kinked Demand Curve)

Exam Technique / Questions

Make sure that you understand the diagrams above and are able to draw them. By drawing a diagram correcly in your response, you may only get up to 6 marks per diagram; however, it can just form the framework your argument, thus setting you up to score the maximum marks available.

Get in touch if you don't recognise nor understand these diagrams.

NB: this is NOT an exhaustive list of diagrams.

-REJC-

Labour Market Imperfections: Trade Union & Monopsony

A Trade Union is an organisation of workers that attempt to improve the working conditions, real income, and job security of its workers by using the collective bargaining power of the workforce in the labour market.

As you can see in the diagram above, closed shop trade unions can withhold their workforce until their demands are met, and can demand the wages of workers W1 - this creates perfectly elastic supply curve, i.e. no worker will work for other wage apart from W1. The supply of labour at W1 is E3 - more workers are willing and able to supply their skills. However, the demand for labour (MRP) at W1 is only E2 - this creates excess supply of labour (unemployment). The effective supply curve is shown in bold blue. It is "kinked" because in order to encourage more workers (above quantity E3) the real wage rate will have to be increased in order to raise the number of workers who are willing and able to supply their skills.

A Monopsony is a single employer of labour in a market and obviously has the market buying power when they are actively looking for new employees, and can use that buying power to drive down wages. Good examples are the Indian Rail, Chinese Army and the NHS (the biggest employer in the world with 1.3million).
[Times Online]

With the monopsony diagram, it is important to follow accurate analysis. The reason why MC are greater than AC is that the monopsonist MUST pay the same wage to all workers. E.g. in order to employ additional worker the firm must increase the real wage for that additional worker and also increase the real wage rate paid to all previously employed workers, thus the MC of employing additional Nth worker is always greater in monopsony.

The number of workers employed by a monopsonist is determined by MC = MRP (1); the quantity demanded is therefore Qm (2); in order to secure Qm quantity of workers the firm must pay a wage of Wm (3,4).

When compared to a Perfectly Competitive Labour Market (W ' L '), the Monopsonist pays lower real wage and employs less workers.

This is why we often see strong Trade Union presence (unionisation of the supply) in a Monopsony. The Trade Union is said to counter-balance the power of monopsony which will increase the real wage and employment as shown by the diagram below.

In this diagram, the real wage level (Wtu+m) and the quantity of labour emplyed (Qtu+m) is the outcome of the "fight" between Trade Unions and Monopsonist employer.

Further Reading :

Trade Union and Monopsonist Employers
-click here.

Labour Market - Explaining Wage Differentials - PPT Show
-click here.

Wage Determination in Competitive Markets
-click here.

Exam Questions

ECN5

Explain how the wage rate is determined in a competitive labour market.
(20 marks)

Explain how trade unions are able to influence wages.
(20 marks)

Evaluate the view that trade unions raise wage rates but reduce levels of employment.
(30 marks)

For more past papers visit the department's intranet pages.

-REJC&LPY-