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-