1. Economics
1.4 Monopolies

2. Agenda- Double Period Review- Think/Pair/Share- 4 min
Topic: Abuse of Monopoly Power
Explain how Monopoly power can create a welfare loss and is therefore a type of market failure
Discuss possible government responses, including legislation, regulation, nationalization and trade liberalization
Review- Think/Pair/Share- 4 min
Notes- Monopolies- 10 min
Group work & partner work- 20 min
Diagram- 1 min
Discussion- Government Intervention- 5 min
Notes- disadvantages/ advantages of Monopolies, government intervention- 20 min
Article- The Economies of Medicine- 25 min
Assigned Homework- past paper questions

3. Review- Think/ Pair/ Share
What is perfect competition?
Why is competition good for consumers?
Could businesses could argue that competition is not always positive? Explain.
What is market failure? Give two examples.

4. Competitive markets
There are many suppliers, none of whom dominates the market
High price elasticity of demand – because consumers have plenty of choice / substitutes
Low barriers to entry and exit – new firms can enter the market if profits are high enough (incentives!)
Intense price and non-price competition – as firms battle for market share and dominance

6. What is a monopoly?
A market in which only one firm produces all the output. A monopolist is a single seller producing a unique product with the ability to set the price and level of output based on its own profit-maximizing decisions. These organizations are often protected by high barriers to entry.

7. Monopoly terms
A pure monopolist in an industry is a single seller. It is rare for a firm to have a pure monopoly – except when the industry is state-owned (public) and has a legally protected monopoly.
A working monopoly: A working monopoly is any firm with greater than 25% of the industries' total sales.
An oligopolistic industry is characterized by the existence of a few dominant firms, each has market power and seeks to protect and improves its position over time.

8. How monopolies can develop
When a firm has exclusive ownership or use of a scarce resource Eg. British Telecom owns the telephone cabling running into the majority of UK homes and businesses
When firms have patents or copyright giving them exclusive rights to sell a product or protect their intellectual property Eg. Pharmaceutical companies
When firms grow through mergers and acquisitions to give them a dominant position in a market.
Monopoly power can come from the successful organic (internal) growth of a business

9. How monopolies can develop
A natural monopoly exists when, due to economies of scale, one firm can produce for the entire market at a lower cost per unit than can two or more firms
Eg. When governments grant a firm monopoly status, such as the Post Office, utilities like electricity

10. Group work- Side A
Imagine your company was the only company in your industry willing to set up in Timbuktu and there are is no competition for your product
You have made an agreement with the government that they will not influence your company in any way as long as you pay your tax
What would your strategies be in terms of: price, quality, variety, etc and defend your choices
Be able to justify to the class why you should be able to market the product however you see fit with no government intervention
Make sure you know your points well as you will each be responsible for explaining your points to a citizen from Timbuktu

11. Group 2- Side B
Imagine you are a citizen of Timbuktu and your government has been getting companies in industries undeveloped in your country to trade in Timbuktu. This gives you access to products you did not have previously. However, the government has made agreements with these companies to only allow one company per industry into the country.
What are you worried will happen in terms of pricing, quality, variety, etc. Explain your concerns.
Be able to justify to the class why the government should not make these type of agreements.
Make sure you know your points well as you will each be responsible for explaining your points to a one of the new companies in Timbuktu

12. Partner Work
Each citizen from Timbuktu will be put together with a representative from a new company from a new industry in Timbuktu. You will both discuss your concerns about government intervention.

13. Welfare Loss
So overall society loses out – there is a net welfare loss when the combined welfare of consumers and producers is taken into account, although producers are likely to be happy as they have gained at the expense of consumers. From an economic point of view, here there is an efficiency loss.

15. Figure 1: The Welfare Loss from Monopoly
1. A monopoly charges a higher price than a competitive market . . . MC
Quantity Produced
Dollars
3. The result is a welfare loss . . .
$22
$19 E
4. from not producing the efficient quantity, at point E. D MR
2. and produces a lower quantity.
2,500
4,000

16. Discussion Question- Should the government intervene to break up or control the monopoly power of firms in the market?
What would the citizens and companies in Timbuktu say?

17. What are the disadvantages of monopolies?

18. Disadvantages of Monopolies–
A monopoly sets its own price
Monopolies might restrict the quantity of goods they supply to the market in order to keep prices high and earn high profits eg. DeBeers/ diamonds
Monopolies might produce poor quality products because there is no opportunity of a competitor producing better quality products
Monopolies may not invest in new products because they can sell the existing ones and have no competition

19. Disadvantages of Monopolies– loss of productive efficiency:
When competition is tough, businesses must keep firm control of their costs because otherwise, they risk losing market share. Businesses may allow the lack of real competition to cause a rise in costs and a loss of productive efficiency.
Some economists say that monopolists may be even less efficient because, if they believe that 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.

20. Case in Point
UK - The Competition Commission is investigating the market for cement and ready-mix concrete. Five businesses account for 90% of the cement market, and 68% of ready-mix concrete. There are worries that a lack of competition has raised building costs, meaning the government is paying too much for schools, hospitals and roads.

21. Are monopolies ever good for society?

22. Benefits from monopoly power
Economies of scale and investment: monopoly suppliers might be better placed to exploit internal economies of scale – means that consumers may benefit from lower prices / improved affordability
An economy may need large scale businesses with market power to compete effectively in the global economy. Domestic monopolies can become dominant in their own territory and then penetrate overseas markets, earning a country valuable export revenues. Eg. Microsoft

23. Benefits from monopoly power
Research and development and innovation: higher profits might lead to a faster rate of technological development that will reduce costs and produce better quality products for consumers e.g. innovation in the motor industry, pharmaceuticals, web search, digital technologies
The natural monopoly justification: A natural monopoly occurs in an industry where costs per unit falls over a wide range of output levels such that there may be room only for one supplier to fully exploit the economies of scale in the market and therefore achieve productive efficiency

24. Benefits from monopoly power
Regulation: Markets with a monopoly can be successfully regulated by regulators so that some of the benefits of competition are achieved without sacrificing the benefits from economies of scale – the regulator is acting as a surrogate competitor (e.g. capping mobile phone roaming charges in EU)
Incentives for innovation: Monopolies that arise from patents and copyrights, provide an incentive for artistic creations and scientific discovery

25. Government Intervention
There may be an economic case for some form of government intervention to limit or reduce the scale of monopoly power
The main role of the regulator is to make sure that producers in the market are providing a good quality service with reasonable prices even when the amount of competition is limited.

26. Government Intervention
Remedies for monopolies
The failure of markets to ‘self regulate’ is at the heart of monopoly as a ‘market failure. There are a number of ways in which the negative effects of monopoly power can be reduced:
Price controls
Regulators can set price controls often called price capping. This means forcing the monopolist to charge a price, often below profit maximising price.
For example, the current UK competition regulator, the Office of Fair Trading (OFT), has developed a system of price ‘capping’ for the previously state owned natural monopolies like gas and water.

27. Government Intervention
Price controls
An alternative to price-cap regulation is rate-of-return regulation. Rate of return regulation, which was developed in the USA, is a method of regulating the average prices of an organization. The system allows firms to cover their costs and charge prices based on a ‘fair rate of return. The ‘fair’ is based on typical rates of return what would be expected in a competitive market. Eg. Being done in the US for privatized utilities like water, electricity
Prohibiting mergers
Prohibiting mergers – in the UK the Competition Commission can prohibit mergers between firms that create a combined market share of 25% or more if it believes that the merger would be against the ‘public interest’. In making their judgment, the ‘public interest’ takes into account the effect of the merger on jobs, prices and the level of competition.

28. Government Intervention
Breaking up the monopoly
Breaking up the monopoly into several smaller firms. For example regulators in the UK were investigating potential abuse of market dominance by Microsoft, which was under threat of being broken up into two companies – one for its operating systems and the other for software.
Nationalisation
Bringing the monopoly under public control – which is referred to as ‘nationalisation’.  The ultimate remedy for an abusive monopoly is for the government to take a controlling interest in the firm by acquiring over 50% of its shares, or to take it over completely. The monopoly will then be made to operate as though the market were competitive. (But remember our lesson on privatization and nationalisation?)

29. Government Intervention
De-regulation
In those cases where a monopolist is State controlled, eg. Post Office, it may be necessary to engage in deregulation to enable it to become more efficient. Deregulation could be used to bring down barriers to entry and open up a previously state controlled industry to competition, eg. British Telecom and British Rail monopolies. This may help encourage new entrants into a market.
Alternatives
Regulators can also force firms to unbundle their products and open-up their infrastructure. Bundling means selling a number of products together in a single bundle. Eg. Microsoft sells PowerPoint, Access, Excel and Word as one product rather than separate ones. Unbundling makes it easier for firms to enter the market, eg. UK telecoms, when BT was forced to unbundle their products enabling new broadband operators to enter the market.
Regulators can use yardstick competition, such as setting punctuality targets for train operators based on the highly efficient bullet trains of Japan.

30. The Economics of Medicine- Article
A) Is this Monopolistic behaviour creating a welfare loss and is it therefore a type of market failure?
B) Should life saving drugs be regulated?
C) If there was going to be government regulation, which regulation strategies would you recommend considering the consequences of unmotivated pharmaceutical companies?
D) Research- What type of regulations are imposed on pharmaceutical companies?

31. Homework- Past paper Questions
Using the concept of welfare loss, explain why monopoly power is a type of market failure. [10 marks]
Discuss government responses to the problem of monopoly power.
[15 marks]

32. Summary
While economists and policy-makers agree in theory that monopolies tend to lead to market failure (the quantity of a product demanded by consumers does not equate to the quantity supplied by suppliers). However, dealing with real-world market failures remains one of the most controversial aspects of government policy and there are many options to consider.