The Government Created Monopolies Economics Essay

1.0 Introduction

Microeconomics are the branch of economics that studies individual units. For example : Households, firms and industries. According to Economics ( Sloman, et al , 2003, p.6 ), microeconomics are the studies of interrelationships between these units in determining the pattern of production and distribution of goods and services.

The first task of this assignment is to elucidate monopoly and its charactheristics. Then, the second task is to differentiate the features of perfect competition, monopolistic competition, oligopoly , and monopoly.

To complete both tasks, I’ve done researches through the internet, e-brary and referred to some books of microeconomics in the library.

2.0 Definition of Monopoly

The word monopoly is a market structure in which there is a single seller and large number of buyers and selling products that have no close substitution and have a high entry and exit barrier. In other words, monopoly exists when there is only one firm in the industry. Examples of products in monopoly market are electricity, water, cable television, local telephone services and many more. LAP ( Lembaga Air Perak) is considered as a monopoly.

However, whether an industry can be classes as a monopoly is not always clear. It depends on how narrowly the industry is defined.

2.1 Charactheristics of monopoly

There are a few charactheristics that we should consider before classifying a market as monopoly.

Only one seller

Many buyers

There are barriers to entry

Product does not have close substitutes

Monopolist can only control price or quantity but not both

Cross-elasticity between the product of a monopolist and that of other firms must be very low or even zero.

Monopoly exists when there is only one seller of a product. Monopoly firm is the only firm in the industry selling a product which has no close substitution. Monopoly market is the place where the monopoly firm operates. So basically there is no difference between a firm and an industry in monopoly as there is only one seller. A monopolist is a price maker since there is one seller or producer and it has the market power to control over the price.

Monopoly form would sell a product which has no close substitute. It means consumers or buyers could not find any substitute for the product. For example, TNB ( Tenaga Nasional Berhad ) is a local public utility which has no close substitutes. However, if the buyer can find any substitute for electricity such as solar energy, then this product is no more in monopoly. In other words, a monopoly cannot exist if there is a competition or any substitute product.

In a monopoly market, there are strict barriers to the entry of new firm. Barriers to entry are natural or legal restrictions that restrict the entry of new firms into the industry. A monopolist faces no competition because of barriers of entry. Types of barriers will be discussed in detail in the next section.

Advertising in monopoly market depends on the products sold. If the products are luxury goods such as imported cars, then the monopoly needs some advertisement to inform the consumers on the goods. Local public utilities such as water, electricity and home phone services do not need advertisement by the monopolist since the consumers know from where to obtain the products.

2.2 Natural Monopoly

Natural monopoly can arise due to economics of scale. According to the theory of economies of scale, larger the firm, lower would be the cost of production. In other words, one single firm can meet the entire demand with lower price charged than more firms.

In the case of natural monopolies, trying to increase competition by encouraging new entrants into the market creates a potential loss of efficiency. The efficiency loss to society would exist if the new entrant had to duplicate all the fixed factors – that is, the infrastructure.

It may be more efficient to allow only one firm to supply to the market because allowing competition would mean a wasteful duplication of resources.

2.3 Government-Created Monopolies

Government creates monopolies to prevent firms from entering into a market. This can be done through difficulty in obtaining license to operate in the market or providing patent and copyrights to a monopoly firm.

In order to create monopolies, government would set up some legal barriers such as the government franchise ( grants monopoly rights to private companies, for example : Astro in Malaysia ), government license ( firms need to obtain license to operate any business ), patent ( an exclusive right to the production of an innovative product ), copyright ( exclusive right given ), control over raw material ( control over the supply of raw material in which a firm can own a bigger portion of natural resources ).

2.4 Monopoly diagram

http://tutor2u.net/economics/content/diagrams/monopolyprofits1.gif

Monopolies can maintain super-normal profits in the long run. As with all firms, profits are maximised when MC = MR. In general, the level of profit depends upon the degree of competition in the market, which for a pure monopoly is zero. At profit maximisation, MC = MR, and output is Q and price P. Given that price (AR) is above ATC at Q, supernormal profits are possible (area PABC).

3.0 Alternative Market Structures

Structures are classified in term of the presence or absence of competition. When competition is absent, the market is said to be concentrated. The market structure under which a firm operates will determine its behaviour. Firms under perfect competition will behave quite differently from firms which are monopolists, which will behave differently again from firms under oligopoly and monopolistic competition.