5 - The Role of Government N Adv, Disa of Monopol

ADVANTAGES AND DISADVANTAGES OF
MONOPOLY
• 1. Product development and technological innovation
• A number of factors suggest that monopolies have good reasons to pursue
innovation: • Their economic profits provide them with the ability to finance
large research and development (R&D) projects.
• Protection from competition due to high barriers to entry may favour
innovation and product development, by offering firms the opportunity to
enjoy the profits arising from their innovative activities (new inventions,
new products, new technologies, etc.). This, after all, is the rationale of
awarding firms patent protection for a period of time.
• • Firms may use product development and technological innovation as a
means of maintaining their economic profits over the long term, by creating
barriers to entry for new potential rivals. If a firm can develop a new
product that potential rivals are unable to produce, the rivals may be less
likely to try to enter the industry and compete with the innovating
monopolist.
2. Possibility of greater efficiency and lower prices due
to technological innovations
• If monopolies pursue R&D that leads to

technological innovations, they may adopt
production processes and new technologies
that can make them more efficient (i.e. able to
produce at a lower cost), and some of these
lower costs could be passed to consumers in
the form of lower prices.
3. Economies of scale
• Economies of scale lead to falling average

costs over a large range of output and fi rm
scale. Extensive economies of scale are a
major argument in favour of large firms that
can achieve lower costs as they grow in size.
Legislation and regulation to reduce
monopoly power: an evaluation
• Whereas monopoly may offer some potential benefits to society, there
is general agreement that its disadvantages outweigh its advantages.
Therefore, most countries around the world do not encourage
monopoly. If there are natural monopolies, these are usually owned or
regulated by the government, so that they will not be permitted to
engage in behaviour that goes against society’s interests.
• The term monopoly power, which refers to the ability of a firm to set
prices, applies not only to monopoly, but also to oligopoly. Oligopolistic
firms sometimes act together (or ‘collude’), usually illegally, to acquire
greater monopoly power. If they are successful, they end up acting as if
they were a monopoly. Therefore, legislation to reduce monopoly
power applies not only to monopolies but also to firms that try to
behave like monopolies.
Legislation to reduce monopoly power may take the
following forms.
1. Legislation to protect competition

• Most countries have laws that try to promote
competition by preventing collusion between
oligopolistic firms (agreements to collaborate, often to
fix prices) for the purpose of restricting competition
between them, as well as preventing anti-competitive
behaviour by a single firm that dominates a market.
• The objective is to try to prevent monopolistic
behaviour by one or a group of firms, and therefore
achieve a greater degree of allocative efficiency.
2. Legislation in the case of mergers
• A merger is an agreement between two or more firms to join together and

become a single fi rm. Mergers may occur for a number of reasons, such as
an interest in capturing economies of scale (a single larger firm may be able
to produce at lower average costs), or an interest in firm growth (the firms
would like to become larger), or interest in acquiring monopoly power,
which is made possible by the larger size of the new, larger fi rm. Mergers
are an issue in competition policy because of the possibility that the single
firm created from the merging of smaller firms may be very large and have
too much monopoly power. Legislation usually involves limits on the size of
the combined firms.
• Difficulties with merger policies include questions and uncertainties about
what firms should be allowed to merge and what firms should not, related
to issues of interpreting the legislation as well as ideological differences
among different governments on the desirability or not of a high degree of
monopoly power (as in the case of competition policies).
3.Regulation of natural monopoly
• If there is a natural monopoly, it is not in
society’s interests to break it up into smaller
firms, as this would result in higher average
costs and would be inefficient. Therefore,
governments usually regulate natural
monopolies, to ensure more socially desirable
price and quantity outcomes.
4. Marginal cost pricing
Advantages and disadvantages of monopoly compared
with perfect competition
• Price and output

• The monopolist produces a smaller quantity of
output and sells it at a higher price than a
perfectly competitive industry.
• Efficiency
• The monopolist’s failure to achieve allocative
efficiency (in terms of loss of social surplus
and the appearance of welfare loss).
Advantages and disadvantages of monopoly compared
with perfect competition - continuation
• Research and development (R&D)

• Firms in perfect competition are unlikely to engage
in R&D for several reasons. They have no economic
profits in long-run equilibrium with which they can
finance R&D. They sell homogeneous products and
therefore are not interested in product development
that would differentiate their products (make them
different from other firms in the industry). They are
unable to create barriers to entry as they are too
small and so have no incentive to engage in R&D.
Advantages and disadvantages of monopoly
compared with perfect competition - continuation
• Economies of scale
• Firms in perfect competition have no possibility of
achieving economies of scale because of their small
size. Monopolies, because of their size, are very well
placed to take advantage of economies of scale, and
may use these to create a barrier to entry of new firms.
On the other hand, economies of scale offer advantages
in the form of lower average costs and lower prices as
well as greater quantities for consumers, and could
possibly approach those achieved in perfect
competition.

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ADVANTAGES AND DISADVANTAGES OF

• If monopolies pursue R&D that leads to

• Economies of scale lead to falling average

1. Legislation to protect competition

• A merger is an agreement between two or more firms to join together and

• Price and output

• Research and development (R&D)

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