Monopoly

A monopoly occurs when a firm dominates a market. This means that the firm determines the price in the market rather than accepting the industry price. It is a “price maker” rather than a “price taker”.

A “pure” monopoly occurs when one firm has a market share of 100%; for example in nationalized industries the government might only allow one state-owned firm to provide a particular service such as healthcare or electricity. More generally, a monopoly exists when a firm exerts a major influence over a market. Under UK law a monopoly occurs when a firm has a market share of 25% or more, that is, its sales are over 25% of the total sales in a market.

Perfect competition and monopoly are two market structures at the opposite ends of the competitive spectrum. However, a comparison of the two structures may influence our view of which structure is the most desirable, and therefore our view of how they should be treated by the government and the types of competition policies the government should adopt.

However, the following are some arguments in favour of monopolies.

· A firm may have achieved its monopoly position because it is so innovative and/or so efficient. In this case splitting it up would work against the public interest. Most governments allow firms to protect inventions with patents. These are intended to reward innovation and encourage other firms to develop new products and new ways of doing things. The patent system highlights that governments think monopoly power can be justified in certain circumstances.

· As a monopoly firm dominates the industry it may be bigger than any individual business in a more competitive industry. This means that it is more likely to benefit from internal economies of scale. Its unit costs may be lower than they would be for firms in a competitive market. This could lead to lower prices and higher output than in a competitive market situation.

· The ability to make monopoly profits provides dominant firms with the funds they need to invest in more research and development. As a result, they can afford to take risks and invest in more long-term research and development projects than firms in a competitive industry. This may lead to greater efficiency and more choice for customers.

· Any abnormal profits that are made will either be invested in the business or paid out to shareholders in the form of dividends. These shareholders will often be individuals or financial institution, such as insurance companies and pension funds. This means that the abnormal profits of monopolies may be redistributing money from customers to investors. The money is not disappearing from society altogether, it is simply moving from one group to another.

· The fact that monopolies can make high levels of profits is an incentive for other firms to be innovative and to establish a monopoly position. This is known as the Schumpeter effect (named after Joseph Schumpeter). Monopoly profits may therefore encourage innovation as other firms try to gain control of a market for themselves. This was described as “the perennial gale of creative destruction” by Schumpeter. Barriers to entry may exist at some point, but new firms will find ways of overcoming these to gain from the abnormal profits, that is, by creating new markets to replace the old ones. Monopoly profits therefore act as a beacon to encourage the development of new products and new ways of doing things, and this stimulates economic growth.

· In some cases the existence of a monopoly may rectify another market failure. For example, in a freely competitive market firms may create negative externalities such as pollution, and overproduce relative to the socially optimal position. A monopoly, by comparison, may cut back on output, which in this case might move the economy nearer to the socially desirable level of output. Given that the First-Best-World (where there are no market failures and imperfections occur) does not exist and therefore we are operating in the Second-Best-World, a monopoly may actually be desirable in some circumstances.

· Monopolies might prevent wasteful duplication. For example, if there are several gas, telecommunications, electricity or railway companies then they might simply be investing in unnecessary infrastructure that duplicates the resources of other firms.

I. Restore the word order in the questions and answer them:

1) does, a, occur, monopoly, pure, when?

2) at the opposite ends, market structures, what, are, of, the competitive spectrum?

3) they, most governments, firms, new products, encourage, don’t, to develop?

4) to be, firms, what fact, stimulate, innovative, can?

5) rectify, what circumstances, may, under, a monopoly, market failure?

II. Complete the following statements:

1) A monopoly occurs …

2) A monopoly determines …

3) A monopoly is …

4) A “pure” monopoly occurs …

5) Perfect competition and monopoly are …

2) Translate the text «The stages and causes of the economic cycle».

The four main stages of the economic cycle are as follows.

· A boom. A boom is characterised by high levels of economic growth. The gross domes­tic product will be growing relatively fast. This should lead to relatively low levels of unemployment. Firms will have busy order books and may have to turn business away because they cannot keep up with demand. Prices may begin to rise due to demand growing so fast that output cannot keep pace.

· A recession

A recession (or downswing) occurs when there is a period of two quarters of negative economic growth. This means that the economy is shrinking. The gross domestic product is growing at a negative rate.

A recession is usually characterised by the following.

- Increasing levels of unemployment.

- Low levels or profits, reducing the amount of infernal funds for investment.

- Unused capacity.

- Downward pressure on prices to try to stimulate demand.

- Less income, leading to less demand in the economy and equally less spending on imports.

- More business closures.

- Less tax revenue for the government (because less people are earning and less products are being sold). At the same time the government is likely to be paying more in sub­sidies and benefits, so overall the government's financial position will he weakened and this may require more government borrowing.

· A recovery, upswing or upturn. In the recovery phase demand begins to pick up, re­ducing firms^’ excess capacity and improving employment levels. With more demand for products, the demand for factors of production increases, which begins to pull up prices and wages. Machinery begins to be replaced or updated and business confidence picks up, leading to more investment.

· A slump or depression. In a slump economic growth is slow and unemployment is high.

There is downward pressure on prices (deflation), and profits and business confidence are low. The point where the slump flattens out is called the ‘lower turning point’ of the economic cycle. The ‘upper turning point’ is in the boom.

Whilst this general pattern of growth outlined in the economic cycle may typically be followed, there will be differences over time in:

· how long each stage lasts;

· how large each stage is, for example, how big the slump or boom is.

In fact, different economists have identified several different economic cycles. These include the following.

· The classical trade cycle. This describes a pattern of boom and slump for which there is often around eight to ten years between one boom and another.

· The Kuznets cycle. This is named after Simon Kuznets, a Nobel prizewinner, who identified a cycle of activity in the construction industry that took between fifteen and twenty-five years.

· The Kondratieff cycle. This highlighted that as well as a ten-year trade there was a major underlying cycle that takes fifty to sixty years to complete, that is, there can he cycles within cycles.

The causes of the economic cycle include the following.

Expectations. Changes in the expectations of firms and households can have a major effect on the state of the economy. If an economy is growing relatively fast and confidence is high, then firms may be more likely to invest because they are more optimistic about future levels of demand. Households are more likely to spend because they are more confident about their employment and earning prospects. If expectations are positive then this is likely to generate greater spending by firms and households, and this helps to stimulate further growth in the economy. Changes in expectations may therefore exaggerate the underlying economic cycle.

Stock levels. Stocks include raw materials, components, semi-finished goods and finished goods waiting to be sold. They are also called inventory. Changes in stock levels can affect demand in the economy. When an economy starts to grow faster, managers may be reluctant to increase output in the short term in case the boom does not last. They will not want to invest and employ more people only to find that demand falls again. They are more likely to keep production at the same level as before and run down their stock levels. However, if demand does keep growing then firms will now have too few stocks and managers will have to expand production. They may need to increase their production capacity, not only to meet the new higher level of demand, but also to re­place their stocks that will have been run down. This leads to a relatively high increase in spending, which leads to even faster growth in the economy. This can create a boom in the economy.

Once demand starts to grow more slowly, managers are likely to be reluctant to re­duce their production levels immediately because it may be only a temporary decline. Rather than make people redundant and reduce capacity, firms are likely to maintain the existing output level in the short term. Given that demand is lower, producing at the old level leads to increasing levels of stocks. However, if demand continues to be low then in the long run managers will cut back output. As they have been building up stocks, they can now reduce output significantly. This leads to a large fall in demand and may push the economy into a recession.

The sluggishness of managers to react to changes in demand exaggerates the changes in demand, and creates booms and slumps.

Government policy. Governments will often intervene to try to stabilise the economy. However, policies that are intended to stabilise the economy can actually end up desta­bilising it! This is because it is difficult for the government to fine-tune the economy effectively and attempts to do so may make things worse. One reason for this is that the information that the government uses to make decisions is inevitably out of date. By the time the government has determined what it thinks the level of national income actually is, the economy will have moved on. Policies intended to correct a particular prob­lem may therefore not be relevant because the economic situation has changed.

This problem is made worse because economic policy changes take time to work through the economy and the effects are not always predictable. For example, a tax cut may not lead to an increase in spending if households decide to save the extra dispos­able income.

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