Question

1. What are the four most important ways a firm becomes a monopoly? Will a monopoly that maximizes profit also be maximizing revenue? Will it be maximizing output? Explain.

Answer 1

Monopoly is a market where a single seller controls the entire supply of a product. It is said to exist when one firm is the sole producer or seller of a product which has no close substitutes. Since a single seller controls the entire supply, the market is the negation of competition. The growth of monopoly is caused by the following factors.

1. Government Policies.

The imposition of heavy taxes by the government on the certain industries reduce the competitiveness of the small firms in such area make them unfit to remain in the market. The imposition of tariff in order to protect the domestic industries gives way to the large profit for the domestic industries. By such huge profit the firms can throw out its rival competitors. The subsidies by the government on certain industries make the chance of huge profit and eliminate the non subsidized firms. The government laws to protect certain industries like ant-thrust laws cause the growth of monopoly. The patent right allowed by the government gives certain industries the exclusive power to use certain resource which prevents the other firms to enter into such fields of economic activity. For the sake of public safety and inapplicability to used price mechanism it is better such industries to be under the exclusive power of the government. For example the public utility services cannot be in the hands of the private person. So the government itself controls such industry which causes the growth of natural monopoly.

2. Economies of scale.

Certain industries with their huge investment and the enlarged plant size can reap the advantages of economies of scale. Such industries can produce the commodities at a lower cost than the small rival firms. This leads to the emergence of the monopoly of a single seller in the market.

3. Merger and acquisition

The merger of firms having Allocative and command of the scarce resources and economies of scale leads to the emergence monopoly by such firms by throwing out the rival firms from the market.

4. Cartel or price leadership.

Under cartel of price leadership, the competing firms after realizing that competition will benefit none decide to form cartel or price leadership. Thus they coordinate together with regards to price and output decision. The firms agree to restrict output and fix a high price in order to maximize their profit. Thus the group of firms acting as a single seller creates monopoly.

The monopolist’s demand curve is a downward sloping curve. Unlike the competitive firm a monopolist is not a price taker but a price maker. The downward demand curve shows that if the monopolist raises the price, the amount of output it can sell decrease. Thu on this demand curve, the firm has to choose between the price to be charged or output to be sold. Thu in order to sell more the monopolist must lower the price. As a result the marginal revenue falls if the monopolist increases the level of output.(revenue is the receipt from the sale of output) It means that the monopolist can fix either the output or profit or revenue, but not both. If the monopolist maximizes profit, it has to limit its sales. Thus a higher profit reduces the revenue from the sale of output. On the other hand if the monopolist maximizes output or sale it has to reduce the price level. Thus at increased sales revenue, the monopolist has to sacrifice the profit. The profit maximization and revenue maximization together is not possible under monopoly. Usually in order to increase profit the monopolist is usually restrict output and charge a high price.