Monopolies do not always lead to increased prices, lower outputs and welfare losses. In fact, monopolies can often lead to increases in society’s welfare as large monopolists benefit from economies of scale in production and distribution. These falls in costs can often be passed on to consumers in the form of lower priced products. We will now discuss briefly some of the potential advantages of monopolistic market structures.
• Lower production costs and increased welfare
Under monopoly, greater output and standardization can lead to lower costs. This can lead to economies of scale and scope, which can be passed on to consumers in the form of lower priced products.
• Natural monopolies
It could be argued that some industries are more efficiently organized as monopolies. Industries such as water, gas, electricity and communications are often referred to as ‘natural monopolies’. A natural monopoly arises when the ratio of the minimum efficient scale to industry size is so large that industries can only support one efficient firm. In natural monopolies, fixed costs form a large part of total costs.
If the monopoly is in private hands, the monopolist maximizes profits where marginal costs equal marginal revenues, and produces at output level and charges price. The monopolist makes excess profits equal to the shaded area. If the firm were forced to charge a price that would prevail under competition, it would set price equal to marginal costs and produce at output level. For example, suppose we have a water company that supplies a certain part of the country through a network of pipes. It would be inefficient for a new firm to enter the market, set up its own system of pipes and then start supplying a segment of the market. This is because the level of output the firm produces would yield insufficient revenue to cover total costs. This competition would therefore lead to wasteful duplication (and competition) of systems.
• Technical progress
Large monopoly profits may be used to finance research and development programmes. Monopoly profits are the reward for successful innovations. These innovations bring welfare gains to society in the form of new products and processes. Furthermore, these monopoly profits will not persist as there will eventually be entry by imitators or patents will lapse, which will eventually dissipate these profits. These assertions have been tested empirically for manufacturing and service industries in a number of countries.
• Avoids wasteful forms of competition
Monopolies may avoid wasteful forms of competition such as advertising, which are prevalent features of many oligopolistic market structures. Given that monopolists to some extent have a captive market, there is little incentive for monopolies to advertise. In addition, monopolists may also generate a degree of price stability. They may be expert in accurately gauging the level of demand and supply. A monopolist may also be better placed to endure any downturn in the business cycle.