Raffles Junior College JC1 Promotion Examinations 2007 H2 Economics Essay Paper

-------------------------------------------------------------------------------------------------------------------------------1 As of May 2007, Microsoft Windows held a near monopoly of 92.68% of the worldwide desktop market share (a) Discuss why some industries tend towards monopoly while others remain competitive. [10] (b) To what extent is the consumer the loser when monopoly emerges? [15] --------------------------------------------------------------------------------------------------------------------------------

Sample Essay contributed by Jasper Wong 08A01A (JC1 2007) This essay was written under examination constraints (Promotion Examinations 2007) and has been left unedited. Based on this, it was awarded a distinction grade. This serves only as a sample and does not reflect the only approach/style.
(a) Monopoly is an industry with one dominant firm only while competitive markets have many firms. In the case of perfect competition (PC), there are no barriers to entry, there is perfect knowledge and they sell a homogeneous product. On the other hand, a monopoly sells a product with no close substitutes, is not a price-setter and has many barriers to entry. Firms may tend towards monopolies firstly due to the presence of barriers to entry that firms may enhance to limit competition. Barriers to entry are what prevent the free entry of new firms to the industry. It can be natural or institutional. A natural barrier to entry would lie with the huge fixed costs required to be efficient (high minimum efficient scale (MES) where no further economies of scale can be experienced. Thus, firms are put off from entry and find it hard to raise such capital. In the case of Windows, there could be huge start-up costs like equipment, research and development etc. Some industries are even natural monopolies where the nature of the industry can only accommodate one form. Public utilities is one example where two firms having multiple parallel pipes running over the island cannot make enough profit from the small Singapore population and thus firms will eventually leave the industry until only one is left.

Price LRAC

D1=AR1 0

D2=AR2

Quantity

In the figure above, the high LRAC determines that when demand is competed among two firms or more at D1, both are unable to make a profit for AC>AR1. When there is only one firm, the leaving firms will contribute to a rise in the demand for that one firm which can make a profit. Perhaps, more relevant in Windows is the network economies it provides to users. As users benefit from having other users using the same file formats and being compatible with the same operating system, they tend to stick to Windows and thus Windows can establish a monopoly of 92.68%. Thus, new firms are unlikely to challenge Windows. Windows is clearly a monopoly with the huge market share. However, not all firms may tend towards monopoly. Some industries like personalized services and perishable goods are incompatible with monopolies and they remain relatively competitive due to the lack of substantial EOS. A hairdresser reaches his MES at quite a small output. Next, demand factors such as a small market will limit tendencies to form monopolies. A market that produces religious statues for a minority group will have only so much a demand, therefore firms do not seek to expand to be monopolies. In firms where there are low barriers to entry like grocers or the eBay market, markets will remain competitive. For example, anyone can just sign up for an eBay account and start selling with a low startup cost. On the other hand, monopolies form in industries where there are substantial barriers to entry like patents and trademarks (applies to Windows for only its firm can produce its operating system). Thus, depending on the nature of industries, such as the presence of barriers to entry like high fixed cost, network economies and legal protection, firms will tend towards monopolies or remain competitive. The presence of EOS to be enjoyed is another factor for it attracts firms to grow in scale to enjoy these EOS. (b) Consumers first experience higher prices and face lower output in a monopoly compared to a competitive market.

Price MC

PM PPC

AR MC 0 QM QPC Quantity

A monopoly like Windows would produce at MR=MC to maximise profits and thus a consumer would face higher prices (PM>PPC) and lower outputs (QM<QPC) than in a perfectively competitive market (P=MC). Thus, there is a loss of consumer welfare.

However, the comparison is highly theoretical for it assumes that the cost structures are similar. Next, as monopolies are not productively efficient or allocatively efficient (P>MC) and might experience X-efficiency (organisational slack due to the lack of competitive pressures), the extra costs is pushed to the consumer who loses consumer welfare. This exploitation of the consumer is even more apparent if the company practices price discrimination and creams off the whole consumer welfare if the firm charges each consumer the maximum price below he/she is willing to pay. However, that is highly unlikely for it is impractical and information of the consumers reservation price is not available. The consumer might have some benefits from a monopoly though. The consumer may suffer from a lack of choice. Users have only Microsoft Windows to choose from because everyone is using it. If the monopoly can experience substantial EOS. It can actually offer lower prices (PM<PPC) at higher outputs (QM>QPC) than a PC firm as in the following diagram.

Price MCPC

PPC PM P3

MCM

AR MR Quantity 0 QPC QM Q3

For example, Microsoft can enjoy much EOS like technical EOS (division of labour); it buys cheaper in bulk; it can spread advertising costs over a greater output etc. However, this is assuming they have similar AR and MR curves. Furthermore, an industry that has EOS is incompatible with PC in the first place; this is highly theoretical. Furthermore, if the monopoly were to set P at MC, PM would be even lower (P3) and output even higher (Q3). A monopoly might also utilise its supernormal profits for research and development which lower costs in the long run and lower costs can be transferred to the consumers. For example, a breakthrough in production of computer chips by Microsofts R&D department can result in lower costs for the consumer.

Next, the extra profit might also be returned to society if the monopolist engages in charitable activities. The founder of Microsoft, for example, has set up the Gates Foundation which supports numerous causes. The extent of the consumer being the loser may not be that great after all. Monopolies, if in contestable markets, might lower prices to consolidate the monopoly. Lured by potential profits, a firm can invest in R&D which benefits the consumer with lower costs. Similarly, price discrimination by a monopoly results in goods initially not profitable to be produced. Microsoft, in wanting to maintain its market share, is wary and thus conducts efforts such as ploughing profits back to society to reduce its image as being an exploitative business and thus consumers and society may benefit.