Monopoly as a Cause of Market Failure — Market Failure & Externalities | IGCSE Economics

Exam Frequency Analysis

Past paper frequency (2018 to 2024)

This topic accounts for approximately 11% of your exam marks.

increasing

Medium

Increasing11%

Externalities and market failure corrective policies are increasingly tested; particularly in evaluate questions since 2020.

The syllabus lists alongside externalities and public goods as a term associated with market failure, and names the abuse of monopoly power as one of its causes.

A monopoly is a market dominated by a single firm (or, more loosely, one firm with a very large share of the market). With no close competitor to undercut it, the firm has the power to set its own price rather than accept the market price.

A monopoly causes market failure through one main mechanism the syllabus tests directly: restricted supply causing higher prices.

To maximise its profit, a monopolist restricts the quantity it supplies below the level a competitive market would produce.
With less of the good available, the price rises above the competitive level.
Consumers therefore pay more and consume less than is socially desirable, so resources are misallocated — the hallmark of market failure.

A monopoly can also harm consumers in other ways: with no competition, there is less incentive to improve quality, less choice, and less pressure to keep costs and prices down, while the firm earns high (supernormal) profit. (A monopoly is not always harmful — a large single firm may achieve economies of scale and fund research — but the abuse of monopoly power is what makes it a market-failure concern.)

Governments respond to the abuse of monopoly power through competition policy, price regulation, or measures to encourage new firms to enter and compete.

Exam tip

Why a monopoly is a cause of market failure

What comes up: a short-answer or analyse question asking how a monopoly leads to market failure, or to identify a consequence of a market being dominated by one firm.

Write: a monopoly restricts supply / output (1) which raises the price above the competitive level (1), so consumers pay more and buy less and resources are misallocated (1). Quality and choice may also fall because the firm faces no competitive pressure.

Watch out: the credited consequence in the syllabus is restricted supply causing higher prices, not simply "the firm makes a lot of profit." High profit alone is not market failure; the misallocation comes from the restricted output and higher price.