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Should governments legislate to prevent monopolies

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Published: Mon, 5 Dec 2016

Monopolies have long been criticized for “miss-allocating” resources as well as affecting general welfare, nevertheless, firms continue their strives in becoming monopolists while governments in many cases tolerate them as oppose to legislate to prevent their emergence. Monopolies have proven to be very disadvantageous to society. Imposing higher prices than competitive markets leads to a decline in overall consumer surplus. The fact that a monopoly has no close substitutes, makes supernormal profits and has merged with the industry, dis-incentivises monopolists to be efficient and may lead to possible diseconomies of scale. [1] In general, monopolies are expected to have negative implications on efficient resource allocation and welfare seeing that the factors that compose a monopoly are assumed to give little way for the contrary (ie: increase social benefits).

This widespread disdain of monopoly power is compared to the ideal nature of a perfectly competitive market. A monopoly’s profit (private benefit) is illustrated on the graph below:

Having no competitors means that a monopolist can set any given price for a good or service, while setting output where Marginal Revenue is equal to Marginal Cost ( making profits of BCDE). [2] By contrast, were the market competitive, prices would be lower and output higher. This in turn diminishes consumer surplus and leads to a deadweight welfare loss. In a monopoly the prices are higher than the marginal cost, P > MC, which can be described as allocatively inefficient, whereas in a competitive market prices would be decreased and consumer welfare would increase. Moreover, an example of a monopoly being productively inefficient is shown when it is not producing at the lowest point of the AC (Average Cost) curve [3] . Stating that it has the potential of producing the given output at a lower cost. The AC curve is commonly higher than it should be in a monopoly firm due to the absence of competition, decreasing incentives to cut production costs.

Be this as it may, governments tend to tolerate monopolies rather than preventing them. Disassembling a monopoly takes a lot of effort and in many cases the industry has grown so dependent on the monopoly that its dissolution would lead to economic turmoil. Governments therefore tend to impose regulations on monopolies. For example, “Ofwat is the economic regulator of the water and sewerage sectors in England and Wales” [4] and state that they “make sure that the companies provide household and business customers with a good quality service and value for money.” [5] In some cases monopolies prove to be relatively efficient. It is common for a monopoly to experience economies of scale, this is to say that a firm obtains cost advantages due to expansion. As the magnitude of output increases, a firm’s average cost per unit decreases. Finally, monopolistic firms aren’t necessarily counterproductive for society. A dominant example being Google. Google is arguably the largest monopoly in terms of search engines, however, this isn’t to say that it is an inefficient firm seeing that innovations are presented constantly, (Google books, Google mail, Google maps, etc.).

As previously stated, a monopoly charges a price higher than the marginal cost. This higher price is undesirable from the consumer’s viewpoint. The higher price however provides profit to the monopoly making it highly desirable by the producer’s viewpoint. Taking total welfare as the sum of consumer and producer surplus, it is arguable to say that a monopoly can be desirable from society as a whole, seeing that the increase in producer surplus increases total surplus. The respective surpluses can be measured in the following way:

consumer surplus = consumer’s willingness to pay – cost of given good

producer surplus = revenue of good – cost of production of good

The monopolist is taken as the single producer of the market. In a competitive market, the equilibrium point of supply and demand is seen as a natural and favourable outcome. Total surplus is at its maximum level because of the efficient allocation of resources set by the “invisible hand of the market”. Overall economic welfare fails to reach its highest level seeing that a monopoly allocates resources differently from a competitive market.

Consider a monopoly in which the profits earned by the firm and consumers’ benefit is cared for. In order for both the producer and consumer to maximise profits, this monopoly tries to maximise total surplus.

Total surplus in this market would be maximised at the level of output where the demand and marginal cost curves meet. Below that level the value of the good to the consumer trumps the marginal cost of producing the good, so by increasing output total surplus would also increase. Conversely, over this level, the value of the good to the consumer is less than its marginal cost, so by decreasing output total surplus again increases.

This “ideal” monopoly could achieve the an equilibrium by charging a price relative to the social optimum level of output. Namely, where the demand and marginal cost curves meet. Much like a competitive market, the “ideal” monopoly would charge a price equal to the marginal cost of the good or service.

Evaluating the implications of a monopoly on welfare includes a comparison of the level of output set by a typical monopolist, to the level of output set by the “ideal” monopolist. The typical monopolist produces at the output where the marginal revenue and marginal cost curves meet. Whereas the “ideal” monopolist sets the output relative to where the demand and marginal cost curves intersect. This example is illustrated by the diagram overleaf:

The fact that a monopoly charges a good at a higher price than its marginal cost, leaves consumers with little incentive to purchase it at more than it is valued, rendering the quantity a monopoly chooses to sell below the socially efficient level. The shaded area between the demand and marginal cost curve is known as the deadweight loss.

It is at this point that monopolies take the blame for making profit by exploiting consumers’ willingness to pay. It is one thing to blame a monopoly for making more money and another to argue that they have an effect on welfare. A monopoly profit-maximising firm does not necessarily conjure any issues for society. Welfare in an monopolistic market involves the consumer and the producer. Every extra pound spend on a good goes to the producer, increasing his surplus but leaving the total surplus unaffected. The “losers” are the consumers for purchasing an overpriced good. Presenting an argument as to how consumers were wronged in this situation becomes more of a moral matter, however in plain monetary terms, a monopoly doesn’t affect welfare in this sense. The problem welfare faces is not in terms of the pricing but of output. A monopolist produces a quantity below the surplus-maximising level. The deadweigt loss is a measure of much the market diminishes as a result. The problem arises from the inefficiently low quantity produced.

As proven above, monopolies fail to allocate resources efficiently. They produce less than the social optimum level of output which in turn leads to higher prices. Governments may intervene in one of four ways to deal with a monopoly. Making a monopolistic market more competitive, regulation, publicising private firms or doing nothing.

In order to make a market more competitive, governments take legal measures in the attempt to prohibit company mergers that coincide with public well-being. Governments also tend to regulate monopolist behaviour. This course of action is more dominant when firms monopolise utilities like water gas or electricity. Firms are no more price setters, government agencies impose prices. It is suggested that prices should equal the monopoly’s marginal cost of producing a good. If this were the case, consumers would consume producer surplus and resources would be allocated efficiently. Nevertheless, seeing that natural monopolies have a declining average total cost, the marginal cost is less than the average total cost. If prices were equal to MC, they would also be lower than the firm’s ATC resulting to the firm losing money. The firm would then exit the industry instead of charging such a low price.

Another governmental policy includes nationalising former privatised firms. Government intervention in this case may prove to be counterproductive in the sense that a privatised firm would be incentivised by the increased market share to minimise costs of production. If firm managers are not reaching expectations concerning maintaining lower costs they are replaced in order to avoid any inefficiencies. This behaviour is popular throughout the European Union seeing that numerous countries have privatised most utility companies.

Every governmental policy has repercussions so governments are generally advised not to take any action.

In conclusion, although monopolies tend to employ profit maximising strategies by charging higher prices, this doesn’t necessarily affect social welfare directly, despite the fact that a fall in total surplus may be traced back to the elevated prices. It has more to do with the quantity supplied, or lack of, seeing that a monopoly will produce at a lower quantity than is socially optimum. In this sense, governments should intervene to prevent monopolies from exploiting consumers’ willingness to pay and their inability to provide a good or service by some other means. On the other hand however, by privatising valuable resources such as coal or water or gas or the environment in general, firms would be forced to maintain a certain level of efficiency while keeping costs to a minimum. Nevertheless by regulating monopolies and preserving competitive markets governments are able to ensure economic stability.


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