Market on monopoly power, how it is

Market failure
typically happens when, in a free market, there is an inefficient distribution
of resources. The market ends up with an outcome that is not Pareto optimal (The
Economy, 2017). Failure can occur because of a wide range of reasons and factors
such as negative externalities, monopoly power, information failure (asymmetric
information), as well as public goods. In particular, market failure can arise
from a monopoly due to the inability to regulate its actions – this is what monopoly
is. This essay will focus on monopoly power, how it is a form of market
failure, the negative effects of it, and how this is dealt with through
government intervention.

 

Monopoly power is
essentially when a single firm has control of the market and so can set higher
prices and because of this a monopoly market is the market condition that has
the most imbalanced power (Nguyen and Wait, 2016). There are several types of monopoly
power that can exist in a market. Firstly, there can be pure monopolistic power
where there is only a single seller in the market. There is also working
monopolistic power in which the monopoly is any firm with 25% or more of total
sales. An oligopoly is a market containing a few dominant firms and, finally,
duopolistic power wherein two firms take the majority of the demand.

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Monopoly power
either comes from a business growing successfully on its own, or through the integration
of firms (mergers and acquisitions). The integration of firms happens when two
firms join together at the same stage of production or a firm integrates with different
phases of production. Monopoly power can be protected with barriers to entry;
barriers to entry can block rival business from being able to profitably enter
a market which protects the power of the monopoly (Gabszewicz, 2000) and other
existing firms as well as maintaining relatively high profits and increasing producer
surplus. These barriers include predatory pricing, perpetual ownership of a
scarce resource, and exclusive contracts, among many others. Overall, monopoly
power is created and maintained through organic business growth, mergers and
acquisitions, and barriers to entry.

 

A monopoly
maximises profit in the long run at MR = MC. It sets the price at P1 and produces
Q1, making a super-normal profit since AR > ATC.

 

Monopoly power can
lead to the monopoly being X-inefficient (Taylor, 2017), meaning the firm has
higher cost curves than if there was competitive pressure. Since the monopoly does
not face any current or potential competition, a consequence of this can be the
firm suffering X-inefficiency due to the workers putting in less effort therefore
causing costs to rise. A lack of competitors in general gives a monopoly fewer
incentives to cut costs as well as to develop better or new products and
services.

 

In addition to
this, monopoly power means the monopoly could restrict output in order to raise
prices which in turn leads to the loss of producer surplus as well as consumer
surplus. In a monopoly, the producer has the power to set the good at any
possible price (Stuart, 2007) due to the fact that consumers do not have
anywhere else to buy the good from. The price set by the producer or firm is
usually a lot higher than both the average and marginal costs thus leading to allocative
efficiency being lost and hence a market failure.

 

Furthermore, monopoly
power leads to market failure through misallocation of resources but it also
leads to welfare loss. Higher prices not only mean that the consumer’s wants
and needs are not being satisfied because the product is being under-consumed,
but they also cause a loss of consumer surplus and welfare which unduly affects
families of a lower income as super-normal profit is inequitable and can be
seen as an imbalanced division of resources in society (Tore, 1991).

 

The welfare loss
as a result of monopoly power market failure is represented by triangle ABC in
the diagram above, it is also known as ‘The Deadweight Loss’ (DWL) Triangle.

The area in the triangle above the line PB represents the loss in consumer
surplus, while the area below shows the loss in producer surplus. The total
welfare loss associated with monopoly power is the loss in consumer surplus plus
the loss in producer surplus which equals to the DWL Triangle (Shughart, 1999).

 

Because of the
inequality of income and the welfare losses that result from from monopoly
power market failure, there is the need for monopoly to be controlled and
regulated. This is done through government intervention and is done mainly
through taxation, regulation of conditions of monopoly, and anti-monopoly laws
and policies being put in place to prevent any unfair price discrimination for
consumers.

 

The government is
able to regulate monopoly power through the use of taxation by either levying a
tax per unit of output – known as Specific Tax – or by imposing a lump sum,
irrespective to output, tax. Specific tax is principally a commodity tax such
as sales tax which is tax on sales and excise duty tax which is levied on
production. Specific tax typically has the effect of reducing outputs sold, the
price consumers are charged increases so that the burden of the tax is not
solely on the firm, and a reduction in profit for the monopoly (Koutsoyiannis,
1975). A Lump Sum tax can be something like a profit tax or even a license fee
which is enforced on a firm irrespective of its level of output and so it is
treated by the monopoly as if it were a fixed cost (meaning it isn’t included
in the firm’s Marginal Costs).

 

Another way the
government intervenes is with price regulation. An example of this is RPI-X
(Anderton, 1993), a form of price capping which is usually used for privatised
industries. The amount that the price has to be cut by is X and it is in real
terms. For example, if RPI was 6% for a specific year and X was to be set at
2%, this would mean that the firm can only increase its prices by 4% (= 6% – 2%).

An advantage of price regulation such as RPI-X is that firms will opt to try
and cut their costs by more than X in order to increase their profits which in
turn means they become more efficient. Price regulation is an incentive to
lower costs and can inspire market competition preventing firms from abusing
monopoly power.

 

The government can
also ensure that profits earned are not excessive, for example through the use
of corporation tax on any profits earned. Moreover, government regulators can
make sure that minimum standards are met and check the quality of goods and
services produced by the monopoly. Sometimes, performance targets are also set
on organisations in order to regulate quality. For example, the NHS is a
monopoly power but is highly regulated and is set huge performance targets by
the government.

 

There is also a
lot of legislation and a number of policies that have been put in place by the
government, as well as bodies created by the government and independently, to
prevent market failure from monopolies and to further regulate them. The
Competition Act 1998 prohibits a wide range of activities by firms including a
firm abusing its dominant position as well as colluding with competitors (Klein,
Dalko and Wang, 2012). The Office of Fair Trading (OFT) is an independent body
with some of its main objectives being to investigate any abuse of market power
from a firm with a dominant position and to investigate any practices of anti-competitiveness
such as restrictive practices. There is also the Competition Commission who
assess whether or not a merger will reduce competition.

 

Government intervention
and regulation of monopoly power can prevent market failure, sometimes
eliminate deadweight loss (Hill and Myatt, 2010), and in some cases there can
be more positive outcomes from monopoly power. With a firm having such high
profits, they can potentially be used to fund innovation causing gains in
dynamic efficiency. Economies of scale could also be achieved – meaning average
costs are lower. Further to this, competition could stem from elsewhere such as
overseas.

 

In conclusion, monopoly
power, without any regulation or intervention from the government, will lead to
a market in which resources are completely inefficiently allocated so accordingly
the final outcome will be market failure with significant welfare losses; the
most important of which is inequality of income. To prevent this market failure
and unfortunate welfare losses that result from monopoly power, the government
imposes various taxes on monopolies and laws which closely regulate their
prices and activities.