Essay on MonopolyGroup MembersMohiuddin AbroDaniyal Abbas KhanWaleed ChohanAdeel UsmanTayyab GhaniWHAT IT ACTUALLY IS? A monopoly has many definitions. It can be a company, institute, or an organisation which is the dominant seller of goods and services in the marketplace. According to Alain Anderton, a Monopoly When there is no involvement by the government for regulation, a monopoly company is free to set any price and it commonly chooses the highest level of profit possible. One thing that should be noted is that it is not necessary that a monopoly becomes profitable as compared with the other members. If enough rivals businesses enter, they will compete among themselves and ultimately drive down monopoly power. Some prominent examples of Monopolies are Microsoft in Computer Operating Systems, Major League Baseball and National Football League in United States. MONOPOLIES’S Main Characteristics• It is one single seller• High barriers to entry keep other firms from entering the industry• There is no second alternative that is available in te market for its product. A monopoly industry can consist of one firm or a number of organisations that operate and make decisions together for their own benefits. HOW ARE MONOPOLIES ACHIEVED? Monopolies appear through three basic broad mechanisms –Through legal action, the state can carry out a decision to make monopolies in the market. Competition can be made illegal. A real-life example of this is in England where prescription drugs are sold by pharmacies in accordance with the law. Monopolies can also be created by the buying o resources available in a marketplace to create a good or service. For example, An aeroplane company can buy the flying rights to operate from an isolated region to a urban one – e. g From Moscow to Alaska. Unethical competition practices can also be performed by monopolist companies. A bus coach with a monopoly on a road route may cut down their bus fare when a new challenger comes in the market. PRICE AND PROFITS IN MONOPOLYWhen there is a lack of government involvement and clear laws, monopolists can manipulate the prices and choose to set them whatever they want. For example, they can choose to keep the price of a toothpaste Rs. 20 or Rs. 40. However, monopolist companies can get a falling demand curve as higher prices will result in lowering demand in the market. However, firms are careful here not to keep a very unreasonable price as it will lead to less profit. The highest price does not necessarily mean it’s the profit maximising price. It is true that a firm with monopoly has price-setting power and will look to earn high levels of profit. However the firm is constrained by the position of its demand curve. Ultimately a monopoly cannot charge a price that the consumers in the market will not bear. A pure monopolist is the sole supplier in an industry and, as a result, the monopolist can take the market demand curve as its own demand curve. A monopolist therefore faces a downward sloping AR curve with a MR curve with twice the gradient of AR. The firm is a price maker and has some power over athe setting of price or output. It cannot, however, charge a price that the consumers in the market will not bear. In this sense, the position and the elasticity of the demand curve acts as a constraint on the pricing behavior of the monopolist. Assuming that the firm aims to maximize profits (where MR= MC) we establish a short run equilibrium as shown in the diagram below. Assuming that the firm aims to maximize profits (where MR= MC) we establish a short run equilibrium as shown in the diagram below. The profit-maximizing output can be sold at price P1 above the average cost AC at output Q1. The firm is making abnormal ” monopoly” profits (or economic profits) shown by the yellow shaded area. The area beneath ATC1 shows the total cost of producing output Qm. Total costs equals average total cost multiplied by the output. Natural monopoliesA monopoly is natural if one firm can produce a given set of goods or services at lower cost than can any other number of firms. A natural monopoly results when costs are decreasing in the scale of a firm (economy of scale) or in the scope of its products or services (economy of scope). In natural monopoly situations the monopolists will raise his costs and tariffs because he lakes incentives for efficiency and is interested in the maximization of profit. Before concluding that regulation is warranted under the natural monopoly rationale, two questions must be answered. The first is whether there are any natural monopolies, and if there are, whether significant economic efficiency or social welfare would be gained by regulation. Economies of scale and scope certainly exist over some sets of goods and services, but these economies can be exhausted at output levels that allow more than one supplier to persist in the market. Empirical studies indicate, for example, that the large electric power plants in the United States have exhausted the achievable economies of scale. A natural monopoly can also result if having more than one supplier would result in an uneconomical duplication of facilities. Local electricity distribution systems within cities may remain a monopoly to avoid duplicate sets of distribution wires. This rationale does not necessarily apply in the telecommunications industry, since cable television and wireless communications systems provide alternatives to the local wire connections. If there is a natural monopoly, it does not necessarily follow that there is substantial economic inefficiency. First, if entry into the industry is easy, the threat of potential competition may limit the extent to which an incumbent monopolist can restrict output (and raise prices). Second a monopolist may choose to use a pricing policy, involving fixed charges and a low unit price, which can both increase profits and benefits consumers. Third, if there are a number of possible suppliers of a monopoly service, competitive bidding for the right to be the monopolist can be used to lower the supply price and increase economic efficiency. Similarly, an alternative to the regulation of the electric power industry is for communities to own the local distribution system and bargain with power companies for the supply of electricity. Market failures can also result from costs associated with making market transactions. To the extent consumers and producers incur costs in becoming informed about market opportunities and completing market transactions, markets will not perform efficiently. Regulation to reduce those transactions costs then can improve efficiency. For example, in the auto industry global auto emissions standards can enhance efficiency, as auto producers would not have to produce different models for different states. As an example, a common problem in markets is the incentive for sellers to shirk on the quality of the goods or services they sell. When quality can only be observed through use, a seller may have an incentive to shirk. As long as a high quality good is more costly to produce than a low-quality good and a consumer cannot tell the difference until after it is purchased, the seller’s strategy can be to cut back on quality. Markets however can resolve some of these problems. For example, If consumers can sully the reputation of the firm by informing other consumers that the firm shirked on quality, consumers will not purchase from that firm. http://www. naruc. org/international/Documents/S4%20-%20Hodge. pdf
Zero provision of public goods
Direct provision of public goods
Financial intervention: taxes (equal to the monetary value of the MEC) are imposed on individuals or a firm, internalizing ECs
Leaves space for market forces to interactProvision of revenue for the government
Difficulty in valuating ECOvervaluation means output is below social optimum, as with undervaluation means that output is not sufficiently lowered (ie, society’s welfare is not always maximized)Effectiveness of tax dependent on PEDLegislation: laws and administrative rules are passed to prohibit or regulate behaviour that imposes an EC, e. g. pollution permitsEnforcement is difficult and expensiveEducation, campaigns and advertisements solve the problem of imperfect information by allowing the external costs to be made known to the consumer, discouraging demandBenefits must outweigh the costs of implementation. A lot of time may be needed for effects to be felt
Financial intervention: subsidies made to the producer or consumer
Considered the most effective way of solving underconsumption as it is easily implemented
Like taxes, the valuation of EB is difficultHigh government expenditure is requiredOkun’s leaky bucket: each dollar transferred from a richer to a poorer individual, results in less than a dollar increase in income for the recipient. Leaks arise as a result of administrative costs, changes in work effort, attitudes etc. arising from the redistributionLegislation include regulation seatbelt usage, compulsory education etc. Enforcement requires constant checking which may translate to high costs.
Non provision of merit goods
There is a need to produce merit goods (which are naturally underconsumed) at low prices or for free due to four reasonsSocial justice: they should be provided according to need and not ability to payLarge positive externalities, for example in the provision of free health services helps to contain and combat the spread of diseaseDependants are subject to their guardians decision which are not necessarily the best, therefore the provision of services like free education and dental treatment is needed to protect dependants from uninformed or bad decisionsIgnorance: The problem of imperfect information makes consumers unaware of the positive externalities and benefits that arise from consumption
Imposition of a lump-sum tax on a monopolist (shifts AC upwards), and supernormal profits are taken as tax. Governments may also regulate MC/AC pricing for monopolies. Government may impose regulations to control a monopoliesForbidding the formation of monopolies (e. g., antitrust laws)Forbidding monopolistic behaviour (like predatory pricing)Ensuring standards of provision. Ensuring competition exists (e. g., deregulation)
Nationalization and Privatization
Nationalization refers to the public (governmental) ownership of certain firms to provide goods or services sold in the market, that is, public corporations engaged in commercial activities. Governments often take over natural monopolies to prevent monopoly pricing and examples include public utilities.
Consumers protected from high pricesCross inefficiency may ariseEnsuring social costs and benefits are taken into account when production decisions are madeNo profit motive may lead to nationalized enterprises being allocatively inefficientPrivatization refers to a change in ownership of an activity from the public to the private sector. State owned companies having lost money may privatize to give new owners the responsibility of restructuring the enterprise.
Forms of Privatization
Denationalization: Privatization of ownership – sales of assets or shares. The government may retain some shares in the enterprise, and acts as a regulator in this case to ensure that public interest is protected. Franchising: Gives the private sector a right to operate a particular service/activity for a given length of time. May be exclusive or competitivePrivatization of production: Government buys goods and services instead of producing themRefuse collection services being contracted to private firmsPrivatization of financing: Government relies on consumer charges rather than tax revenue to subsidize operations. (e. g., independent school fees)Deregulation: Liberalization of regulation to promote competition through the removal of barriers to entry (creation of contestable markets)Telecommunications, financial industry, airline (US ‘ open skies’ policy)
Evaluation of Privatization
Revenue for the government – reduces public-sector borrowing requirement. Allows the government to make tax cuts without reducing spending. Revenue might come in from higher corporate tax receipts from the privatized companiesLong term revenue loss – future profits from industries are lost by the stateNatural monopolies are best left to the public sector as duplication of services is unnecessary – wasteful and inefficient and not in the best interests of consumersIncreased competition due to contestable markets and profit motives which translates toBenefits for consumers in the form of lower prices, wider choices and better qualities as X-inefficiency is reduced (see Nationalization)Competition may not increase replacing a public-sector monopoly with a private-sector one does not increase competition as firms are still able to act like monopolistsIncreased efficiency and flexibility as private companies are normally more successful in raising capital, lowering prices and cutting out waste. Little governmental interference allows the company to respond to market forces, and make commercially sensible decisions and investmentsMarket forces may not ensure greater efficiency – like before, remaining as private-sector monopolies are likely to earn supernormal profits even if they are inefficient. Large firm size also prevents firms from being taken overWider share ownership increases accountability to the publicPrivate-sector firms may not act in public interest as they do not take into account negative externalities (like resultant unemployment) and are unlikely to base their output and pricing on social justice and equityCost-push inflation is reduced. Private firms are less willing to accept inefficient working practices. Wage raises have to be justified by higher productivity.