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Public Policy Toward Monopoly

25 April, 2016 - 09:12

Pulling together what we have learned in this chapter on monopoly and previously on perfect competition, Table 10.1 below summarizes the differences between the models of perfect competition and monopoly. Most importantly we note that whereas the perfectly competitive firm is a price taker, the monopoly firm is a price setter. Because of this difference, we can object to monopoly on grounds of economic efficiency; monopolies produce too little and charge too much. Also, the high price and persistent profits strike many as inequitable. Others may simply see monopoly as an unacceptable concentration of power.

Table 10.1 Characteristics of Perfect Competition and Monopoly

Characteristic

Perfect Competition

Monopoly

Market

Large number of sellers and buyers producing a homogeneous good or service, easy entry.

Large number of buyers, one seller. Entry is blocked.

Demand and marginal revenue curves

The firm’s demand and marginal revenue curve is a horizontal line at the market price.

The firm faces the market demand curve; marginal revenue is below market demand.

Price

Determined by demand and supply;

Each firm is a price taker.

Price equals marginal cost.

The monopoly firm determines price; it is a price setter. Price is greater than marginal cost.

Profit maximization

Firms produce where marginal cost equals marginal revenue

Firms produce where marginal cost equals marginal revenue and charge the corresponding price on the demand curve.

Profit

Entry forces economic profit to zero in the long run.

Because entry is blocked, a monopoly firm can sustain an economic profit in the long run.

Efficiency

The equilibrium solution is efficient because price equals marginal cost.

The equilibrium solution is inefficient because price is greater than marginal cost.

 

Public policy toward monopoly generally recognizes two important dimensions of the monopoly problem. On the one hand, the combining of competing firms into a monopoly creates an inefficient and, to many, inequitable solution. On the other hand, some industries are characterized as natural monopolies; production by a single firm allows economies of scale that result in lower costs.

The combining of competing firms into a monopoly firm or unfairly driving competitors out of business is generally forbidden in the United States. Regulatory efforts to prevent monopoly fall under the purview of the nation’s antitrust laws, discussed in more detail in a later chapter.

At the same time, we must be careful to avoid the mistake of simply assuming that competition is the alternative to monopoly, that every monopoly can and should be replaced by a competitive market. One key source of monopoly power, after all, is economies of scale. In the case of natural monopoly,the alternative to a single firm is many small, high-cost producers. We may not like having only one local provider of water, but we might like even less having dozens of providers whose costs—and prices— are higher. Where monopolies exist because economies of scale prevail over the entire range of market demand, they may serve a useful economic role. We might want to regulate their production and pricing choices, but we may not want to give up their cost advantages.

Where a natural monopoly exists, the price charged by the firm and other aspects of its behavior may be subject to regulation. Water or natural gas, for example, are often distributed by a public utility— a monopoly firm—at prices regulated by a state or local government agency. Typically, such agencies seek to force the firm to charge lower prices, and to make less profit, than it would otherwise seek.

Although economists are hesitant to levy blanket condemnations of monopoly, they are generally sharply critical of monopoly power where no rationale for it exists. When firms have substantial monopoly power only as the result of government policies that block entry, there may be little defense for their monopoly positions.

Public policy toward monopoly aims generally to strike the balance implied by economic analysis.Where rationales exist, as in the case of natural monopoly, monopolies are permitted—and their prices are regulated. In other cases, monopoly is prohibited outright. Societies are likely to at least consider taking action of some kind against monopolies unless they appear to offer cost or other technological advantages.