Essay/Term paper: Why is monopolies harmful and how can regulation ameliorate these harmful effects?

Essay, term paper, research paper:  Marketing

Why Is Monopolies Harmful and How Can Regulation Ameliorate These Harmful
Effects?

Why is monopoly "harmful? How can regulation ameliorate these harmful effects?
What problems confront the regulators?

In order to deduce that a monopoly is "harmful', there must be another market
system which is preferable to monopoly so as to offer greater benefits to the
public. A monopoly can therefore be compared to perfect competition. If the
benefits of perfect competition outweigh the benefits of monopoly then a
monopoly can be regarded as "harmful' since the consumers are not receiving the
maximum possible utility for their purchases.

Monopolies are criticised for their high prices, high profits and insensitivity
to the public. Some governments therefore, in the light of these protests,
advocate policies relating to monopolies, in order to regulate their power in
favour of the public's interest.

There are several reasons why monopolies may be against the public interest. It
is claimed that monopolies produce at a lower level output and charge a higher
price than under perfect competition in both the short run and the long run.

Consider the diagram above. Assume that this monopolist attempts to maximise
profits. Equating MC=MR yields an output of Qm and a price of Pm. If the same
industry existed under perfect competition however, the price would be Ppc and
output would be Qpc since under perfect competition P=MC=AR. The price in such a
situation would thus be lower than under monopoly and output would be greater.
Consumers obviously benefit if this is the case since P=MC implies P=Marginal
utility so that consumers are maximising their total utility(Under monopoly P>MC
and therefore arguably, not the optimum).

In the long run under monopoly, supernormal profits persist. Under perfect
competition complete freedom of entry leads to the elimination of these profits
and forces firms to produce at the bottom of the long run average cost curve.
Under monopoly however, there are barriers to entry so as to prevent new firms
from entering the industry and reducing the monopolist's profits to the normal
level. Higher prices and lower output thus continue to persist in the long run.

Due to lack of competition, it is argued, a monopolist has no incentive to
develop new techniques in order to survive. A monopolist can therefore make
supernormal profits without using the most efficient techniques. Under perfect
competition, in order for firms to survive, the most efficient techniques must
be adopted or developed whenever possible or else the firm which fails to do so
will be forced to shutdown. This argument leads to the conclusion that
monopolies have higher cost curves than firms under perfect competition(Assuming
that the monopolist does not use supernormal profits to finance research and
development and hence reduce costs. ).

Even if a monopolist does invest in research and development, although prices
will fall and output will rise, extra supernormal profits received will merely
accumulate with old profits. These high profits lead to the question of
distribution of income. The answer to this question is a normative one and is
thus subject to much controversy. It is therefore up to the government to decide
if intervention is necessary to curb a monopolist's power and hence to uphold
the public interest.

If the government weighs up the cost and benefits of " monopoly' and concludes
that they are in fact "harmful', the government can adopt policies of
intervention or regulation.

The diagram below shows how a government can keep the price at a maximum Pm
below market equilibrium.

The government may feel that a price of op1 is excessive so a price of opm is
implemented. At this price however, the monopolist is only willing to supply oq1
units while quantity demanded is oq3 units. There is thus an excess in demand(Or
shortage in supply) of oq3-oq2 units. In such a case the price should rise but
it can't because of the price maximum. The monopolist would thus have to sell
its output on a "first come, first served' basis, or some sort of rationing
system will have to be organised for those who desire the good and can afford
to pay for it.

Alternatively a government can adopt an RPI-X formula(As in the UK with
privatised industries), which provides an incentive for monopolies to be as
efficient as possible. If the monopolist reduces its costs below X the
monopolist can still make large profits. If the monopolist does not succeed in
doing so a loss is inevitable. Monopolies are thus forced to cut costs if
profits are to be attained.

There are however various problems with regulation. Since the government gives
the regulator power to implement decisions. Who is to say that the regulator's
perception of the public interest coincides with the government's?(Since the
government acts in the public interest, or is supposed to anyway.) Moreover,
regulation is very complex and difficult especially with large powerful firms
which exert political influence. There is thus a danger of regulatory capture.
This is where the regulator is persuaded to operate in the monopolists' interest
rather than in the public interest. Regulatory capture may be due to corruption
or due to regulators actually believing the managers point of view.