Economics Essay Monopoly Power

Explain how welfare loss may result from monopoly power. (10 marks) 

Welfare loss equals to loss of a portion of social surplus that arises when marginal social benefits are not equal to marginal social costs, due to market failure. Market failure refers to when the market fails to allocate resources efficiently, or to provide the quantity and combination of goods and services wanted by society. Market failure results in allocative inefficiency where too much or too little of goods or services are produced ad consumed from the point of view what is socially desirable. Monopoly power occurs when a firm has the ability to control the price of the product it sells. Market power can be achieved by obtaining as little as 25% market share.
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Monopoly power causes market failure and allocative and productive inefficiency. Consumer surplus in monopoly (area C), is smaller than area A in perfect competition. Part of producer surplus comes from part A because price has risen from Ppc to Pm. Area E, which represents welfare loss, exists because the quantity in monopoly has been decreased from Qpc to Qm.

Producer surplus in monopoly has increased, because a fraction was taken away from the consumer surplus (area C), and it has also lost area F (which represents welfare loss). The monopoly’s higher price and lower quantity has causes E + F. MC does no longer equal MB=D. Consumers are not getting the quantity desired because MB is larger than MC (at Qm), which causes an under allocation of resources.

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Allocative efficiency occurs when P = MC at profit maximising level of output. However, a monopolist’s price (Pm) is higher than MC. Therefor, allocative inefficiency occurs in a monopoly. Productive efficiency takes place when the quantity produced equals to the minimum ATC.  Qm is not at the minimum level of ATC; therefore, there is productive inefficiency.

Google and Monsanto are great and famous examples of monopolists as they both acquire 90% of the market share within their own market, meaning they are price makers and not price takers.

(b) Discuss the effectiveness of government policies (legislation and regulation) to reduce monopoly power. (15 marks)

Government intervention equals to the practice of a government interfering in markets, to prevent the free functioning of the market, usually for the purpose of achieving particular economic or social objectives. Governments tend to evaluate that the disadvantages outweigh the advantages of a monopoly market.

Many governments try to promote healthy competition and prevent collusion between oligopolistic firms. The objective is to prevent monopolistic behaviour by one or a group of firms, and therfore achieve a greater allocative efficiency. Microsoft has been guilty of restricting consumer choice and preventing from competitor firms from selling operating systems, thus maintaining its monopoly within the market. A government can prevent this by requiring companies to pay fines or break the company up into smaller companies (so there s no more monopoly). However, there are some problems as anti competitive behaviour laws are very ambiguous and open to interpretation. Firms collude secretly; making it difficult for law enforces to find evidence.

Firms merge together to increase their economies of scale or an interest in firm growth, or wanting to become a monopoly. This can be an issue because when too many firms merge together, they can acquire a too large monopoly power. Ideological differences amongst governments can lead to similar merges being approved in one country but denied to be allowed to merge in another country.

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It is not in a society’s best interest to break up a natural monopoly, as this would result in higher ATC and would be inefficient. We can see on the diagram above that an unregulated frim would produce at Qm and sell at price Pm (because of the MC = MR rule). The firm will make an economic profit of a-b. A government can regulate this sort of behaviour by applying marginal cost pricing. The most optimal policy would to force the monopoly to produce at P = MC, since allocative efficiency would be achieved. The intersection of AR and MC causes price to go to Pmc and Quantity Qmc. Quantity has increased from Qm to Qmc and Price has fallen from Pm to Pmc. This is a socially desirable level. However this policy does have its drawbacks, as the natural monopolist will suffer losses. Pmc lies below the ATC Curve. The firm can’t cover their costs (loss per unit is given by c-d). Although MC pricing leads to an efficient solution, it is impractical, as the losses forced on the monopolist would make it go out of business in the long run.