Abuse of monopoly power Essay

Imagine what it would be like if there was only one bakery in your home town, and no possibility of opening up a new one because of the fact that there are no shops for rent. People who are looking to get their hands on freshly baked bread would have no choice but to go to the one bakery. We say that the baker is a monopolist; that is, he is the only baker in the market and is thus able to set the price at whichever levels he wants. Chances are that the price of bread is going to be considerably higher than if the baker had to compete with others for consumers. The result, as this lesson deals with, is market failure as a result of the abuse of monopoly power. MONOPOLY POWER AND MARKET FAILURE A monopoly exists when there is only one producer of a certain product. Other firms are prevented from competing with the monopolist because of the very high barriers to entry. Because of this, the monopolist is a price setter – it can itself decide what price to charge so long as it covers the cost of production. It is often argued that Microsoft has a monopoly on the operating system market, making consumers pay a very high price for Windows as they buy a new computer. Another example comes from supermarkets, which may acquire a monopoly in a neighbourhood if planning permission to build other shops is denied. It can then sell the same products as it would sell before, but for a much higher price. Hence, in such markets, the price and quantity demanded of the product do not reflect a true equilibrium – abuse of monopoly power is a kind of market failure resulting from the ability to charge a higher price than it otherwise would. Moreover, the quantity on the market is restricted below what is socially optimum by the monopolist. This results in a welfare loss, as consumer surplus is not maximised, which is represented by the grey triangle in the diagram below. Examiner Tip However, in cases where we have a negative externality (e. g. pollution) it would actually be good to have a monopolist that restricts the quantity – the welfare loss would rather be a welfare gain in this case. Government intervention is common in the case of monopolies, if they abuse of their power and damage consumers’ welfare. Possible responses include: ?Legislation – competition policies to ensure that markets are not dominated by one firm only, as the EU proceedings against Microsoft show. ?Regulation – for example, planning regulations could be relaxed to allow more shops to open in the same area where the supermarket operates. ?Nationalisation – this is the case of national monopolies where the state takes over a business and regulates prices in the social interest. E. g. Following the financial crisis of 2008 banks, insurance companies and car manufacturers were nationalised in the USA and UK. ?Trade liberalisation – allowing foreign firms to compete in the national market contributes to breaking up monopolies that were formed due to the lack of internal competitors. What you should know ? Monopolies act as single producers in a market and can set prices and quantity. ?Their power may be abused, damaging consumers’ welfare. ?Government intervention can limit abuse of power through legislation, regulation, nationalisation and trade liberalisation.