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Microeconomics BY 239177 Is it necessarily a good thing, in terms of the welfare of society as a whole, for the government to step in to break up a monopoly in order to create a competitive industry? A monopoly exists when one single firm is the only producer of a commodity in the market, allowing them to set prices as they wish and maximise profits due to the high barriers to entry. In this case, the firm is given the ability to exploit their consumers in terms of price discrimination based on price elasticity.
In this essay, I will be discussing whether it is wholly reasonable for a monopoly to perate, or whether there is a need for the economy to revert to a more perfectly competitive alternative. Firstly, some would say that it is feasible to break up a monopoly, as consumers will no longer be charged extortionate prices, leaving pricing to be determined competitively by supply and demand. In this case, consumers will benefit from the lower pricing and also the better quality goods. Conversely, it can be said that with a monopoly being a price maker, the firm will make supernormal profits in the short run.
This can be shown from the diagram below. Firms maximise profits where marginal revenue is equal to marginal cost, at Qmon output. However, instead of selling at perfectly competitive price Pc, the firm is able to sell at Pm, and this creates short-run supernormal profits. On the contrary to a monopoly being detrimental for society, it can be said that with these supernormal profits, firms are able to innovate and invest in research and development in order to provide consumers with products of the best quality more efficiently.
On the other hand, there is a loss in consumer surplus as a result of a monopoly in the market, as shown below. Consumer surplus can be defined as the difference between what consumers are willing to pay for a good or service relative to its market price. A consumer surplus occurs when the consumer is willing to pay more for a given product than the current market price. ‘ The pink areas portray the consumer surplus in a perfectly competitive case on the left, and a monopoly one on the right.
Currently, it is evident that monopoly firms exploit their consumers such that they transfer the consumer surplus to producer surplus, which is the amount that producers benefit by selling at a price that is eadweight loss shown by the yellow triangle, created through the allocative inefficiency of the market. Therefore, if the government were to step in to break up this monopoly, it is clear that in a perfectly competitive market, the producer surplus and consumer surplus would be equal, benefitting the welfare of society.
Additionally, due to the firm holding a monopoly in a certain industry, it is likely that employees may be forced to accept low wages. This hinders economic development, as there is a multiplier effect in that lower wages will mean that people consume less nd save more, concluding in apathetic behaviour which may make production inefficient. Oppositely, it can be said that a monopoly uses price discrimination, seen to benefit those more vulnerable in society.
An example of this is with the different classes in aeroplane fares, or the ability to purchase a student ticket at the cinema. In these cases, consumer surplus is extracted from buyers, creating additional revenue for producers. There is continuous doubt in the economy as to whether it is reasonable for monopolies to exist, especially if the firm owns more than 25% market share in terms of a legal monopoly. An example of where a firm has exercised this is when Vodafone had to sell Orange. A German corporation called Mannesmann owned Orange and Mannesmann was taken over by Vodafone.
When the company was taken over, Vodafone acquired Orange as part of the agreement, and not only did this boost Vodafone’s market share, it also threatened Vodafone’s ability to abuse its dominant position in the market place. ii iii Similar to this, and one of the most popular accusations of a monopoly was with the Microsoft Company whose Windows computer operating system was being in used in over 90% of computers being sold n the United States. This almost caused the company to be broken up into several separate companies as well. v Monopoly power does have many benefits, a major one being that of economies of scale. The firm can pass this on to consumers through their more efficient services costing less, whether external or internal, something which smaller firms would not find as easy to exploit. If a monopoly wishes to gain the benefits of natural monopoly to the full extent, there needs to be subsidies. Natural monopoly is where the entire market of demand can be supplied by one firm for a good or service at a low price.
As economies of scale are used in a natural monopoly, the cost of producing goods or services is lower. Consumers could end up with better products from a monopoly firm and there could potentially be cheaper costs because they can invest and decrease their cost of production. Consumers will only be able to see the cheaper product if the decrease in average total cost is passed onto the consumer. v However, it can also be a good thing to break up monopolies in order to create a competitive industry.
Prices charged by monopolies are always higher than they would be if they were operating in a perfectly ompetitive market. Monopolies are able to increase their revenues by raising prices. The net result is that there would be a deadweight loss to the society. The quality of goods that are being produced by monopolies may be very low and the reason why the products may be of low quality is because they have no competitors to compete against, so they have not gone to their best ability to produce these products at low prices.
Whereas in a perfectly competitive market, it could be the opposite, where the standard of the products could be of high quality but the prices would be low due to as to break up a monopoly, it would be much more difficult for firms to survive in the competitive market, as initially, these entrants are lured by the high supernormal profits. However, the high barriers to entry are because it is a risk for potential producers to enter the market but at a high price. ii One of the big differences between monopoly and competitive firms are that monopolies are price makers and competitive firms are price takers. The disadvantage about being a price taker is that there is no control over the price that the products are sold at. For example, Tesco ould need to look at all of their competitors’ products and pricing and compete at a level where the consumers who are looking for the same products choose Tesco because they are the most cost effective company out of all their own competitors.
The advantage about being a price taker is that if they are not able to identify what kind of price they should set their products at, they can look at their competitors’ prices, and it will give them an idea of what kind of pricing is most suitable for that product that they are selling. Similarly, the disadvantages of being a price maker are hat the firm may overprice the products that they are selling to their consumers. Without having the influence of other firms in the same market, the firm might not have enough knowledge on how to price their products and what will attract their consumers.
However, if the products being sold in the monopoly firm are a limited product, then the customers will be willing to pay whatever price the firm is offering because they know that they will not be able to find the product somewhere else. Friedland (1978) estimated that the size of the welfare gains was dependent on the xtent of the product substitutability between the monopoly and competitive firms. The greater the substitutability, the greater the welfare gains and the less the difference between partial and general equilibrium estimates. iii There is no definitive answer as to whether the government should step in and break up monopolies to create a competitive industry, but it often depends on the impacts of the monopoly and whether consumers are willing to purchase the goods at the price offered. If they are not, the firm is likely to decrease their prices or go into liquidation. Monopolies can be bad for the economy because they concentrate economic power in a single entity that can encourage the prices of most products to be manipulated, which removes competitively low pricing.
Consumers who have relatively low income will have low standard of living and if there is no competition, inflation increases and prices rise dramatically. In order to benefit the consumer and society in terms of pricing it can be seen to be hugely beneficial to break up a monopoly; however, in terms of price discrimination and technological advances, a monopoly is likely to provide the most innovative products.