10196000

A
brief look at market failures via monopoly power: their welfare effects and how
governments can intervene

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I’ll be discussing monopoly power and how
it’s a form of market failure by identifying several negative effects including
the welfare losses that occur because of it. I will also be discussing a few
methods of how government intervention can reduce or eliminate monopoly power.

Market failure occurs when goods and services
are not used up efficiently within the market, meaning that quantity supply and
quantity demand are not equal, this doesn’t allow the market to be Pareto
efficient meaning that all parties within the market are maximising their
utility, one of the main causes of market failure is monopoly power, and as a
result of monopoly power one party (which is the producer or the firm) is
exploiting other parties (consumers) by several methods which we will discuss
later.

To better define monopoly power, it is the
by-product of extreme free market capitalism where there aren’t many rules and
regulations, this allows firms to expand to the point of creating a monopoly
and having the greater share of the market. It allows firms to have control
over the market with little to no competition. Firms can also control different
aspects of the market, like the price (price fixing) or the supply level within
it.

There are several reasons why monopoly power
is a form of market failure. The first is price fixing as a result of
monopolies firms can fix prices as they have control over the market, this
process is illegal and may result in the creation of cartels in order to
increase return and to increase their joint profit much as possible, (OPEC) is
considered a cartel as only a few countries are controlling the price of oil
within the market. Cartels are widely known in industries where an oligopoly is
present (where there are several firms that are controlling the market). Also
in 2010 it was uncovered that British Airways and Virgin Atlantic where
operating an illegal cartel and as a result passengers who book from their
airlines were charged higher prices.

Another reason that monopolies is a form of
market failure is that product innovation is greatly reduced as a result of
reduced competition, firms with the largest share are able to stop or increase
the difficulty for any new firms who are trying to enter the market this
reduces the level of research and development in a market as there are less
firms innovating, firms can sometimes use methods like backwards innovation
where the produce and sell products that are out dated in terms technological
advancement as it is much cheaper and can be sold in large quantities
generating large revenue levels, this can be dangerous in markets like
pharmaceuticals as research and development is reduced, a similar process
happens with the business Pfizer where the buy new market entries in order to
reduce competition. Another method that firms use that results in loss of
innovation are patents, although it is totally legal however many firms don’t
only patent their products, they patent new technologies. It is very visible in
pharmaceuticals where firms patent their products and drug research in order to
have market power and sell the drugs with higher prices, pharmaceuticals exploit
this idea by patenting drugs for diseases such as HIV and hepatitis C and thus greatly
increasing their prices meaning that not everyone will be able to afford it,
however in India firms don’t follow those patent laws and create the same drugs
but sell them with way cheaper prices.

The welfare effects of monopoly power

This is an example of a perfectly competitive
market where demand is equal of supply meaning that what producers make is sold
and that consumers wants are fully met this is called equilibrium and is known
as market clearing. And because it’s a competitive market there is a wide range
of products with a wide range of prices, so most customers are satisfied.

Fig: 1

 

 

In a pure monopoly market prices are
controlled by the controlling firms and as a result prices are increased this
results in a decrease in output as not all consumers are able to afford the product
or service or output can be controlled and reduced (creating artificial
scarcity) in order to increase prices, this reduces the consumer surplus and
increases the producer surplus, and the sum of both the net loss of consumer
surplus and the net loss of the producer surplus is the dead weight loss. As
discussed before this is not Pareto efficient, not all parties are maximising
their utility. As we can see form the graph quantity has shifted from Q1 to Q2
whereas prices shifted from B to A.

Deadweight
loss causes a decrease in total surplus, although it is beneficial for firms as
their surplus is increased however for consumers it’s quite the opposite.
Although this results in a decrease in sales however because it is a result of
increased prices total revenue is actually increased.

Government intervention to reduce monopoly
power

In order to reduce market failures via
monopoly power governments can use several methods one of which the prohibiting
of mergers. Many firms gain monopoly power by merging or buying of other firms
one example was the potential purchasing of T-Mobile by AT&T for $39 billion;
however the department of justice stopped this purchase from any further advancement.  Mergers and purchases like these pose great
threats to the industry they are in as a much larger firm is suddenly created
and can negatively affect the welfare of consumers and other firms within the
market.

Nationalization is another method where
governments can eliminate monopoly power in different industries, it’s where
the government buys the firm with monopoly power in order to free the industry
from monopoly and reduce welfare effects. There have been several successful publications
of nature monopolies, in 2008 and 2009 after the financial crisis some major UK
banks have been partly nationalised including The Royal Bank of Scotland and
Lloyds Banking Group.

There is another method where governments can
use although won’t reduce monopoly power, however will reduce its negative.
Governments might put up regulations and rules that firms have to obey, they
can set up regulations regarding the quality of the product or service, and if
firms follow those regulations properly then consumers won’t be exploited by
monopolies.

Governments can break up large monopolies
into smaller firms so the market consists of a small group of firms. Each firm
will operate separately and as a result there will be competition and
innovation, prices will fall to a competitive level and consumer surplus will
increase.

In conclusion with all the negative effects
that monopoly power creates and the welfare losses behind it, governments can
still control those monopolies to a degree. However even though governments can
intervene it doesn’t seem to be that successful as many monopolies still thrive
and control the industries they are in, this could be due to the fact that
governments might actually benefit from the fact that those monopolies are running.