Monopoly Power and Market FailureA Monopoly is a market in which there is only one seller.Also a natural monopoly is when the monopolies solo position is due to theexclusive position of a necessary output or economies of scale that make itimpossible for a new entrant to be profitable once an incumbent firm isestablished as described by Black, J, Hashimzade, N and Myles, G (2012). Marketfailure describes an economic situation where in market the quantity of aproduct demanded by consumers does not match the quantity supplied by suppliersthis is result of a lack of economically ideal factors such as a lack of supplywhich prevents an equilibrium in the market.
This essay will be describing howa monopoly market is a form of market failure as well the welfare loss that canresult from it in the first section. As well as further on describing how thesaid welfare loss can be countered by government intervention.Amonopoly market is an example of market failure due to the monopoly firmdominating the market which enables it to charge prices much higher thanaverage cost and make a super normal profit. The ability of the firm to do somay be due to high barriers to entry such as large economies of scale such asin the automotive business or due to statutory reasons where it is impossiblelegally for firms to enter the market such as buses where a firm has won therights to an area such as First buses in northern Manchester which results in awelfare loss. As shown on the diagram to the left which illustrates a monopolymarket and how it results in a welfare loss. The diagram shows a demand/average revenue curve which exceeds the average cost curve which results in asupernormal profit highlighted on the graph. this is a reduction in welfare asthe it is a transfer to the producer in the form of profits. However some isnot reassigned and is known as a deadweight welfare loss or the social cost ofmonopoly this is shown on the diagram above.
An example of what can be considered an monopoly is a carcompany which provides the only form of that particular car available anexample of this may be Ferrari selling cars which are so differentiated thatthey can sell cars for well above the marginal cost which means that the firmis earning monopoly rents as it is the only firm selling that particular profitso it can set its own price. (Core Project, 2017)A firm that has no competitors or few firms selling substitutesthat can rival the brand products that the firm puts out such as Ferrari willhave a low elasticity of demand due to the car being highly differentiated. Alsoa firm such as Ferrari would be said to have high market power as it has strongenough bargaining power with its customers to be able to set a high price wellabove the cost of producing the product and be able to sell it without loosingcustomers. Also another example of a monopoly firm using its power tocontrol price due to the lack of a threat of new firms entering the marketwhich usually results in price being driven down are able to extract a pricefrom the consumer well above the cost of the resources required to produce thegood or service. An example of this is Microsoft selling windows 10 operatingsystem which due to them developing in they are the sole firm able to sell thesystem which enable them to set a price to sell the product much higher thanthe cost to produce each operating system which may well be nil due to it beinga software which is possible to download as shown on the diagram Microsoft isable to harvest massive super natural profits which is great for the firm.
However, it may well be that this may result in a deadweight loss or welfareloss as the monopolist may begin to forgo transactions with the consumer incomparison to a firm in competitive market which results in the market beingless efficient than a competitive market.However, a monopoly market does have some advantages over acompletive market as firms which have large super normal profits are able toinvest in research development which can make the cost fall i.e.
thorough theuse of new cheaper materials or production techniques. The lower costs can thenbe pushed onto the consumer through lower pricing which is advantageous to allas it can result in higher sales and more profits which can result in evenlower priced better products. The merits of this are limited in reality as itis up to the monopolist how they choose to use the large super normal profitsas they can be used as dividends for shareholders. (Nutter 2016)Monopoly markets cause issues for governments due to thedeadweight loss they result in therefore Governments take action against themin many ways one of the is through competition policy. Competition policy iswhen regulation is applied to sectors in which the structure is such that one wouldnot expect competitive forces to operate without problems.
(Motta, 2004) When afirm has high market power then policy makers become concerned and take actionagainst them in the form of competition policy such as in the case of amonopoly. An example of this is in Iceland were two firm’s Volvo and Scaniadominate the heavy trucks market. The government intervened through the use of completionpolicy and intervened to stop the two firms merging which would have created amonopoly as they would have had over 90% percent after the merger. the mergedfirm would have been as almost monopoly but would have dominated the Nordic countryin the same fashion of one as it could have raised prices knowing that any retaliatoryaction from other competitors would have little effect on them as they have noreal competitor. (Core Project, 2017) Also in the past monopolies have ben forced to break up anexample of this is in the early 1900’s when the US president John D. Rockefellersused the Sherman Antitrust Act passed in 1890 to break up Standard Oil companywhich he felt was abusing its economic strength. This Act help to break largemonopolies into smaller firms who would compete against each other to reducethe negative impacts of monopolies such as high prices which are to the disadvantageof the consumer.
Also acts such as the Clayton Antitrust Act passed in 1914 outlawedfirms making agreements with distributors to only sell to dealers who do notstock a rival firms product this helped reduce the risk of monopoly asconsumers have more choice when buying products.