Why Is Monopolies Harmful and How Can Regulation Ameliorate These Harmful

Effects?

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Why is monopoly "harmful? How can regulation ameliorate these harmful effects?

What problems confront the regulators?

In order to deduce that a monopoly is "harmful', there must be another market

system which is preferable to monopoly so as to offer greater benefits to the

public. A monopoly can therefore be compared to perfect competition. If the

benefits of perfect competition outweigh the benefits of monopoly then a

monopoly can be regarded as "harmful' since the consumers are not receiving the

maximum possible utility for their purchases.

Monopolies are criticised for their high prices, high profits and insensitivity

to the public. Some governments therefore, in the light of these protests,

advocate policies relating to monopolies, in order to regulate their power in

favour of the public's interest.

There are several reasons why monopolies may be against the public interest. It

is claimed that monopolies produce at a lower level output and charge a higher

price than under perfect competition in both the short run and the long run.

Consider the diagram above. Assume that this monopolist attempts to maximise

profits. Equating MC=MR yields an output of Qm and a price of Pm. If the same

industry existed under perfect competition however, the price would be Ppc and

output would be Qpc since under perfect competition P=MC=AR. The price in such a

situation would thus be lower than under monopoly and output would be greater.

Consumers obviously benefit if this is the case since P=MC implies P=Marginal

utility so that consumers are maximising their total utility(Under monopoly P>MC

and therefore arguably, not the optimum).

In the long run under monopoly, supernormal profits persist. Under perfect

competition complete freedom of entry leads to the elimination of these profits

and forces firms to produce at the bottom of the long run average cost curve.

Under monopoly however, there are barriers to entry so as to prevent new firms

from entering the industry and reducing the monopolist's profits to the normal

level. Higher prices and lower output thus continue to persist in the long run.

Due to lack of competition, it is argued, a monopolist has no incentive to

develop new techniques in order to survive. A monopolist can therefore make

supernormal profits without using the most efficient techniques. Under perfect

competition, in order for firms to survive, the most efficient techniques must

be adopted or developed whenever possible or else the firm which fails to do so

will be forced to shutdown. This argument leads to the conclusion that

monopolies have higher cost curves than firms under perfect competition(Assuming

that the monopolist does not use supernormal profits to finance research and

development and hence reduce costs. ).

Even if a monopolist does invest in research and development, although prices

will fall and output will rise, extra supernormal profits received will merely

accumulate with old profits. These high profits lead to the question of

distribution of income. The answer to this question is a normative one and is

thus subject to much controversy. It is therefore up to the government to decide

if intervention is necessary to curb a monopolist's power and hence to uphold

the public interest.

If the government weighs up the cost and benefits of " monopoly' and concludes

that they are in fact "harmful', the government can adopt policies of

intervention or regulation.

The diagram below shows how a government can keep the price at a maximum Pm

below market equilibrium.

The government may feel that a price of op1 is excessive so a price of opm is

implemented. At this price however, the monopolist is only willing to supply oq1

units while quantity demanded is oq3 units. There is thus an excess in demand(Or

shortage in supply) of oq3-oq2 units. In such a case the price should rise but

it can't because of the price maximum. The monopolist would thus have to sell

its output on a "first come, first served' basis, or some sort of rationing

system will have to be organised for those who desire the good and can afford

to pay for it.

Alternatively a government can adopt an RPI-X formula(As in the UK with

privatised industries), which provides an incentive for monopolies to be as

efficient as possible. If the monopolist reduces its costs below X the

monopolist can still make large profits. If the monopolist does not succeed in

doing so a loss is inevitable. Monopolies are thus forced to cut costs if

profits are to be attained.

There are however various problems with regulation. Since the government gives

the regulator power to implement decisions. Who is to say that the regulator's

perception of the public interest coincides with the government's?(Since the

government acts in the public interest, or is supposed to anyway.) Moreover,

regulation is very complex and difficult especially with large powerful firms

which exert political influence. There is thus a danger of regulatory capture.

This is where the regulator is persuaded to operate in the monopolists' interest

rather than in the public interest. Regulatory capture may be due to corruption

or due to regulators actually believing the managers point of view.