Failures in monopoly
Community welfare is given by the sum of the consumer surplus and producer surplus, shown as the shaded region in the diagram above, the area ABC. The area OCBQe represents the total cost of producing Qe units of output. Profits are given by TR - TC, so the area PeBC represents the profits of the firm.
Further to previous analysis of the loss of consumer surplus under a monopoly in comparison to perfect competition of PmBCPc. A deadweight loss or loss of community welfare is caused by overcharging the consumer and producing a lower output. This area is shown as BCD on the diagram and proved the welfare loss proves one of the market failures of a monopoly.
Qc is the socially optimum output as here community welfare is greatest. Monopolies fail further as they create equity issues as large firms make large supernormal profits, they create low customer choice as in a pure monopoly there is no substitute good and the firm can make inferior quality goods as there are no substitutes for a consumer to choose. To correct this market failure in a monopoly different economies have different policies. In the USA the market structure of a monopoly is illegal, which is very hard to enforce. In the UK the government aims to reform monopolies. Monopolies are left to produce but regulated and the government intervenes when it believes a firms actions to be against the public interest.
Taxes on high supernormal profits
This improves equity issues as the revenue received from taxes can be used to improve the equity by giving to poorer people. However the output is unchanged so efficiency remains poor. The firms also have lower profits to reinvest into research and development so fewer new products will be made and lower quality products may be made.
Subsidies
A subsidy causes an increase in community welfare and consumer surplus as it causes the marginal cost curve to shift outwards from MC1 to MC2. The shaded area represents the increase in consumer surplus and the vertical distance between the marginal cost curves the magnitude of the subsidy. However, the use of subsidies has a number of problems.
- There may be public objection, as the firm should improve efficiency itself instead of being subsidised.
- The firm is already making supernormal profits and so the use of government funds to subsidise with tax money will be unpopular. Taxes will either need to be raised or spending lowered elsewhere.
- The firm becomes dependent on the support of the government and do not improve efficiency themselves.
Price controls: Marginal cost pricing policy
This is where the government is a price setter and so the firm is no longer a complete price maker. Usually the government will impose a maximum price.
This means that the firm achieves allocative efficiency as P = MC. PmaxaD is the new demand curve of a regulated monopoly. This cures all the problems associated with a monopoly but is very hard to enforce accurately as it requires detailed information about the firms costs (MC and AR) and the demand curve of the consumer. It is impossible to obtain this information accurately so it is very hard to set an appropriate price. Many monopolies are multi-product firms and it is very hard for the firm to determine their own costs of producing a single extra unit of output, so for the government to obtain this information is even harder.
If price controls are implemented then the firm will have lower supernormal profits and so will have a negative effect on investment in research and development.
Price controls: Average cost pricing policy
P1, Q1 represents the unregulated monopoly. P2, Q2 represents the regulated monopoly. This pricing policy entirely removed supernormal profits as AR = ATC, and so TC = TR. This lack of supernormal profits is likely to completely halt investment into research and development and lower the rate of expansion of the firm. If the firm is labour intensive this is likely to result in unemployment. The firm will need to reconsider its investment plans.
However this pricing policy, like the marginal cost pricing policy is very hard to implement, as again a detailed knowledge of the firms cost structure and the consumer's demand curve is needed.
Nationalisation
Nationalisation is when firms are owned by the state and operate in the public sector. Privatisation is the opposite of this process. During the 1980s industries that had been nationalised after the Second World War were privatised and now operate as private firms.
Whilst some indutries like the provision of utilities such as water, electricity and telecommunication form natural monopolies whilst one company may operate the pipes and cables in an industry many companies can pay to use this network and sell water or electricity on it.
These notes are from a lesson on 15/9/2004.
Homework
Define the MES, the minimum efficient scale.
The minimum efficient scale is the lowest point on a firm's long run average total cost curve.
