Throughout market and how it leads to market

                                                        

 

Throughout this essay I will be discussing the power that a
monopoly has over a market and how it leads to market failure. Firstly a
monopoly is formed when one firm has by far a dominant presence in a market
over firms within that market. This is usually due to factors that give it a
competitive edge over its competitors. Such as being first entrant into a new
market, this would allow a firm to gain an early advantage. However
realistically this is not very often the case in markets with a low barrier for
entry as it is relatively easy to copy a successful product or create a
substitute. Another factor which can cause monopolies to occur is
differentiation and innovation of a product or service. In addition it is
easier to maintain this type of monopoly due to potential legal protection of
products/services through patents. This is prevalent in the Pharmaceutical
industry in the United States, typically millions of dollars of investment is
injected into product research until a safe and effective drug is developed.
Then the developed drug is usually protected by a legal patent before being
made available for sale. This is because a lack of legal protection on a product
leaves the market open for competitors to release cheaper alternative drugs
into circulation. Therefore forcing the prices of the initial firm downwards.
Which makes the initial firm make a loss due to the high research and
development costs. Another factor that can lead to the formation of a monopoly
is the prime user of slim resources 1’such
as British Telecom who owns the telephone cabling running into the majority of
UK homes and businesses.’ A further factor that can lead to the formation
of monopolies is the result of government-granted monopolies. These are mostly
found in public services such as The Post office, National Rail and The
National Grid. However state monopolies are often criticised. Former Prime
Minister David Cameron believed that 2’A
“complete change” was needed to boost standards and end the “state’s monopoly” over
public services. An issue with government-granted monopolies is that it does
not allow fair competition in services that are perceived to be public. However
it does allow the firms to charge much cheaper prices than competitors due to
the Government backing as seen in the NHS, Post Office and BT. Which makes
these basic services more affordable for the consumers however reduces the
economic rent due to the expectation of wide availability of the various
resources.

Monopoly power can firstly lead to market failure as it
tightens the demand curves makes them rigid. This means that the goods sold
will see a change in their price elasticity and will become an inelastic good.
This means that a change in price will not have a significant change in the
demand for the good/service. If a good/service is perfectly inelastic it would
be a straight line vertically showing that a change in price has zero effect on
demand. This has a negative effect on the market as consumers would likely pay
much more for the service than it is worth due to their lack of bargaining
power. This would create a static market until substitute products come along
to compete with the monopolist. This would then increase the price elasticity
of the market, therefore encouraging healthy competition between firms.
Secondly a monopoly can lead to market failure through restricting supply of
goods into a market. This occurs if a monopoly is ordering stock or materials
from a supplier. For example If Supplier A only sells its cloth to Firm A
(which is a monopoly) then Firm A can use their purchasing power to force the
supplier to lower their prices, this can also be known as bullying suppliers.
This is achievable because Firm A is Supplier A’s largest customer, and if they
do not meet the demand of Firm A then Firm A can do one of two things. Either
force down the prices of their supplier or move along to a competitor such as
Supplier B who would sell them cloth at a cheaper price. However issues that
can arise from this is firstly the closure of suppliers, which then reduces the
competition in markets further back in the supply chain. A third way in which a
monopoly can lead to market failure is through causing a deadweight loss to the
wider economy. This occurs when there is a disequilibrium in the supply and
demand for a product/service and a loss of efficiency in the market. This is
displayed as a triangle on a supply and demand graph which is also known as
Herzberger’s triangle. This leads to a loss of total welfare as well as the
social surplus meaning that it leads to a more dissatisfactory outcome for both
the producer and consumer. This deadweight can also be the result of monopoly
style pricing by introducing a minimum and maximum of a product/service. This
is because it inhibits the market from naturally adjusting to changes in the
equilibrium price. If a price ceiling is issued on a certain product then it
may not be worth it for a firm to produce at a lower price. Therefore they
would naturally produce a lower quantity as seen in the diagram.

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The shaded area underneath the price ceiling is also known
as a supply shortage which means that producers won’t produce as much product
at such a low price, while simultaneously consumers demand more product due to
the lower cost.

How can the
government intervene to address the market failure?

A first way in which the Government can intervene in market
failure is through taxes and subsidies. Subsidising the manufacturing process
means that a firm would have lower production costs, which allows the firm to
charge cheaper prices without affecting their profit margins. This is effective
at preventing market failure if the current price is above equilibrium price
for example newly developed pharmaceuticals. However, a potential issue with
the government subsidising a monopoly is that funding a firms supply puts
others at a disadvantage which would increase the gulf in technology, market
share therefore reducing chance of a competitive market. However, if the
Government subsidises smaller firms trying to operate in the same market as a
monopoly it may lead to an increase in healthy within the market.

A second way in which the government can address the market
failures of a monopoly is by introducing either a maximum or minimum price of a
product/service. A minimum price (price floor) can be seen by the government
when labour regulations such as minimum wage are implemented firstly for the
welfare of the employees and their quality of life and secondly so that the
labour is level with the equilibrium rate of the economy. This is so monopolies
do not pay their employees unliveable wages so that they can cut their costs
and undercut their competitors. Price ceilings/maximum prices work in a similar
way but in the opposite way. Governments can introduce price caps to prevent
pricing that eliminates the chance of competition by creating high entry
requirements in a market. This also prevents a firm from achieving excessively
lucrative profits by maximising the producer surplus.

 

A further way in which the Government can intervene to
prevent market failure is through potential commodity stabilisation schemes
(3)”which aim to reduce the risks facing producers, leading to higher level
of production and investment.” (Stiglitz 1989) Commodities can be
stabilised through potentially putting subsidies on export so that commodities
can be sold at artificial prices. If there is a stability in prices there will
be a stability in investment.

 

Monopolies are one of the factors that cause market failure
in any given free market. Whilst monopolies cause those problems in theory,
they are much rarer in practice. This is because as soon as a firm is obtaining
abnormally high levels of profit in a competitive market over a sustained period
would most likely lead to government intervention by either regulating the
monopoly or aiding the firms who are in competition with them. Hence monopolies
in a free market are a rarity and if they did exist within the market would not
last long unless they were backed by the regulators of the market.

 

 

References

 

{1} Economics Online,
Monopoly Power, Formation of monopolies, Viewed 4th January 2018 http://www.economicsonline.co.uk/Market_failures/Monopoly_power.html

{2} BB,C News
Politics, David Cameron: End state monopoly over public services, 21/02/2011,
Viewed 4th January 2018, http://www.bbc.co.uk/news/uk-politics-12520491

{3} Markets, Market
Failure, and Development, Joseph E. Stiglitz, The American Economic Review Vol.
79 No. 2, May 1989

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