Question

What are two ways each that higher prices, Barriers to entry, and reduced competition are breaking the power of monopolies

Answer 1

A pure monopoly is defined as a single supplier. While there only a few cases of pure monopoly, monopoly ‘power’ is much more widespread, and can exist even when there is more than one supplier – such in markets with only two firms, called a duopoly, and a few firms, an oligopoly.

According to the 1998 Competition Act, abuse of dominant power means that a firm can 'behave independently of competitive pressures'.  See Competition Act.

For the purpose of controlling mergers, the UK regulators consider that if two firms combine to create a market share of 25% or more of a specific market, the merger may be ‘referred’ to the Competition Commission, and may be prohibited.

Formation of monopolies

Monopolies are formed under certain conditions, including:

When a firm has exclusive ownership or use of a scarce resource, such as British Telecom who owns the telephone cabling running into the majority of UK homes and businesses.When governments grant a firm monopoly status, such as the Post Office.When firms have patents or copyright giving them exclusive rights to sell a product or protect their intellectual property, such as Microsoft’s ‘Windows’ brand name and software contents are protected from unauthorised use.When firms merge to given them a dominant position in a market.Maintaining monopoly power - barriers to entry

Monopoly power can be maintained by barriers to entry, including:

Economies of large scale production

If the costs of production fall as the scale of the business increases and output is produced in greater volume, existing firms will be larger and have a cost advantage over potential entrants – this deters new entrants.

Predatory pricing

This involves dropping price very low in a ‘demonstration’ of power and to put pressure on existing or potential rivals.

Limit pricing

Limit pricing is a specific type of predatory pricing which involves a firm setting a price just below the average cost of new entrants – if new entrants match this price they will make a loss!

Perpetual ownership of a scarce resource

Firms which are early entrants into a market may ‘tie-up’ the existing scarce resources making it difficult for new entrants to exploit these resources. This is often the case with ‘natural’ monopolies, which own the infrastructure. For example, British Telecomowns the network of cables, which makes it difficult for new firms to enter the market.

High set-up costs

If the set-up costs are very high then it is harder for new entrants.

High ‘sunk’ costs

Sunk costs are those which cannot be recovered if the firm goes out of business, such as advertising costs – the greater the sunk costs the greater the barrier.

Advertising

Heavy expenditure on advertising by existing firms can deter entry as in order to compete effectively firms will have to try to match the spending of the incumbent firm.

Loyalty schemes and brand loyalty

If consumers are loyal to a brand, such as Sony, new entrants will find it difficult to win market share.

Exclusive contracts

For example, contracts between specific suppliers and retailers can exclude other retailers from entering the market.

Vertical integration

For example, if a brewer owns a chain of pubs then it is more difficult for new brewers to enter the market as there are fewer pubs to sell their beer to.

Evaluation of monopoly

Since Adam Smith the general view of monopolies is that they tend to act against the public’s interest, and generate more costs than benefits.

The costs of monopolyLess choice

Clearly, consumers have less choice if supply is controlled by a monopolist – for example, the Post Office used to be monopoly supplier of letter collection and delivery services across the UK and consumers had no alternative letter collection and delivery service.

High prices

Monopolies can exploit their position and charge high prices, because consumers have no alternative. This is especially problematic if the product is a basic necessity, like water.

Restricted output

Monopolists can also restrict output onto the market to exploit its dominant position over a period of time, or to drive up price.

Less consumer surplus

A rise in price or lower output would lead to a loss of consumer surplus. Consumer surplus is the extra net private benefit derived by consumers when the price they pay is less than what they would be prepared to pay. Over time monopolist can gain power over the consumer, which results in an erosion of consumer sovereignty.

Asymmetric information

There is asymmetric information – the monopolist may know more than the consumer and can exploit this knowledge to its own advantage.

Productive inefficiency

Monopolies may be productively inefficient because there are no direct competitors a monopolist has no incentive to reduce average costs to a minimum, with the result that they are likely to be productively inefficient.