The reason for choosing this topic is to discuss the various tools and methods adopted by the government to address the economic situation created as a result of market failure from monopoly power. It will provide various ideas of economic concepts which are integral for knowing aspects of market failure, monopoly power etc. Various methods can be adopted by the government to control the market failure caused as a result of monopoly power (Cairns and Calfucura, 2012). This may include implementation of taxes on certain commodities, enforcement of laws and regulations, creating buffer stocks, providing subsidies to certain producers etc. The entire essay is divided into three main sections. The first part acts as introductory information where the topic is being discussed. The second section is the main body which will discuss various aspects of market failure and its types. Different approaches of the government will discuss critically and their advantages and disadvantages will be analysed (Rios et al., 2013). Five intervention strategies are being identified namely indirect taxes, use of price caps, and use of subsidies. The other strategies are use of legal intervention and use of information. The final section refers to the concluding statements wherein the important points will be analysed in brief.
When referring to pure monopoly it shows a single seller. The cases of pure monopoly are very less. However the aspect of monopoly power is more ambivalent and can be present even in case where there is presence of more than a single supplier. This is possible in the case of markets where only two firms have market power i.e. duopoly and where few firms hold market power i.e. oligopoly. Monopolies are created in case of different situations. It can be when a particular firm has total and exclusive control resources which are scarce (Twomey and Neuhoff, 2010). An example can be cited from UK. The sole business of telephone cables is owned by British Telecom and they are effective in most of the houses and businesses in UK. Monopoly is created when the government provides monopoly status to a single firm like the Post Office.
Monopoly is again created when firms are owners of patents and copyrights allowing them exclusive rights to sell the product and protecting the product as intellectual property. For example ‘Windows’ is a brand name of Microsoft. The contents of the software of this company are protected from users who are unauthorised. Monopoly power is also created when two companies merge to occupy a dominant position in the market. Monopoly power is maintained in many ways. If the company is able to reduce the cost of production and increase the scale of business and volume they will have advantage over new entrants to the market (Ariss, 2010). Often few companies reduce their prices to such an extent that it puts pressure on competing rivals. This is known as predatory pricing. Moreover heavy expenditure on advertising by existing firms hinders new firms from entering the market. This is because new firms lack the capital base for such expenses (Swinnen and Vandeplas, 2010). Again maintaining contracts between suppliers and retailers gives impetus to monopoly power.
It is important to understand how monopoly power leads to market failure. The problem with monopoly is that high profits are made resulting in poor effectiveness of allocation. Those firms having monopoly power try to derive a price from the consumers or buyers which is more than the cost of raw materials which are used for manufacturing the product (Dodgson et al., 2011). Due to the higher prices, the buying capacity of the consumers decline. This leads to needs and wants of the consumers not getting satisfied. This dissatisfaction is a result of the products not being consumed properly. Increase in prices reduces the consumer surplus and impacts the welfare of the consumers. Thus there is a negative impact on the households that have low incomes.
Market failure is when the markets are not competitive enough and causes dissatisfaction for the society. Market failure can be either complete or partial. A market fails completely when there is absolute absence of product supply (Gilmore et al., 2010). The market failure is partial when there is functioning of the market but suffers due to wrong quantity of production and wrong pricing. There are various factors leading to market failures. Due to environmental pollution the society has to bear the costs rather than the companies. These are known as negative externalities (Pitelis and Teece, 2010). Again if there the government provides health care and education, the society is benefited over the producers. This is known as the positive externalities. Again market fails when goods having social value are under produced while goods lacking social value are increasingly produced and consumed.
Often the private sectors in a free economy charge high prices in order to derive profits on pure and quasi public goods. This leads to dissatisfaction and needs not being met. Market dominance leads lack of supply and increased prices damaging welfare of the consumers (Stiglitz, 2010). Another reason of market failure is factor immobility which leads to unemployment and harm to efficiency in production. Often inequality in distribution of income and social exclusion lead to market failure.
It is true that market domination and monopoly power has a negative impact over consumers and results in lack of supply and market failure. However there are certain possible benefits of monopoly power. Monopoly power leads to economies of scale. Consumers will benefit in the long run since the average costs will be constant and eventually the prices will get lowered. Thus it is always beneficiary that public services are run by a single organisation so that there is a fixed pricing (Acemoglu and Robinson, 2013). However monopoly power always does not lead to economies of scale. Hence there is no certainty that the average prices will be lowered in the future leading to reduced prices. Monopoly power can also help in research and development. The supernormal profits can be utilised for investment in novel products and innovations which will eventually help the consumers in the future. This can be related with the oil and gas industry. Again domestic monopoly might face competition from the international markets which will force them to reduce costs leading to efficiency and economies of scale (Rubalcaba et al., 2010).
There are various methods by which government can put checks and measures on monopoly power and improve upon the situation of market failure. Some of them will be discussed below-
Use of indirect taxes- Indirect taxes refers to the tax which the government imposes on the producers to increase the cost of supply. This can be showed with the help of diagrams. The vertical distances between two supply curves refer to the amount of tax. Hence due to the presence of taxes the supply becomes less at every price level (Sakovics and Steiner, 2012). As a result of the lowering supply the market price increases leading to the demand fall. Thus a new equilibrium output is established. There are different kinds of indirect taxes. There may be a specified tax wherein it is directed that a certain amount of tax will be charged on a single unit of the product sold (Pirard, 2012). For example, the government may charge £6 as tax for one kg of sugar that is being sold. Another kind of indirect tax is ad valorem tax which refers to a percentage of tax charged on the unit price of a product. Suppose the price of one cigarette is £ 2, the government may charge 10% as ad valorem tax on the price.
The main form of ad valorem tax which is charged in UK is in the form of value added tax i.e. VAT. Currently value added tax contributes to a revenue of over 100 billion pounds to UK treasury and public funds every year (Salanie, 2011). The taxes levied on fuel provide more than 25 billion pounds of revenue every year. UK government generates almost 10 billion pounds form levying tax on tobacco products every year. Duties paid for flight passengers generates up to 3 billion pounds for the government every year.
Thus from the diagram it can be inferred that ad valorem taxes may cause significant shifts in the supply curve. This is due to tax being a percentage of the unit cost of supplying a product. In UK the standard rate of value added tax is 20%. Thus a product that will usually cost 50 pounds will cost 60 pounds after the value added tax is levied (Aaron and Boskin, 2011).
However the problem of indirect taxes is that the producers increase their prices by adding the tax rates and the ultimate bearer of the burden are the consumers.
Government subsidies- Subsidy refers to any kind of support by the government usually financial in nature. These are usually offered to a class of producers and at some times to the consumers.
For every unit of product receiving subsidy the market supply curve shifts outwards. This results in the equilibrium price becoming low. Hence the total expenditure on subsidy can be calculated as the subsidy provided for a single unit multiplied by production level. Thus subsidies can be used by the government for various reasons. The reasons can be social, political or economic (Ehrenberg and Smith, 2016). Subsidies help loss making industries in times of recession by protecting jobs. With the help of subsidies health care facilities and treatments become affordable and accessible. Subsidies encourage investment in small industries and this leads to increased output. The government provides subsidies to poor families in the form expenses for child care and food subsidies. With the help of subsidies the companies can lower the expenses for training and hiring employees (Brown et al., 2011).
Price caps- Maximum prices or price caps are used by the government to hinder the market prices from increasing at a certain level. Price caps or maximum prices are in several forms. The government can set a ceiling for house rents. This is for the protection of poor tenants from being manipulated and ill treated (Walras, 2013). The government also applies maximum prices on energy resources to reduce fuel bills. Water companies are also given direction to maintain a certain price on its supply. Money lenders also have to adhere to limits in terms of charging interest rates. Hence price caps ensure that there is healthy competition in the market. It is done for the welfare of the consumers. It also induces the businesses to reduce the costs to gain profits. However caps on prices reduce profits and discourages investors (Blair and Kaserman, 2014). The firms raise their prices leading to pressure on the ultimate consumer.
Government’s role in information sharing- Market failure often occurs if people consume products which have negative externalities i.e. increase social costs over private costs. Thus the government carries out campaigns informing people and they set minimum age for consumption.
Laws and regulation- The government controls monopoly with the help of anti monopoly laws like competition laws (Gual and Mas, 2011). These legislations try to remove unhealthy competition, prevent unfair discrimination of prices and they fix the prices to be competitive.
From the above discussion various economic concepts can be understood. The concept of monopoly power has been discussed with the help of diagrams. It is a misnomer that there are only demerits of monopoly power. Monopoly if used constructively by the companies can benefit the service users in the long run. Market failure can be attributed to various reasons. They can be tackled with the help of different government methods of intervention.
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Acemoglu, D., & Robinson, J. A. (2013). Economics versus politics: Pitfalls of policy advice. The Journal of Economic Perspectives, 27(2), 173-192.
Ariss, R. T. (2010). On the implications of market power in banking: Evidence from developing countries. Journal of banking & Finance, 34(4), 765-775.
Blair, R. D., & Kaserman, D. L. (2014). Law and economics of vertical integration and control. Academic Press.
Brown, A. J., Merkl, C., & Snower, D. J. (2011). Comparing the effectiveness of employment subsidies. Labour Economics, 18(2), 168-179.
Cairns, R. D., & Calfucura, E. (2012). OPEC: Market failure or power failure?. Energy Policy, 50, 570-580.
Dodgson, M., Hughes, A., Foster, J., & Metcalfe, S. (2011). Systems thinking, market failure, and the development of innovation policy: The case of Australia. Research Policy, 40(9), 1145-1156.
Ehrenberg, R. G., & Smith, R. S. (2016). Modern labor economics: Theory and public policy. Routledge.
Gilmore, A. B., Branston, J. R., & Sweanor, D. (2010). The case for OFSMOKE: how tobacco price regulation is needed to promote the health of markets, government revenue and the public. Tobacco Control, 19(5), 423-430.
Gual, J., & Mas, N. (2011). Industry characteristics and anti-competitive behavior: evidence from the European Commission’s decisions. Review of Industrial Organization, 39(3), 207-230.
Pirard, R. (2012). Market-based instruments for biodiversity and ecosystem services: A lexicon. Environmental Science & Policy, 19, 59-68.
Pitelis, C. N., & Teece, D. J. (2010). Cross-border market co-creation, dynamic capabilities and the entrepreneurial theory of the multinational enterprise. Industrial and Corporate Change, 19(4), 1247-1270.
Rios, M. C., McConnell, C. R., & Brue, S. L. (2013). Economics: Principles, problems, and policies. McGraw-Hill.
Rubalcaba, L., Gallego, J., & Hertog, P. D. (2010). The case of market and system failures in services innovation. The Service Industries Journal, 30(4), 549-566.
Sakovics, J., & Steiner, J. (2012). Who matters in coordination problems?. The American Economic Review, 102(7), 3439-3461.
Salanie, B. (2011). The economics of taxation. MIT press.
Stiglitz, J. E. (2010). Government failure vs. market failure: Principles of regulation. Government and markets: Toward a new theory of regulation, 13-51.
Swinnen, J. F., & Vandeplas, A. (2010). Market power and rents in global supply chains. Agricultural Economics, 41(s1), 109-120.
Twomey, P., & Neuhoff, K. (2010). Wind power and market power in competitive markets. Energy Policy, 38(7), 3198-3210.
Walras, L. (2013). Elements of pure economics. Routledge.
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