Abuse of monopoly power

Imagine what it would be like if there was only one pastry shop in your home town, and no possibility of opening up a brand-new one due to the fact that of the reality that there are no buy rent. People who are looking to get their hands on newly baked bread would have no option but to go to the one bakery. We state that the baker is a monopolist; that is, he is the only baker in the market and is hence able to set the rate at whichever levels he desires.

Chances are that the price of bread is going to be considerably higher than if the baker needed to compete with others for customers.

The outcome, as this lesson deals with, is market failure as an outcome of the abuse of monopoly power.

MONOPOLY POWER AND MARKET FAILURE A monopoly exists when there is only one producer of a specific item. Other firms are avoided from contending with the monopolist since of the very high barriers to entry.

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Because of this, the monopolist is a rate setter - it can itself choose what cost to charge so long as it covers the cost of production.

It is typically argued that Microsoft has a monopoly on the operating system market, making customers pay a very high cost for Windows as they purchase a brand-new computer system. Another example originates from supermarkets, which might get a monopoly in a neighbourhood if planning consent to develop other shops is denied.

It can then sell the same items as it would sell before, however for a much higher rate. Thus, in such markets, the price and amount demanded of the item do not show a true equilibrium - abuse of monopoly power is a type of market failure arising from the ability to charge a higher rate than it otherwise would.

Additionally, the amount on the marketplace is restricted below what is socially optimal by the monopolist. This results in a welfare loss, as customer surplus is not maximised, which is represented by the grey triangle in the diagram listed below. Examiner Suggestion However, in cases where we have a negative externality (e. g. pollution) it would actually be good to have a monopolist that restricts the quantity-- the welfare loss would rather be a welfare gain in this case.

Government intervention is common in the case of monopolies, if they abuse of their power and damage consumers’ welfare. Possible responses include: ?Legislation – competition policies to ensure that markets are not dominated by one firm only, as the EU proceedings against Microsoft show. ?Regulation – for example, planning regulations could be relaxed to allow more shops to open in the same area where the supermarket operates. ?Nationalisation – this is the case of national monopolies where the state takes over a business and regulates prices in the social interest.

E. g. Following the financial crisis of 2008 banks, insurance companies and car manufacturers were nationalised in the USA and UK. ?Trade liberalisation – allowing foreign firms to compete in the national market contributes to breaking up monopolies that were formed due to the lack of internal competitors. What you should know ?

Monopolies act as single producers in a market and can set prices and quantity. ?Their power may be abused, damaging consumers’ welfare. ?Government intervention can limit abuse of power through legislation, regulation, nationalisation and trade liberalisation.