A monopoly may be referred to as a market scenario where only one producer has exclusive control over the supply of goods and services. In most countries, monopolies have control over a majority of the factors within the market, including natural resources. As a result of these excessive market manipulations, some consequences occur because of the existence of monopoly firms. Some of these consequences include price discrimination, the provision of low-quality and low-quantity goods, and, due to low competition, a lack of creativity and innovation in the monopoly’s production process (Berg et al. n.p). Hence, a policy regarding the regulation of monopolies must be enacted to protect customers, as well as infant industries within the local market.
Whenever we consider the economy, three factors come to mind: supply, demand, and price. Since a monopoly has the potential to increase prices indefinitely, this becomes its biggest disadvantage for consumers. Lack of industrial competitiveness makes the monopoly price the market price, and monopoly demand becomes market demand (Berg et al. n.p). As the only supplier, a monopoly may also decline to provide services to its customers. The regulation of monopolies is important for the following reasons:
Prevent Excess Price
Without government regulation, monopolies would take advantage of their position and set their prices above the equilibrium price. As a result, there would be a decline in customer welfare, and this would also lead to allocative inefficiency.
Quality Of Service
In a case where a manufacturer has monopoly power over the provision of a specific service, it may have fewer incentives to provide high-quality services. Through government regulations, standards are set, and monitoring the monopoly also ensures that these required standards of service are met.
Monopsony Power
Firms with monopoly power also have the opportunity to take advantage of monopsony buying power. To illustrate, a supermarket may use the prevailing market situation to squeeze the profit margins of farmers. Government regulation ensures that these big firms do not use monopsony buying power to take advantage of small farmers.
Promote Competition
For some industries, even if a monopoly exists, there is still a possible way to encourage competition through government support.
Natural Monopolies
Due to large economies of scale, some firms automatically become monopolies because the most efficient firm becomes the leader. However, in such cases, it becomes practically impossible to enhance competition, and therefore, it becomes essential to regulate the firm to avoid the misuse of monopoly power.
Furthermore, the growth and prevalence of monopolies may result in an economic crisis. The government would, therefore, undertake various activities to enact policies regulating monopolies. The government regulates monopolies in the following ways:
Price Capping By Regulators RPI-X
For privatized industries such as gas, water, and electricity, the government has developed various bodies that regulate these industries. These regulatory bodies include the Office of Rail Regulator (ORR), OFGEM for regulating the electricity and gas markets, and, finally, OFWAT, which focuses on the regulation of water industries. Their most basic function is to control increases in prices. One way they can achieve this is through the use of the RPI-X formula, where X represents the amount by which prices have to be reduced in real terms. So, if the inflation rate is three per cent and X is one per cent, then firms can only increase the actual price by two per cent, that is, (3% – 1% = 2%) (Mayo 210). If the regulators perceive that the firm can make efficiency savings and that it is charging its customers too much, the body can decide to increase the level of X to a higher margin. For instance, in the early years of telecom regulation, the level of X was extremely high because efficiency savings made large price cuts possible.
For the water industry, the regulation formula varies slightly and is RPI -/+K, where K is the investment amount that the water firm is required to implement. If a water company needs to invest in better water pipes, the institution will have to increase its prices to finance the investment. One of the advantages of regulation through RPI-X is that the regulator can set price increases based on potential efficiency savings and the state of the industry. Also, if the firm reduces the costs it incurs by more than X, it may be able to increase its profit margins. In other words, there is an excellent incentive for reducing costs. As a final point, where there is no competition, the regulatory measure of RPI-X may be used as a means of increasing competition (surrogate competition) (Spence 423).
Nonetheless, there are also some disadvantages of this method of regulation. First, it is difficult and, at times, costly to decide what level X should be. Second, there is the danger of regulatory capture. This happens when regulators become lenient toward firms and allow them to make supernormal profits through price increases (Rochet n.p). Third, most firms argue that these regulators are stringent and prevent them from making adequate profits required for investment. Finally, if a firm becomes more efficient, it may be punished by being assigned a high level of X. Thus, it cannot retain its efficiency gains.
Merger Policy
The government has a policy of investigating mergers that would generate monopoly power. In cases where a new alliance forms a firm that controls more than 25% of the market share, it is referred to the competition commission. This commission has the authority to block or allow the merger.
Breaking Up A Monopoly
In severe circumstances, the government may choose to dissolve a monopoly because the firm has become very powerful. This occurs in rare cases; for example, the American government attempted to break up Microsoft Corporation, but ultimately the action was abandoned.
Regulation Of Quality And Service
Regulators may also observe the quality of all services offered by each monopoly firm, such as when rail regulators examine the safety records of railway firms to ensure that the firms do not violate required standards. Likewise, in electricity and gas markets, regulators ensure that the concerns of elderly people are considered. For example, monopolies were restricted from cutting off gas supplies during the winter period.
One of the obstacles facing the policy of regulating monopolies is that some of these monopolies have grown to a great extent, and the government may find them difficult to control. Due to the large market share that most monopolies have, the government may shy away from interfering with these organizations. This is because the government may fear that if it interferes with the activities of some monopolies, the economy could suffer, thus leading to an economic crisis (Posner 815).
In conclusion, the regulation of monopolies is an important issue, and it needs to be addressed seriously. Monopolies, at times, tend to take advantage of customers because they know there is no close competition. Due to a lack of competitiveness, they may offer products of poor quality and services that are not up to the required standards. Through regulation, the government can restrict the operation of monopolies, and it can also ensure that these firms provide high-quality services and products.
Works Cited
Berg, Sanford V., and John Tschirhart. Natural monopoly regulation: principles and practice. New York: Cambridge University Press, 1988.
Mayo, John W. “Multiproduct monopoly, regulation, and firm costs.” Southern Economic Journal (1984): 208-218.
Posner, Richard A. “The social costs of monopoly and regulation.” Journal of Political Economy 83.4 (1975): 807-827.
Rochet, Jean-Charles. “Monopoly regulation with two dimensional uncertainty.” Journal of Mathematical Economics(1984).
Spence, A. Michael. “Monopoly, quality, and regulation.” The Bell Journal of Economics (1975): 417-429.
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