Question

Case Monopoly power and competition policy We have seen that a monopoly creates a social loss compared to a perfectly competitive market. If it is possible to increase the level of competition in a monopolized market, then society is better off since social surplus increases. Competition policy (also known as antitrust policy) deals with markets where competition can arise; however, given the behaviour of some firms in those markets, competition is restricted. There are markets in which increasing the level of competition is not feasible, so competition policy does not apply. This is the case of a natural monopoly, which will be discussed at the end of this chapter. Broadly speaking, competition policy can be divided into policies to deal with monopoly power that already exists, and policies to deal with mergers that may increase monopoly power. While mergers will be discussed in the next chapter, here we discuss policies to address existing monopoly power. Since the UK belongs to the European Union, EU competition law takes precedence where it is relevant, essentially in the case of larger businesses with significant European or global activities. The original Common Market was created by the 1956 Treaty of Rome. The modern and enlarged EU is largely underpinned by the 1999 Treaty of Amsterdam. Article 81 of this treaty prohibits anti-competitive agreements (called cartels) that have an appreciable effect on trade between EU member states and which prevent or distort competition within the EU. Article 82 prohibits the abuse of any existing dominant position. A firm has a dominant position in a given market if it has a large market share in that market. For example, Microsoft has a dominant position in the market for operating systems (OS) for PCs, with a market share of around 90 per cent. Article 82 prohibits the abuse of a dominant position not the dominant position itself. A firm can become a dominant firm simply because it is more productive than the others and this is fine for competition policy. What is not fi ne is a firm that uses its dominant position to restrict competition in the market. Responsibility for enforcement of these articles lies with the European Commission. Although global businesses are increasingly subject to transnational competition law, many businesses still operate primarily within one country; national decisions are then appropriate. Within the UK, these are governed by the Competition Act 1998 and the Enterprise Act 2002. The latter made it a criminal offence, punishable by a jail sentence, to engage in a dishonest cartel. Two key institutions addressing UK competition policy are the Office of Fair Trading (OFT) and the Competition Commission. In particular, the OFT has the power to refer cases in which existing monopoly power may be leading to a ‘substantial lessening of competition’ to the Competition Commission for detailed investigation. Prior to the Enterprise Act 2002, the Competition Commission was asked instead to evaluate whether or not a monopoly was acting ‘in the public interest’, without any presumption that monopoly was bad, and many previous judgements of the Commission concluded that companies were acting in the public interest, for example because they had an excellent record of innovation, despite having a monopoly position.

Questions on case study:

1. Explain the ways in which a monopolist can abuse its power when compared to a perfect competitor.

2. In light of your answer to question 1, explain why it is important for monopolists to be regulated to protect the interests of consumers, as done by the OFT and the Competition Commission.

3. Discuss how monopolists can be beneficial to the economy and consumers.

Answer 1

1. Monopolist can abuse thier powers as compared to a competitive seller-

• The monopolist can charge way higher prices than a competitive seller would and earn super normal profits. This can occur in a market where the monopolist has established his dominance and is the sole producer of a good.
• The next problem is predatory pricing. If the monopolist senses any new competition in the market he can sell his goods at a price below the average cost and drive out any competition.
• Price discrimination- A monopolist can sell at different prices in different markets based on the location of the market and the availability of alternatives in the market. Thus reducing consumer surpluses in those markets.
• Monopolies can restrict product improvement and technological upgradation. Since they are the only ones selling a product, they might keep selling products made with obsolete technology or a product of inferior quality and still charge a high price.
• Vertical Restraints- A monopoly can impose restrictions on retailers and supplier based on their personal decisions. The restriction can be a price or quantity restriction. Sometime restrictions are just based on personal preferences. E.g- selective and exclusive distribution.
• Monopsony Power- At times monopolist also posess monopsony power. On account of this they can pay lower wages to their workers.

2. The reasons why a monopoly must be regulated are-

• Prevent unfair pricing- High pricing or unfair pricing for low quality products can reduce consumer welfare in the form of reduced consumer surplus and dead wieght loss.
• Quality Products- Monopolies can sell poor quality products made with obsolete technology. They can do it in some selected markets where there is huge asymmetry about product and pricing information. Regulation is important to preserve consumer welfare.
• Improve Competiton- Monopolies often abuse their power by restricting competition by unfair pricing. Competition is essential for consumers as well. In the sense that competition invokes better quality products and fair pricing. This provides consumers with more alternatives.

3. A monopoly can abuse its power, no doubt. However a monopoly has the power to do better for everybody else. Some benefits of a monopoly are-

• Improved Research and Development- Monopolies earning super normal profits can involve in research and development through which they can create better quality products at lower costs in the long run. This will lower product prices for the consumer at the same time provide provide them with better products. The technological spillover from such monopolies can benefit other industries in the nation.
• Economies of Scale- As output increase they can reduce average costs in the long run. This will reduce prices for the consumers. This is more true for a Natural Monopoly.
• Monopolies are successfull firms- Monopoly indicates that a firm has been efficient and dynamic. This is what made the firm a monopoly in the first place. It can reflect the firm's innovation and quality. For e.g- Google and Apple.
• International Competitiveness- A firm may be a monopoly at the domestic level but not so at the international level. There it faces competition which can make the monopoly firm more efficient. Since domestic monopoly are competitive internationally, they bring in foriegn exchange for the economy in form of exports. This can also lead to world standard goods for the consumers domestically.