Question

Question 2 [25 Marks]

As the lead advisor to the parliamentary economic planning cluster, write a technical brief advising policymakers on four approaches that the government can adopt in response to inefficiencies caused by monopolies within an economy. Discuss the potential problems associated with each policy response. Note: Your answer must be supported by using relevant examples from an economy of your choice and a brief explanation of the nature of the sector in which the monopoly operates.

Answer 1

By definition, Monopoly means a single seller for a product. This actually applies for a pure monopoly like Indian railways. In the real world, we find a dominant monopoly which has 40 percent of market share. Monopoly may abuse its market power by selling fewer quality products at a high price. As there are no substitute products and if the product has inelastic demand, then people still buy. In order to control the monopoly government should adopt some changes in the policy.

1. Deregulation: When there are more legal barriers to entry and exit, very few firms will be in the market. But if the rules and regulations are decreased, it will be easy for many people to start their firm where monopoly is there now. In India, there was only one telecommunication network- BSNL. But once the government opens its sector, there are more telecommunication networks and because of competition, consumers are able to get quality service at the lowest possible price. But there may be a chance of wasteful competition that leads to wastage of resources. There may be a chance of surplus of products in the economy.

2. Subsidies: When people are not having enough money to start a business against an established monopoly, if the government provides them subsidies, then they will be able to start and compete with the monopoly firm. As the cost of production decreases for them, they may be able to sell products at less price. But these small firms may rely on subsidies given by the government. They may not improve and compete with the monopoly firm.

3. The decrease in corporate tax: if the government decreases tax on profit, the monopoly firm will have more retained profit. This will attract new firms to emerge as the tax is low. This will increase competition and increases efficiency in the market. But there may be a chance that monopoly firm gets more benefit than other firms. It may expand and increase its market power. It may abuse market power much more.

4. Competition policy: Government can create more policies which will encourage new firms to enter the market. It can put restrictions on a merger or take over. So no new firms will be able to become a monopoly. But it may not work for already merged firms. The government can decrease environmental read policies. So small firms will be able to exploit resources and make more products. But this will create pollution and negative externality will be more. The third party who is not involved in consumption and production will get affected.

Thus these are the four approaches that the government can use to respond to the inefficiencies of the monopoly firm. A government needs monopoly firms so that it will be able to compete in international market. But when it is exploiting resources and consumers, the government should take actions to minimise their exploitation.