Economic analysis: To what extent should governments prevent firms from being monopolies?

Short run refers to the time period in which at least one factor of production is fixed. Long run refers to the period of time where all factors of production are variable. Natural Monopoly occurs when a monopoly can supply the entire market at a lower price than two or more smaller firms.

The most important aspect of ALOCA, an example of monopoly that produces aluminum is that cross efficiency is not achieved because unlike that of perfect competition where firms are under constant pressure to produce with the lowest possible costs to survive, in ALCOA the lack of competition makes the monopolist less concerned about keeping costs low. Thus, higher costs could arise because of inefficiency and complacency, which may cause the firm to suffer from cross efficiency. In producer’s perspective, they may enjoy this situation, as they can earn high profit due to increase in producer surplus. On the contrary, consumers may not enjoy this situation, as since the firm is producing at a higher than necessary ATC, they would have to pay a higher price for each aluminum.

Perhaps the biggest benefit of operating a firm under monopoly is that the firm is able to achieve social efficiency. For example, In January 9, 2014, the Chinese government increased the price of China National Tobacco Corporation’s tobacco to about 90%. At a first glance, this might not be preferable for the consumers who heavily rely on tobacco, as they would have to pay higher prices under limited quantity of output. However, by doing so social efficiency can be easily achieved as huge consumption of tobacco, a demerit good with negative externalities that affects the third party, namely second-hand smoker can be reduced. Higher price can discourage the consumers from purchasing more number of tobaccos, thus allowing a form of market failure to diminish.

While a monopoly can help achieve social efficiency when demerit goods are over-consumed, Chanel, an example of monopoly, in some respects may not help achieve dynamic efficiency. Unlike perfect competition, as Chanel has high barriers to entry it reduces contestability among firms, which results in a danger of Chanel to have no incentive on investing in improving the cosmetics because they become complacent, thus not being able to achieve dynamic efficiency.

In addition, a pharmaceutical industry such as Pfizer, an example of monopoly, is unable to achieve neither productive efficiency nor allocative efficiency, as the firm does not produce at the minimum of average variable cost (AVC). When Pfizer sets its price above the marginal cost, consumers are not willing to pay for a higher price than necessary for a lower quantity of medicine than they really want. By doing so, medicine, a merit good, which has positive externalities is under consumed, and becomes a form of market failure. This pricing then creates a deadweight loss because the firm forgoes the transactions with the consumers. As a result of the deadweight loss, the consumer surplus of Pfizer is less than that of obtained by consumers in perfect competition. When consumer sovereignty is not maximized, allocative and productive efficiency is not achieved.

One stakeholder in a monopoly is the consumer. Consumers may get negatively affected in some situations where the monopoly power is abused. For example, in 2004, Microsoft pressured Compaq to not market an Internet appliance and integrated certain technologies into Windows designed to exclude WordPerfect and other Novell applications from relevant markets. This prevented potential competitors from reaching consumers. Thus, the consumers had less variety of options and were not able to switch to substitute goods. However, in some respects, consumers may enjoy if the firm is running under natural monopoly. For example, in November 26, 2010 as OFWAT got bigger due to large economies of scale, the average cost continuously fell. Thus, OFWAT was able to pass on the price saving to consumers in the form of lower prices.

Another stakeholder is producer. For example,as Chinese government set a significantly high barriers to entry to China National Tobacco Corporation’s tobacco through different types of barriers to entry, namely through legislation, new firms were not able to enter the industry in the long run, thereby allowing the firm to earn supernormal profit in the short run and long run. Their supernormal profit can provide them with the ability to finance large research and development project, thereby achieving dynamic efficiency. However, in some instances, in 2012 when Tesco, a UK multinational grocery took an advantage of diseconomies of scale, the output rose while the price fell, thereby causing the firm to earn subnormal profit.

All in all, the government should be preventing firms from being monopolies depending on whether the firm is Malign monopoly or Benign monopoly. If the firm is running under Malign monopoly, the government should prevent it from operating any longer as Malign monopolies has no incentive to innovate and provide new and improved products, thus may not achieve dynamic efficiency. On the other hand, if the firm is operating under Benign monopoly, the government should continue to encourage the firm to operate, as it can take a huge advantage of economies of scale through bulk buying. This in return can help pass on the cost saving to consumers.