What criteria should be applied in judging whether monopolies are acting in public interest? (25)

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What criteria should be applied in judging whether monopolies are acting in public interest? (25)

In judging whether monopolies are acting in public interests, we are essentially examining their relative merits and demerits to the society.  A monopoly is a single producer in the market that produces a unique product with no close substitutes.  The monopoly is so large that the firm is considered to be the industry in producing the good.  The monopoly also has high barriers to entry to potential competitors.  The barriers to entry can be natural barriers like the monopoly control of supply of inputs or the high initial setup costs or artificial, man-made barriers like copyright laws, market franchise etc.

Public interests refer to the general welfare of the society which consists of both the firms and the consumers.  The households and the producers make up the public and the welfare of these groups of people is usually termed as public interest.

Let us first consider how the monopoly acts against public interest of the society at large.  

The basic economic problem of scarce resources and unlimited human wants forces us to make choices and try to achieve an optimal allocation of resources (i.e. an utmost efficiency in the allocation of resources).  However, the monopolies often fail to achieve a efficiency in the allocation of resources.

Figure 1

Refer to figure 1. The monopoly faces a downward sloping demand curve since the firm is an industry and quantity demanded increases as prices falls.  The monopoly can either fix price and let market forces determine the equilibrium output, or fix the output and let market forces determine the price.  Very often, the profit-maximising monopoly will set the quantity to be sold at marginal revenue equals to marginal cost (MR=MC) at OQ1.  He will then charge a prince of OP1.  However this output level (OQ1) is not at the productive efficient output level (OQ2).  Productive efficiency is achieved when the production is at the lowest point of the average cost curve (OQ2). Any output less than OQ2 represent excess capacity as average costs can be reduced when output increases (to OQ2).  Any output more than the productive efficient output will mean that the production is at over capacity and the output should be reduced to OQ2 so as to reduce the average costs.  As illustrated, monopoly will be producing as excess capacity most of the time and this represent a waste to the society as costs are not minimised and resources are not efficiently allocated.  It is by fluke if the OQ1 output level correspond to the minimum point of the AC curve.

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From figure 1, we can also see that there is a loss of consumer surplus equivalent to the shaded area.  The monopoly restricts output to OQ1 and raises the price level to OP1 such that consumer surplus is reduced from ABC to P1BD.  The loss in consumer surplus is an undesirable consequence to the consumers as a result of monopolies' pricing decision.  The consumer will now have to pay more for smaller quantity consumed.  It is especially undesirable if the poor can now no longer afford to buy the good because of higher prices and this is definitely going against public interests ...

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