Problems with Markets: Monopolies

Introduction to Problems with Markets

• Markets need to function well to efficiently allocate resources, requiring prices and output to be capable of moving and a price to exist.
• When markets don't work properly, consumers often suffer, leading governments to intervene.

Monopolies

• A monopoly occurs when there is only one supplier of a good or service.
• Pharmaceutical companies with patents on uniquely effective drugs are an example of monopolies.
• They can charge high prices due to high demand, leading to 'super profits' and permanent excess demand.
• In a properly functioning market, more producers would enter to increase supply and reduce prices.
• Patients could benefit from the drug at lower prices which would be a more desirable allocation of resources.
• Monopolies or monopolistic behavior can arise as follows:
• A true monopoly where only one supplier exists, or can be created by taking over rivals.
• A natural monopoly which exists because there are extremely high fixed costs, such as electricity distribution.
• Restrictive trade practices like cartels and predatory pricing.
• Cartels involve several suppliers colluding to keep prices artificially high.
• Predatory pricing involves a rich supplier dropping the selling price to drive others from the market.
• Tied selling where goods have to be bought from one supplier.
• Market allocation involves agreements not to compete in some markets.
• Governments regulate these behaviors and markets, for example through the Competition and Markets Authority in the UK.
• The Competition and Markets Authority is responsible for:
• Investigating mergers which could restrict competition.
• Conducting market studies and investigations in markets where there may be competition and consumer problems.
• Investigating breaches of UK or EU prohibitions against anti-competitive agreements and abuses of dominant positions.
• Bringing criminal proceedings against individuals who commit the cartel offense.
• Enforcing consumer protection legislation to tackle practices and market conditions that make it difficult for consumers to exercise choice.
• Industries like telecoms, electricity, gas, and water are regulated by government agencies in the UK, such as Ofgem.
• Ofgem's principal objective is to protect the interests of electricity and gas consumers.

Public Goods

• A public good is a product or service that one individual can consume without reducing its supply to another individual, and from which no one is excluded.
• Examples include public roads, street lighting, defense and law enforcement.
• Public goods are:
• Non-rivalrous, meaning that one person's consumption does not affect another's; consumers are not rivals.
• Non-excludable: no consumer can be excluded from consumption, even if they have not contributed to its supply.
• Non-rejectable: even if you don't want a nuclear deterrent you might have one.
• Public goods are not supplied by markets because of the difficulty of charging inevitable consumers who might not actually want the product or service and who will benefit anyhow even with making a contribution.
• Public goods are therefore provided by the state and are financed by tax revenues.
• This is the 'freerider' problem.
• Governments must decide on the appropriate levels of tax and service.

Externalities

• An externality is the cost or benefit that affects a party who did not choose to incur that cost or benefit.
• For example:
• People living near airports bear the cost of noise and air pollution.
• Airlines do not bear the full consequences of air pollution.
• Car manufacturers do not bear any cost of the road infrastructure.
• Society at large benefits from university education as a more skilled workforce improves the economy.
• Externalities interfere with the ability of market forces to optimise the allocation and use of resources.
• If the cost of healthcare problems is not reflected in the costs of manufacturing and running cars then the cost of cars will be lower than should really be the case and demand will be higher.
• Governments attempt to correct for negative externalities by:
• Taxes and subsidies to correct economic unfairness, like taxing airports on noise production to soundproof neighboring houses.
• Regulation, like limiting decibel levels and restricting flying hours.
• Law suits where those negatively affected claim damages from those positively affected.
• Negotiation between the affected parties.
• If there are positive externalities, then producers might not be adequately rewarded for the side-benefits created, and consumers might not properly value what those benefits are.
• Take the example of a bee-keeper.
• The price of honey will determine the supply and demand of honey, bees will be performing the vital task of pollinating the crops of nearby farmers.
• That is a positive externality.
• More bees would mean more pollination and higher crop yields but the bee-keeper would not benefit and would not be encouraged to have more bees.
• Government intervention could help by subsidising the price of honey or by paying bee-keepers a grant to encourage them to increase their stock.
• The term 'merit goods' is applied to a commodity or service that is regarded by society or government as deserving public finance because otherwise they will be under-consumed, like flu vaccinations.
• If people had to pay for a vaccination then many would decide not to have one.
• If they are free then there will be greater uptake and at some point there will be major positive externalities when a big enough proportion of the population is vaccinated to achieve 'herd immunity' that should stop an epidemic.

Minimum and Maximum Prices

• From time to time governments experiment with setting minimum and maximum prices for products and services.
• Minimum prices help suppliers and maximum prices help consumers.

Minimum Prices

• Setting a minimum price per liter of milk so that farmers are more or less guaranteed goods profits.
• A minimum price for producers is also a minimum price for buyers and there is likely to be excess supply: lots of farmers will produce at the artificially high price, but many consumers will not want to buy at that high price.
• The consequences are therefore:
• Over-production
• Producers being attracted to a business where there is already surplus supply
• Waste of resources.
• Inefficiency on production.

Maximum Prices

• Setting a maximum price per liter of petrol due to concerns about high prices.
• The maximum price will increase demand, but will suppress production because profits for producers are held down.
• Furthermore, the development of new sources of energy for cars will be inhibited because the new technology has to compete with artificially suppressed prices.
• When there are maximum prices, demand will begin to exceed supply and there is no price mechanism to correct this.
• Demand and supply do have to be balances (simply a matter of physical quantities having to match) and this can only be achieved by:
• Rationing
• Queuing
• Providing vouchers to limit supply to quotas for each person
• These approaches then usually give rise to black markets for goods where some people will be willing to pay very high prices to get their hands on scarce goods.
• An example is seen with ticket touts for very popular shows or sports events.