Economics †monopoly Essay

A monopoly is an enterprise that is the only seller of a good or service. In the absence of government intervention, a monopoly is free to set any price it chooses and will usually set the price that yields the largest possible profit. Just being a monopoly need not make an enterprise more profitable than other enterprises that face competiton the market may be so small that it barely supports one enterprise. But if the monopoly is in fact more profitable than competitive enterprises, economists expect that other entrepreneurs will enter the business to capture some of the higher returns. If enough rivals enter, their competition will drive prices down and eliminate monopoly power. Why do economists object to monopoly? The purely â€Å"economic† argument against monopoly is very different from what noneconomists might expect. Successful monopolists charge prices above what they would be with competition so that customers pay more and the monopolists (and perhaps their employees) gain. It may seem strange, but economists see no reason to criticize monopolies simply because they transfer wealth from customers to monopoly producers. That is because economists have no way of knowing who is the more worthy of the two parties—the producer or the customer. Of course, people (including economists) may object to the wealth transfer on other grounds, including moral ones. But the transfer itself does not present an â€Å"economic† problem. Rather, the purely â€Å"economic† case against monopoly is that it reduces aggregate economic welfare (as opposed to simply making some people worse off and others better off by an equal amount). When the monopolist raises prices above the competitive level in order to reap his monopoly. Profits, customers buy less of the product, less is produced, and society as a whole is worse off. In short, monopoly reduces society’s income. The following is a simplified example. Consider the case of a monopolist who produces his product at a fixed cost (where â€Å"cost† includes a competitive rate of return on his) of $5 per unit. The cost is $5 no matter how many units the monopolist makes. The number of units he sells, however, depends on the price he charges. The number of units he sells at a given price depends on the â€Å"demand† schedule shown in Table 1. The monopolist is best off when he limits production to 200 units, which he sells for $7 each. He then earns monopoly profits (what economists call â€Å"economic rent†) of $2 per unit ($7 minus his $5 cost, which, again, includes a competitive rate of return on investment) times 200, or $400 a year. If he makes and sells 300 units at $6 each, he earns a monopoly profit of only $300 ($1 per unit times 300 units). If he makes and sells 420 units at $5 each, he earns no monopoly profit—just a fair return on the capital invested in the business. Thus, the monopolist is $400 richer because of his monopoly position at the $7 price. Table : 1 Price Qty. Demanded Monopoly Profit/Year 7 200 400 6 300 300 5 420 0 The main kind of monopoly that is both persistent and not caused by the government is what economists call a â€Å"natural† monopoly. A natural monopoly comes about due to economies of scale-that is, due to unit costs that fall as a firm’s production increases. When economies of scale are extensive relative to the size of the market, one firm can produce the industry’s whole output at a lower unit cost than two or more firms could. The reason is that multiple firms cannot fully exploit these economies of scale. Many economists believe that the distribution of electric power (but not the production of it) is an example of a natural monopoly. The economies of scale exist because another firm that entered would need to duplicate existing power lines, whereas if only one firm existed, this duplication would not be necessary. And one firm that serves everyone would have a lower cost per customer than two or more firms. Whether, and how, government should regulate monopoly is controversial among economists. Most favour regulation to prevent the natural monopoly from charging a monopoly price. Other economists want no regulation because they believe that even natural monopolies must face some competition (electric utilities must compete with home generation of wind power, for example, and industrial customers can sometimes produce their own power or buy it elsewhere), and they want the natural monopoly to have a strong incentive to cut costs. Besides regulating price, governments usually prevent competing firms from entering an industry that is thought to be a natural monopoly. A firm that wants to compete with the local utility, for example, cannot legally do so. Economists tend to oppose regulating entry. The reason is as follows: If the industry really is a natural monopoly, then preventing new competitors from entering is unnecessary because no competitor would want to enter anyway. If, on the other hand, the industry is not a natural monopoly, then preventing competition is undesirable.