lOMoARcPSD|19852018
Regulation of monopoly-2
management with law (University of Technology Mauritius)
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lOMoARcPSD|19852018
Regulation of monopoly
The government may wish to regulate monopolies to protect the interests of consumers.
1. Regulation of quality of service
Regulators can examine the quality of the service provided by the monopoly
2. Merger policy
The government has a policy to investigate mergers which could create monopoly power.
If a new merger creates a firm with more than 25% of market share, it is automatically
referred to the Competition and Markets Authority (CMA). The CMA can decide to allow
or block the merger depending on whether it believes it is in the public interest.
3. Breaking up a monopoly
In certain cases, the government may decide a monopoly needs to be broken up because
the firm has become too powerful. Government can remove barriers to entry by removing
patent and allow competition. Government can subsidise production of other substitutes.
With deregulation that is breaking down of barriers to entry the government can increases
competition
4. Investigation of abuse of monopoly power
One effective method of checking and controlling monopoly is that the Government
should help in the formation of consumers associations.
The government can investigate the abuse of monopoly power. This may include unfair
trading practices such as:
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lOMoARcPSD|19852018
Text
Collusion (firms agree to set higher prices)
Predatory pricing (setting low prices to try and force rival firms out of business)
5
Institutional control whereby the government creates regulatory bodies to monitor
and control activities that might be judged against public interest. For example
The MMC (Monopoly and Merger Commission), Mauritius Standard Bureau, ICP
(Institute for consumer Protection)
6
Price ceilings(maximum Price)
Control over Prices:
Monopoly will always try to fix the highest possible price which it can obtain from the
customers, so as to earn minimum profit. The government can control the monopoly by
fixing the profits and the prices and ensure that the industry does not earn undue profit.
Suppose a price ceiling is imposed. How does this affect the monopolist's revenue
curves?
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lOMoARcPSD|19852018
Suppose the monopolist is not allowed to charge a price above P. Then the MR
curve becomes PMTSMR. Thus its marginal revenue has a discontinuity, as in the
following figure.
Cost/Revenue
AT THE NEW EQUILIBRIUM POINT ZM, OUTUT RISES TO QM.
MC (SS)
AC
P
T
PM
Z
ZM
S
AR =DD
Q QM
output
MR
The outcome of the regulation is thus that the price falls and output increases
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lOMoARcPSD|19852018
TUTORIAL QUESTION 118
118 A monopolist has a marginal revenue curve shown in the diagram by RTVX.(question 130)
What will be the monopolist’s new marginal revenue curve if the government
introduces a maximum price, OS?
A
RTVW
B
RUVX
C
STVX
D
SUVX
130 In the diagram, MC and AC are a profit-maximising monopolist’s marginal and
average cost curves, and MR and AR, its initial marginal and average revenue curves.(Q118)
Which distance will measure excess demand if the government sets a maximum price of P?
A
JK
B
KL
C
KM
D
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LM
lOMoARcPSD|19852018
8
Regulations through Taxation:
I.
Imposition of tax:
The Govt. can regulate monopoly through taxation. Govt. can levy a tax per unit of output
(Specific Tax) or impose a lump sum tax irrespective to its output.
Imposition of a Specific Tax: (increase marginal cost and increase Average total cost)
Specific taxes are commodity taxes like excise duty and sales tax. Excise duty are levied
on production while sale tax on sales.
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lOMoARcPSD|19852018
COST/REVENUE
MC1
AC1
A1
P1
MC
A
P
B1
AC
E1
B
AR
E
Q1
Q
OUTPUT
MR
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lOMoARcPSD|19852018
Point E = This is the equilibrium point before the tax is imposed. The firm produces OQ
units and sells at price OP. Firm cams profit of AB per unit.
AC1= After government levies a specific tax on the firm, the AC increases as shown by
higher AC curve AC1.
MC1= The new MC curve after specific tax is levied
Point E1 = After tax the firm is in equilibrium at point “E1 where MR = MC1. The firm sells
OQ1 units at price OP1. The profits earned are A1B1 per unit.
Evaluation of indirect tax
The effects of a specific tax are stated below:
1. Output sold reduces.
2. Price charged increases; consumers have to share the burden of the specific tax.
3. Profit reduces.
4. To what extent, the monopolist will shift the burden of a per unit tax to the consumer.
It depends on the elasticity of his supply and demand for his product.
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lOMoARcPSD|19852018
II.
Imposition of Lump Sum Tax :( Increase average cost, Marginal cost unchanged)
Sometimes, the government levies a lump sum tax on monopolists. A tax such as a profit
tax or license fee are imposed on a firm regardless of its level of output. It is treated as a
fixed cost and hence, docs not enter the monopolist’s MC.
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lOMoARcPSD|19852018
COST/REVENUE
MC
A
AC1
P
AC
B1
B
AR
E
Q
OUTPUT
MR
Where:
Point E = It is the equilibrium point where MR = MC before lump sum tax is levied. The
firm sells OQ units at price OP. Profits are earned which are AB per unit.
AC1 = since the lump sum tax is levied on the firm irrespective of its output, its AC curve
will shift upwards by the amount of the tax. AC is the new AC curve and MC curve remains
the same.
Point E = The equilibrium point, after tax is levied, is the same i.e., point E. There is no
difference in equilibrium price and output. But the profit has fallen from AB per unit to AB1
per unit. The effects of lump sum tax are;
(i) Output sold remains unchanged
(ii) Price remains unchanged
(iii) Profit reduces
(iv) Incidence of a lump sum tax is completely on the sellers and the buyers will escape
from the burden.
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lOMoARcPSD|19852018
6. Nationalisation:
The last resort of the Government is that it should nationalise the business, in which
monopoly exists and which the society is not willing to tolerate.
Social monopoly
A social monopoly is created by the government and operates public sector. For
example, CEB, CWA, ARMY.
The aim of the social monopoly is maximize social welfare and will achieve equilibrium at
the point where Price = MC, that is the social monopolist adopts marginal cost pricing.
With Price = MC, there will be an improvement in efficiency.
Comparing a private monopoly with a social monopoly
Cost/revenue
AC
MC
Ppm
N
Z2
Psm
Z1
+
0
-
Mc=MR<AR=
price > AC
1. AR>AC:SNP:NB
2.P>MC:
Absence of
3. AC>MC:
allocative
Abs of
efficiency
productive
efficiency
AR (DD)
Qpm
Qsm
MR
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D.W.L
ZNZ2
output
lOMoARcPSD|19852018
Aim
Equilibrium
Equilibrium point
price
output
Dead weight loss
Private monopoly
Maximize profit
MC = MR
Z1
Ppm
Qpm
Z1NZ2
Social monopoly
Maximize social welfare
P = MC (marginal cost pricing)
Z2
Psm
Qsm
0
As compared to a private monopolist, the social monopolist charges a lower price, for a
higher output. Under a social monopoly, since p = mc, there is allocative efficiency, as
consumers are getting the good at the socially most desirable price.
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