Monopoly Profit - Government Intervention

Government Intervention

Anti-Trust (Competition) Laws were created to prevent powerful firms from using their economic power to artificially create the barriers to entry they need to protect their monopoly profits. This includes the use of predatory pricing toward smaller competitors. In the United States, Microsoft Corporation was initially convicted of breaking the Anti-Trust Laws and engaging in anti-competitive behavior in order to form one such barrier in United States v. Microsoft; after a successful appeal on technical grounds, Microsoft agreed to a settlement with the Department of Justice in which they were faced with stringent oversight procedures and explicit requirements designed to prevent this predatory behavior. Microsoft was successfully convicted of similar anti-competitive behavior in the European Economic Community's second highest court, the Luxembourg-based Court of First Instance, in 2007. If firms in an industry collude they can also limit production, thereby restricting supply to ensure the price of the product remains high enough to ensure all of the firms in the industry achieve an economic profit.

The diagram to the right depicts an industry that initially starts out with a single firm that enjoys a monopoly and the initial monopoly profit that comes with it. Later, a second firm enters into the industry, lowering its price to obtain customers that usually do not purchase the product at the high monopoly price. As the initial monopoly firm loses customers, it is forced to lower its price to retain profitability. In the competition for sales to customers, the firms lower their prices even further, which increases the consumer demand for the product, and thereby entices the firms to raise production and which then increases the industry's total production and sales. Finally, the price and production in the industry stabilizes into its "competitive equilibrium"; the price paid by the consumers are just high enough to cover the average economic cost of producing the product, and the available quantity of the product doubles from its initial sales (under the monopoly).

If a government feels it is impractical to have a competitive market, it will sometimes try to regulate the monopoly by controlling the price the monopoly charges for its product. The old AT&T (regulated) monopoly, which existed before the courts ordered its breakup and tried to force competition in the market, had to get government approval to raise its prices. The government examined the monopoly's costs, and determined whether or not the monopoly should be able raise its price and if the government felt that the cost did not justify a higher price, it rejected the monopoly's application for a higher price. Though a regulated monopoly will not have a monopoly profit that is high as it would be in an unregulated situation, it still can have an economic profit that is still well above a competitive firm has in a truly competitive market.

The government examines the marginal cost associated with raising the production level up to its presently desirable quantity, and allows the regulated monopoly to charge a price that is no greater than this marginal cost. Though the monopoly's profit is lower than it is in an unregulated Situation, it can still make a positive economic profit.