MONOPOLY POWER AND ECONOMIC CONSERNTRATION

HOW POSSIBLE IT IS TO MEASURE MONOPOLY POWER – ECONOMIC CONCENTRATION

BY EDE KENECHUKWU KENNETH edekenechukwuk@gmail.com

Pure monopoly is a rare phenomenon in private industry in that a single firm producing a good with no close substitutes and therefore no competitors is seldom observed. More often than not, in the recent research, we find a dominant firm in an industry in which other perhaps smaller firms produce similar products. Measuring the extent of the monopoly power of the dominant firm in such cases is not easy. A number of alternative methods have been suggested and used but they are all subject to various criticisms.

1.   THE PRICE-COST RATIO: this measure is defined as the difference between price and marginal cost divided by price. Under long-run competitive equilibrium, price equals marginal cost, and so this measure would give a value of zero, indicating (correctly) an absence of monopoly power. Under monopoly, price is set above marginal cost and so the ratio would give a positive value. Accordingly, the greater the price-cost ratio, the greater the extent of monopoly power. In practice however, a number of difficulties arise.

Firstly, the monopolist may attain substantial economies of scale, thus reducing marginal cost. This may cause the price charged by the monopolist to fall below what would be charged in an equivalent competitive industry composed of smaller, less-efficient firms. This may distort the observed price-cost ratio.

Secondly, the monopolist may be earning such high profits that he is not motivated to find the cheapest method of production. This would suggest that his marginal costs are higher than they would be if he minimizes costs. Thus, the price-cost ratio would be smaller because of his inefficiency and so understate his monopoly power.

Thirdly, it is often the cases that information on marginal costs are unobtainable, so the ratio cannot be calculated.

 Lastly, the price-cost ratio does not measure the extent of the potential competition the monopolist might face if he raised his prices.

2.   CROSS-ELASTICITY OF DEMAND: This is defined as the percentage change in one firm’s output divided by the percentage change in another firm’s price. Under competitive conditions, cross-elasticity are high for one firm cannot increase its price without losing sales to its rivals. In a monopoly situation, cross-elasticities are low and a firm may raise its price without significant loss of sales. The lower cross-elasticities of demand, the higher the level of monopoly power. The main criticism of this measure results from its attempted use in imperfect markets, such as oligopoly. Here firms realize that competitors may respond to price changes by altering their own prices or advertizing to maintain market share. This may completely swamp the cross-elasticity effect.

3.   EXCESS PROFITS : It is claimed that the greater the monopoly power of a firm, the larger its excess profits will be. But, although it is true that a competitive firm in the long-run equilibrium earns no excess profits, it is not the case that excess profit indicate monopoly power or that a monopolist always earn excess profits.

Firstly, the monopoly may be operating in a high cost industry, where even he can only just cover costs.

Secondly, the monopolist may be operating inefficiently and so earn no profit. Also, excess profits may be the result of short-run shift in demand, or innovation by competitive firms, rather than monopoly power.

4.   N-FIRM CONCENTRATION RATIO: These are measure of the proportion of output (or employment, or some other variable indicating relative size) provided by the N largest firms in a particular industry.

This is a widely used method of estimating monopoly power. Under competitive conditions, a single firm’s output is negligible compared with the total so that for example if we consider 3-firm, there concentration ratio is close to zero. A pure monopoly would give a one firm concentration ratio of 100%. For a given number of firms, a high concentration ratio denotes a great extent of monopoly power. Again, this method has its disadvantages: (1) under conditions of imperfect competition and differentiated products it is often extremely difficult to draw a boundary where one industry ends and another begins. (2) Changes in the relative importance of the N largest firms may not be related to the extent of the monopoly power wielded by any one firm. (3) There may be some understatement of the extent of monopoly power exerted by a firm if it operated in several separate but related markets.

In conclusion, monopoly power can be controlled using the methods aforementioned above. There is no monopolist who can weigh up to 100% of concentration ratio.