Monopoly Regulation

Because monopolies lower the economic output of a society, and therefore, its wealth, governments regulate monopolies with the objective of benefiting societies more than would be the case if the monopolies maximized their profits. There are 3 major methods to increase the benefits of monopolies to society:

  1. removing or lowering barriers to entry through antitrust laws so that other firms can enter the market to compete;
  2. regulating the prices that the monopoly can charge;
  3. operating the monopoly as a public enterprise.

Antitrust Laws

The main purpose of antitrust laws is to prevent business practices that either create or maintain a monopoly. In the United States, the 2 major antitrust laws are the Sherman Antitrust Act, passed in 1890, and the Clayton Antitrust Act, passed in 1914. The Sherman Antitrust Act is the broadest of the antitrust laws, prohibiting practices whose main objective is to create or maintain a monopoly. The Clayton Antitrust Act prohibits price discrimination, interlocking directorates, tying arrangements, mergers and acquisitions if they restrained trade and also allowed private parties to sue under the Act. The Federal Trade Commission Act was also passed in 1914, creating the Federal Trade Commission (FTC) with power to conduct investigations and prohibiting unfair practices in interstate commerce.

Price Regulation

There are some products that can be provided at a lower cost by what is called a natural monopoly than what could be provided by competing firms. The primary characteristic of a natural monopoly is that its average total cost declines continually over any quantity demanded by the market. If the industry has a large fixed cost, then a single firm can provide the product at a much lower cost than several or many firms, because the average total cost of each firm will be much higher than it will be for the natural monopoly. Hence, a natural monopoly can provide a product for a lower price if there is no competition. Some examples of a natural monopoly include the distribution of natural gas, electricity, and landline phone service.

A diagram showing the price of a product charged by an unregulated natural monopoly, the fair-return price equal to the average total cost of producing the product, and where the price intersects the marginal cost curve.

What price should be set for the natural monopoly? For a competitive firm, profit is maximized when marginal cost (MC) equals market price. However, since the average total cost of a natural monopoly continually declines, the marginal cost will always be less than the average total cost (ATC), since the average total cost is the average of all costs including the large fixed costs while the marginal cost is only the extra cost of producing an additional unit. Therefore, a natural monopoly will continually lose money if the price that they can charge is limited to its marginal cost.

A better regulated price would be one that allowed the monopoly to charge a price — sometimes referred to as the fair-return price — that is equal to its average total cost, which in economics, also includes a normal profit. This would allow the natural monopoly to survive as a going concern, but it would not incentivize the owners to reduce costs. So this type the regulation can be enhanced by allowing the monopolist to keep some of the profits earned by reducing costs. Note not this price is less than the price charged by a profit-maximizing monopoly, which selects the price corresponding to the point where marginal cost equals marginal revenue (MR).

Government Ownership

Sometimes the government will regulate a monopoly by actually owning it. For instance, in the United States, the federal government owns the United States Postal Service, and in Europe, many governments own and operate utilities, such as water and electricity.

The main problem with government ownership is that these monopolies are operated by bureaucrats, and more often than not, they are unionized, so they have little incentive to operate the business efficiently or to provide good service to the taxpayer. Indeed, if technology were available that increased the efficiency of the monopoly, the bureaucrats would probably reject it to protect their jobs. Furthermore, the bureaucrats act as a special interest group that actively works to enrich itself at the expense of the taxpayers, especially if they are unionized. Since they are operating a monopoly, they don't have to worry about competition. That bureaucrats, and especially unions, operate in their self-interest is well evidenced in the United States by their high salaries and lush pensions, even though most of their work is administrative and under ideal conditions. A primary reason that Greece is so far into debt is because a large part of the Greek economy consists of public workers, whose actual work is often nonessential or perfunctory, yet they have relatively large salaries and a nice pension, and they can retire quite young.