James d. Gwartney

ELEMENT 3.2
When a monopoly is present and barriers to entry are high, markets will fail to achieve ideal
efficiency.

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example. As power plants for the generation of electricity become larger, the per-unit cost of
generating electricity generally declines. As a result, there is a tendency for a single, large firm
to dominate this market. This is why the government usually regulates the prices charged by
electric power companies and, in some cases, owns and operates the power plants.
Even where monopolies do not develop, some industries may have only a few
dominant firms, usually because the market is costly to enter. This is referred to as an
“oligopoly” meaning “sales by a few.” Note the similarity to “oligarchy,” or “rule by the few.”
A firm may have to produce a large share of the industry output—for example 20 or 25 percent
—in order to achieve a low per-unit cost and compete effectively. When this is the case, there
may be room for only four or five low per-unit cost firms. Such markets tend to be dominated
by a small number of firms, which have an incentive to collude, raise the price of their product,
and act as a monopolist would. Manufacturing industries such as automobiles, television sets,
and computer operating systems are examples of markets dominated by a relatively small
number of firms. The privatization of large state enterprises in post-communist countries often
resulted in such market concentration by oligarchs who benefited from insider deals in return
for support to those in power.
But the government itself is sometimes the source of monopoly. Licensing, taxes that
favor one group over another, tariffs, quotas, and other grants of privilege reduce the
competitiveness of markets. While some of these policies may be well-intentioned, they
protect existing firms and make it more difficult for potential rivals to enter the market, thereby
encouraging monopolies and dominant firms.
What can the government do to ensure that markets are competitive? The first guideline
might be borrowed from the medical profession: Do no harm. The government should refrain
from making things worse through licensing requirements and discriminatory taxes. In the vast
majority of markets, sellers will find it difficult or impossible to limit the entry of rival firms
(including rival producers from other countries). This means that suppliers will be unable to
limit competition unless government imposes entry restrictions or creates rules and regulations
that favor some firms relative to rivals.
To promote competition, governments may also prohibit anticompetitive actions such
as collusion
(?)
, the merger of dominant firms in an industry, and interlocking ownership of

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firms. In this regard, the European Union competition law promotes competition within the
European single market by making it illegal for firms to collude or attempt to monopolize a
market.
The record of government in this area has been mixed, however. On the one hand,
government policies have reduced the incidence of collusion and various practices that limit
competition. But some laws have almost the opposite effect; they restrict entry into markets,
protect existing producers from rivals, and limit price competition. Thus, while high entry
barriers and the absence of competition provide the potential for government to improve
market performance, some policies have actually granted monopoly powers. As we proceed,
the underlying reasons for this become more visible.

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