Heterodox Approach : The Impact of Monopolies on the British Car Industry (Theory)

Generally, Western institutions have developed in order to encourage competitive markets, and therefore reduce the potential for monopolistic developments. This is reflected in law developments such as the 1890 Sherman act, and the UK’s Restrictive Trade Practices Act of 1956. It is widely accepted that monopolistic power is disadvantageous to a market’s competitiveness, incentive to innovate, and efficiency. However, the increase in globalism throughout the 20th and 21st centuries have meant that now firms must compete internationally in order to survive, hence giving way to the formation of monopolies in markets where previously there was strong competition. Schumpeter’s phenomenon of “creative destruction” has meant that smaller inefficient firms are run out of business by firms that dominate the market share. As seen in the British car market, this has meant that gradually classic “British” cars such as Morris Minor and Daimler have been run out of business by trans-national firms that dominate the global market, such as Volkswagen (German) and Ford (American). However, the extent of the benefit to which this transition of concentration of market power to fewer larger firms is debatable.

Keep Rover Running

On one hand, monopolistic firms are able to make supernormal profit, which can then be invested into concentrated research and development, as seen in the diagram below. The potential to make supernormal profits is increased as the market becomes less perfect, as there are fewer firms who can replicate the profit enhancing developments made by the monopolistic firm. Therefore, these excess profits can be invested in research and development in order to reduce the cost of production, meaning ATC would shift down, leading to a potential reduction in price which would enhance consumer utility. Applied to the British car market, one could argue that the most relevant area for R and D to the automobile market is the emergence of electric cars. However, investment in electric car battery innovation is a capital intensive and risky venture. Firms which have gained monopolistic power are more likely to spearhead this research than smaller undeveloped firms, as they have the necessary capital through supernormal profits. However, the success of supernormal profits being invested towards universally beneficial research and development depends upon the extent to which firms are incentivised to invest their profits back into innovation research. Capitalist firms have no obligation to re-invest their profits, particularly if there is no competition from other firms. Therefore, these supernormal profits may be distributed to shareholders rather than allocated towards research and development.

Monopoly Super-normal-profits

Moreover, a monopolistic market climate may be beneficial in allowing firms to take advantage of economics of scale. If industrial output is concentrated over a few large firms (rather than a country’s aggregate output diluted over many firms), then these few firms can grow sufficiently large to take advantage of subsequent economies of scale. With growth, Short Run ACs will shift downwards over time, eventually creating an “envelope curve” which reflects the Economies of Scale available to a growing firm.

Envelope Curve

As the firm moves towards the MES, the average total cost of production falls, which allows a firm to then reduce prices to consumers (whilst still maintaining profit levels), hence consumer utility increases.

Indeed, as technology improves and economies become more internationally integrated, increased globalisation means that domestic firms must compete on the international market. During the 20th century, British consumers’ choice would have been restricted as they would have predominantly only been able to purchase British cars. However, due to the fall in costs of transportation, today a British consumer can purchase a vehicle from a plethora of international markets. Therefore, British car firms that have been unable to compete on an international level have been forced to close down (reflection of “creative destruction”, whereby the hypothetical end for a market is a total monopoly). Increasingly, for a firm to compete on an international level (and take advantage of the economies of scale that come with a dominant firm), they must first establish domestic market share majority. This domestic monopoly can be beneficial to a country. Take Nokia’s influence in Finland as an example. In 2007, Nokia held a 49.4% market share (Gartner Analysts). This international dominance was only possible as the firm was able to take advantage of the domestic economies of scale, through establishing a domestic monopoly. The monopolistic position of Nokia was beneficial to Finnish economic growth, as The Economist predicts that the firm contributed a quarter of Finnish growth from 1998 to 2007. Therefore, one can surmise that in a global market place, in order to compete internationally it is first vital to establish a dominant domestic market share, so that the firm may make use of necessary economies of scale that allows it to become internationally competitive. Establishing international reputation and competitiveness can then be beneficial for the country’s overall trend growth rate. However, the extent to which this theory may come to fruition depends on the spare capacity of a firm (distance from MES). For a car manufacturing plant, the lack of communication between different sectors and mismanagement of large numbers of staff may lead to potential diseconomies of scale if the firm became too large, hence it would become less productively efficient and eventually succumb to increasing costs of production, meaning it would become less internationally competitive.

On the other hand, one could argue that the concentration of British car manufacturer’s market share is disadvantageous in terms of maximising social welfare and efficiencies. Theoretically, a monopolistic firm has no obligation to produce at an allocatively efficient point. A firm will produce at MC=MR in order to profit maximise, however, in a monopoly MR may not equal P, hence P>MC, leading to allocative inefficiency. The diagram below shows the subsequent consumer welfare loss due to this inefficiency.

monopoly deadweight loss

Furthermore, in a monopoly there is no incentive or necessity to produce at a productively efficient point, if that point is not MC=MR. If a firm is not producing at the MES, then they are not making use of economies of scale, and are therefore wasting potential resources/producing at a higher cost per unit than necessary. This misuse of scarce resources is unsustainable, and therefore implies an environmental burden in terms of the car manufacturing industry.

Moreover, in a purely monopolistic market, there is no incentive for a firm to lower prices, as for a PED inelastic good consumers have no option but to consume said product. Therefore, even if there was innovation to reduce the ATC, it would not translate to a reduction in prices for the consumer, as instead the firm would maintain prices and reap larger profits. Indeed, a firm could even increase their prices for a demand inelastic good (such as a car in a purely monopolistic market), and the firm would suffer a proportionally smaller reduction in demand. Therefore, a monopolistic firm is under no moral obligation and bares no competitive incentive to reduce prices, even if they reduces ATC. However, the legitimacy of this assumption depends on the barriers to entry for the market. If a firm were to innovate, reduce ATC, and maintain price levels (making increased supernormal profits in the process), then it would encourage more firms to attempt to enter the market and compete for market majority. The ability for new firms to enter the market and provide competition depends on the artificial barriers to entry (patent laws, copyright laws), and natural barriers to entry (high fixed costs involved with starting a car manufacturing firm).

Ultimately, the concentration of market power within the car industry is not necessarily disadvantageous to the automobile market. Having fewer firms hold a greater market share allows these firms to take advantage of economies of scale, and therefore reduce prices to increase consumer welfare. Indeed, it would be a gross oversimplification to say that just because the number of British car manufacturers has decreased, the global car market has become one large monopoly. Currently in America, the largest car manufacturer “Ford Motor Company” controls 15.8% of the market share. This does not equate to the 25% stake necessary to be classed as a monopoly. Therefore, there is still competition within the car market, as another 13 car companies form the majority of the remaining market share. The fact that there are numerous other car companies competing for market share means that there is incentive to innovate, which can lead to sustainable new developments (electric cars), or a reduction in the ATC of conventional cars (increasing consumer welfare). However, this is not to say that concentration of market share will always result in a more efficient market. If market influence were to become even less diluted to the point where the market becomes a totally imperfect monopoly dominated by one single firm, then the high barriers to entry would deter new firms from competing to reduce prices, and a single firm could extort the consumer whilst making huge supernormal profits, without any competition.

Therefore, it is important to find the correct balance of firms’ influence within a market. If there are too many firms in a market, then there will be little productive efficiency due to no single firm being large enough to make use of economies of scale, and no single firm will make substantial enough profits to invest in innovation. However, on the inverse, a market dominated by the a single firm is free to extort the consumer, whilst having no incentive to invest profits in innovation. It should be the responsibility of the government to ensure that every established market has sufficiently low barriers to entry so that Adam Smith’s “invisible hand” may guide markets to the most efficient number of firms, in order to maximise profit, innovation, and subsequent consumer utility.

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