IB Economics: Monopolies and Abnormal Profits

excite caps hat final 50 matching colourAmerica, considered a land of opportunity based on the principles of capitalism and a free market economy has seen huge and persistent profits which are largely sustainable because of a lack of healthy competition. Many firms are acting as monopolies or oligopolies with a tenth of the economy controlled by a handful of firms from dog food and batteries to airlines, credit cards and telecoms.In addition, excess cash generated by American firms making abnormal profits is more likely to be invested abroad because of relatively high interest rates.If profits are not reinvested in the business or shared with stakeholders such as  employees through higher wages and consumers with lower costs , these high profits will not stimulate aggregate demand and growth in the economy.

This will further lead to income disparity, lack of motivation and unequal distribution of wealth as well as a lack of incentives for entrepreneurs and start ups that are unable to compete with monopolies with access to significant economies of scale and cost savings.

The Government could intervene to decrease the control and pricing power of such firms through measures such as

  • increasing corporate taxation, which would likely deter investment
  • minimum wages which would discourage hiring
  • legislation to control mergers which lead to high market shares
  • encourage competition
  • reduce copyright and patent powers
  • reducing the bureaucracy and regulation of small firms and start ups with reduced licensing laws and permits

Listen to this podcast from The Economist , Editor’s Picks 26th March 2016, to explore how profits may not always have a positive impact on an economy.

The Economist : The problem with American Firm’s profits