Legal Restrictions

Governments sometimes restrict competition in certain industries. Important legal restrictions include patents, entry restrictions, and foreign-trade tariffs and quotas. A patmt is granted to an inventor to allow temporary exclusive use (or monopoly) of the product or process that is patented. For example, pharmaceutical companies are often granted valuable patents on new drugs in which they have invested hundreds of millions of the few forms of government-granted monopolies that are generally approved of by economists. Governments grant patent monopolies to encourage inventive activity. Without the prospect of monopoly patent protection, a company or a sole inventor might be unwilling to devote time and resources to research and development. The temporarily high monopoly price and the resulting inefficiency is the price society pays for the invention. Governments also impose entry restrictions on many industries.

Typically, utilities, such as telephone, electricity distribution, and water, are given franchise monopolies to serve an area. In these cases, the firm gets an exclusive right to provide a service, and in ‘return the firm agrees to limit its profits and provide universal service in its region even when some customers might be unprofitable. Historians who study the tariff have written, “The tariff is the mother of trusts.” (See question Iu at the end of”this chapter for an analysis of this subject.) This is because government-imposed import restrictions have the effect of keeping out foreign competitors.

It could very well be that a single country’s market for a product is only big enough to support two or three firms in an industry, while the world market is big enough to support a large number of firms. Then a protectionist policy might change the industry structure from Figure 9-2(a) to (b) or even to (c). When markets are broadened by abolishing tariffs in a large free-trade area, vigorous and effective competition is encouraged and monopolies tend to lose their power. One of the most dramatic examples ofincreased competition has come in the European Union, which has lowered tariffs among member countries steadily over the last three decades and has benefited from larger markets for firms and lower concentration of industry,

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