Gov Intervention Essay, Research Paper

?The information economy has resulted in a reduction in the barriers to entry, more competitive markets and less need for government intervention? Discuss.

The Information Economy, Primarily Information Technology and the Telecommunications have seen a dichotomous effect in relation to barriers to entry and government intervention. In relation to specifically these two industries in Australia and abroad, the Information Technology sector is to some degree an Oligopolist market. However foremost to many, Microsoft Corporation has eclipsed the industry into a Monopoly over software in the information Technology sector. In the Telecommunications Industry in Australia, the economic sector has seen for initially the deregulation of Telstra, into two-thirds privatisation with the public float. From then the telecommunications industry in Australia has seen for less government intervention with the barriers to entry reduced and many new companies being attracted to the positive profits in this multi billion-dollar industry. Therefore this conclusion is dichotomous in nature because in the Information Technology industry there are extremely high barriers to entry and more need for government intervention. However on the other hand, the telecommunications industry in Australia has seen for a reduction in barriers to entry as a result of government deregulation and intervention.

Arguably, there has been no reduction in barriers to entry in the Information Technology sector. The primary justification for this can be seen in the definition of Barriers to entry: ?the disadvantages that entrants face relative to incumbents? (Yip 1982:17). The precursor in the Information technology industry, Microsoft has been able to manipulate the market in such a way that these disadvantages far outweigh real gains

or profits. To understand this from an economic perspective one must realise the explanation of costs. Fixed costs do not by themselves constitute a barrier to entry. However, sunk costs must be incurred by a new entrant but are not recognised as costs by an incumbent firm. (Sharkey 1982:146) Therefore it can be seen at the cost side, an incumbent firm such as the nature and size of Microsoft can make it very difficult for a new entrant.

The economic classification of this is called Price Fixing, thus a price set below the equilibrium level. This results in a price being set below the equilibrium price by the incumbent firm to limit competition in the industry inflicting short-term losses on both themselves and the new entrant. After the new entrant is forced out of the market, the incumbent firm will then raise the price to cover its short-term losses.

The telecommunications Industry in Australia however, has seen for a reduction in barriers to entry and entry to many new firms. Before Government intervention and deregulation of the telecommunications industry, Telstra was able to price fix because it was a Monopoly. However with this deregulation, the barriers to entry have been reduced and thus Telstra has been forced to lower price to remain competitive. However, the reason why this market has become so attractive to potential new firms is for so long Telstra fixed prices above the equilibrium level because it was a monopoly. Thus the ?Output Effect? of new entry reduces price. Now, to reduce prices, Telstra would experience mass losses in profits because of their huge customer base where firms with a smaller consumer base would lose less revenue.

The objectives of government intervention as outlined by Yip (Yip 1982:147) describe concisely the economic rationale of deregulation and

price control. Primarily, government intervention protects buyers from prices that are too high & opportunistic behaviour. It promotes stability in an unstable market and prevents collusion among incumbent firms.

In the diagram above it can be seen that by setting a price equal to the Average Cost of Production (AC) regulation can improve both consumer welfare and economic efficiency. An unconstrained Monopoly will set a price equal to Marginal Revenue (MR) rather than Marginal Cost (MC), thus Price (P) will be set at a level greater than the Average Cost (AC) of production. (P=MR & P*AC) (Sharkey 1982:147) Therefore if the profit maximising price for a monopolist is equal to average cost, then regulation can do nothing to improve customer welfare or productive efficiency. Regulation can improve both consumer welfare and economic efficiency by setting Price equal to Average Cost. (P=AC)

On May 18, 2000, the U.S. Department of Justice and 20 states filed an antitrust lawsuit against Microsoft in violation of the Sherman Antitrust Act of 1890 designed to protect consumers and to guard businesses fixing prices, rigging bids or allocating customers. The primary charge of giving away its Internet Explorer browser to drive competitors out of business. As Paul Maritz was quoted in the New York Times as telling industry executives regarding Netscape, ?We are going to cut off their air supply. Everything they?re selling, we?re going to give away for free?. (MSNBC: CNBC & The Wall Street Journal.) Therefore in regards to economic theory, it is illegal to leverage a monopoly position in one product to force companies to agree to distribute another of the monopoly owner?s products at the expense of a competitor. Therefore, Microsoft is being sued for acting like a monopoly.

In the diagram above, it can be seen that Average Cost is lower or market Demand is higher. A Price equal to monopoly price (Pm) would invite entry, providing Average Costs (AC) are equal for the entrant and the incumbent. However by lowering price to P1, the incumbent firm is able to drive the Demand curve to a point of tangency with Average Cost, thus deterring entry. Microsoft?s actions can be seen under the same respect of ?Price Fixing?. Although Microsoft gave away their products, they in effect set their price to ?0?, thus below the equilibrium level to

drive their competitors out of the market. Thus Microsoft violated the U.S. anti-trust laws by price setting to sacrifice short-term profits in order to attain higher levels of long-term profits by deterring entry.

In a $30.5bn Industry, Communications is one of the fastest growing sectors in the Australian market. Deregulation of the industry has seen for a host of new competitors, but has not quite squeezed the former monopoly. In 1998-99 Telstra recorded profits of $3.84bn up 17% on 1997-98. The ?Output Effect? of lowering prices, has seen to be too consequential for Telstra and has enabled new companies such as Optus, Vodaphone and RSL COM to secure a new market share. With greater competition in a newly formed Oligopoly, the costs of reducing prices are too costly for a firm with the sheer size and consumer base as Telstra. However Telstra is still able to run at record profits.

Thus the reduction in Barriers to Entry in the telecommunications industry has seen for a reduction in prices and new market share for many new firms. In this industry there is less need for government intervention because if Telstra wish to remain competitive, in the long run it will be forced to lower prices. However in the Information Technology sector, primarily concerning with Microsoft Corporation, it is evident that there is further need for Government intervention as exemplified by the current lawsuit.

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