Government Intervention on Public Interest:

Having stated the need for equity on grounds of social welfare lets us bring out the situations under which government intervention is necessary.

Imperfect Competition: The presence of market power in a producer leads to imperfect competition in the market. You may recall that under perfect competition price is equal to marginal cost (P = MC) while in the presence of monopoly power, price is higher than marginal cost (P > MC) . Thus perfect competition is considered as an ideal condition and any deviation from it is seen as a loss of social welfare. Monopoly is natural in certain firms (such as electricity supply) where economies of scale are present throughout (or at least for a longer stretch). It implies that the average cost curve is downward sloping and does not turn upward after reaching a minimum level. In such a situation the necessary condition for equilibrium of the firm, that is, MR = MC. is satisfied. However, the sufficient condition that MC must have a positive slope is not fulfilled. It indicates a hypothetical situation where higher the output, lower is the average cost. The presence of two or more firms in the case of natural monopolies would lead to increase in cost of production. Secondly, the presence of monopoly power may prompt the firms to discriminate among buyers. The above argument , forms a basis for imposition of controls on monopoly firms. Thirdly, in certain cases competition among firms is possible but the firms form cartels to avoid competition. In order to curb monopoly power the government imposes various controls on production technology, prices and distribution of output.