Monopoly and Public Policy
• Welfare Effects of Monopoly
▫ By holding output below the level at which
marginal cost is equal to the market price, a
monopolist increases its profit but hurts the
consumer.
▫ To assess whether this is a net benefit or loss to
society, we must compare the monopolist’s gain in
profit to the consumer’s loss.
 This shows that the consumers’ loss is larger than
the monopolist’s gain.
 Monopoly causes a net loss for society
▫ Why is this loss?
 Because some mutually beneficial transactions do not
occur.
 There are people for whom an additional unit of the good
is worth more than the marginal cost of producing it but
who don’t consume it because they are not willing to pay
the monopoly price.
 By driving a wedge between price and marginal cost, a
monopoly acts much like a tax on consumers and
produces the same kind of inefficiency.
▫ So monopoly power detracts from the welfare of
society as a whole and is a source of market failure.
• Preventing Monopoly Power
▫ Policy toward monopolies depends crucially on
whether or not the industry in question is a
natural monopoly (one in which increasing
returns to scale ensure that a bigger producer has
lower average total cost)
▫ If the industry is not a natural monopoly, the best
policy is to prevent a monopoly from arising or
break it up if it already exists.
• Dealing with a Natural Monopoly
▫ It is not easy to decide to break up a natural
monopoly because it could raise average total cost.
▫ However even in the case of a natural monopoly, a
profit-maximizing monopolist acts in a way that
causes inefficiency.
 It charges consumers a price that is higher than
marginal cost and, by doing so, prevents some
potentially beneficial transactions.
▫ Two ways to address natural monopolies
 Public Ownership
 Instead of allowing private monopolists to control an
industry, the government establishes a public agency to
provide the good and protect consumers’ interests.
 Advantage in principle is that a publicly owned natural
monopoly can set prices based on the criterion of
efficiency rather than profit-maximization.
 Downside to public ownership is that publicly owned
firms are often less eager than private companies to
keep cost down or offer high-quality products
 Another downside is that publicly owned companies all
too often end up severing political interests.
 Regulation
 In the United States, the more common answer has
been to leave the industry in private hands but subject
it to regulation.
▫ Most local utilities are covered by price regulation that
limits the prices they can charge.