Monopoly Power

Social Effects of a Monopoly

Compared to a perfectly competitive market, a monopoly has higher prices and a lower quantity of products available for purchase. There is both excess capacity in the market and deadweight loss to the economy as a whole.
One aspect of the cost to society of a monopoly compared to a perfectly competitive market is that consumers pay a higher price and see less product available for purchase. This affects consumer surplus and, as a result, total surplus.
  • Consumer surplus is the difference between the maximum price that an individual consumer would be willing to pay to receive a good or service and the actual market price that the consumer has to pay. It is the area below the demand curve and above the market price.
  • Producer surplus is the difference between the minimum price at which an individual supplier would be willing to sell a good or service and the actual market price that the supplier receives. It is the area above the supply curve and below the market price.

In a perfectly competitive market, the market price is exactly equal to each producer's marginal cost and there is no profit in the long run.

  • Total surplus is the total net gain to consumers and producers from trading in the market. It is the sum of consumer surplus and producer surplus.
Consider surplus in a perfectly competitive market. Consumer surplus is the area below the demand curve and above the market price. In the long-run of perfect competition, firms are selling at a price equal to their average total cost, so there is no producer surplus. Firms are making a profit, but it is a normal profit level, the amount of profit they need to stay in business. They are selling their product at exactly the price they need to sell it and not a penny higher.
Consumer surplus, the difference between how much a consumer is willing to pay and the actual price, is the area below the demand curve and above the market price. In a perfectly competitive market with suppliers providing 400,000 units of output (Qpc), consumer surplus is maximized. Consumer surplus is also equal to total surplus. Under perfect competition, firms are selling at a price equal to their marginal cost (MC). In the case above with constant marginal cost and average total costs, there is no producer surplus. Firms are making a profit, but at a normal profit level, the amount of profit they need to stay in business. They are selling their product exactly the price they need to sell it, and not a penny higher.
When comparing a perfectly competitive market to a monopoly, a reduction in both consumer surplus and total surplus by the monopolist can be observed. Consumer surplus is still the area below the demand curve and the market price, but the price is now the higher price set by the monopolist. As a result, consumer surplus has shrunk from being the large triangle to being the small triangle. Total surplus has also shrunk—unlike in perfect competition, there is deadweight loss in the economy. Because the monopolist reduces output and raises the market price compared to what is seen under perfect competition, the economy has less activity. There is excess capacity in the market: sometimes the monopolist could produce more but chooses not to because its profit-maximizing amount of output is below its maximum capacity. By comparison, a perfectly competitive firm's profit-maximizing amount of output is also its maximum capacity of production: at the market price, it can sell all it can produce. The higher price that a monopolist charges also reduces the quantity demanded compared to that in a perfectly competitive market. The law of demand still has its effect, and at a higher market price, the quantity demanded in the market is lower.
In a monopoly, the marginal revenue curve (MR) lies to the left, reducing both consumer surplus and total surplus. Consumer surplus is now the area below the demand curve and above the higher market price set by the monopolist. As a result, consumer surplus is now a much smaller triangle. Unlike in perfect competition, there is producer surplus in a monopoly, equal to the amount of monopoly profit. Total surplus has also shrunk; unlike in perfect competition, there is deadweight loss in the economy.

Potential Disadvantages of a Monopoly

Disadvantages of a monopoly include higher prices with lower output, higher costs from lack of innovation, and unequal distribution of income in the economy.
In the short run, the economy sees higher prices and lower output with a monopoly than it would under perfect competition. This is also true in the long run: under perfect competition, ease of entry makes it impossible for any firm to maintain earning above normal profits—increased competition from new competitors would ensure that all firms in the market earned normal profits. This keeps long-run prices down under perfect competition. In a perfectly competitive market, firms make profit by selling as much as they can at the given market price. However, a monopolist with its market control can charge higher prices than those in a perfectly competitive market. For example, historically in the United States, the corporation American Tobacco had a monopoly on cigarettes and sold them for a high price, profiting greatly.

In a monopoly, however, the high barriers to entry for new competitors and subsequent lack of competition allow the monopolist to keep earning above-normal profits in the long run, and there is no pressure for it to lower prices or to add output into the market. In the early period of home internet usage in the United States, many rural communities had slow or nonexistent internet connections. Internet service providers were not motivated to invest in these communities because they were not profitable. Today, there are still many rural areas in the United States that do not have high-speed internet access.

There is also the possibility of higher costs in the long run, as the monopolist has no need to innovate once it has secured the market. It has no need to develop new and more efficient techniques as it can make a high level of profit without doing so. In fact, as a way of maintaining its advantage, it may spend most of its time developing more barriers to entry instead of new technology.

An unequal distribution of income is also possible. The monopolist's producer surplus was created by reducing consumer surplus—a direct transfer of wealth from consumers to producers. Its higher profits could be seen as unfair as they are achieved by charging a higher price than a perfectly competitive firm could. This also reverberates through the wider economy: as a result of paying the monopolist's high price, consumers have less money to spend elsewhere in the economy than they would otherwise have. Producers in other markets are affected because consumers have less money to spend. And consumers are affected again because they cannot afford to buy all of the products they wish to buy in these other markets.

Potential Advantages of a Monopoly

Advantages of a monopoly include economies of scale and lower costs over time because of innovation.
Although monopolies are generally regarded skeptically and are typically monitored closely where they exist in order to guard against the monopolists abusing their market power, monopolies also have some potential advantages.

In a market that is a natural monopoly, a single supplier can be the most efficient way of operating. As such, the monopolist actually charges a lower price than if there were even two firms competing in the market and much lower than if there were a large number of suppliers, as is possible in a perfectly competitive market. This could be because of high startup costs, such as in many public utilities, where high setup costs prevent others from entering the market and a monopoly may be the only way these goods are provided. For example, installing gas pipes and all the other infrastructure needed for a distribution network is expensive—just getting the permits needed to start construction costs time and money. Any new firm would seek to recover those costs. An established firm, on the other hand, has already created the network. Once that is done, much lower costs are needed for the monopolist to maintain the network. The monopolist's break-even price, the minimum that it needs in order to cover costs, is lower than a new supplier's could be, and as a result the market price is lower as well.

Alternatively, the market itself could be too small to have more than one firm operate profitably. Rural bus routes are a good example. With a fairly small population and fairly large distances between towns, a single provider may get enough customers to be successful. However, even with just two suppliers competing, having half-full buses might not allow either company to cover its costs (fuel, maintenance on the buses, wages for staff). With a small enough market, sometimes the choice is between having one supplier or having none at all.

Innovation is one of the barriers to entry in a monopoly. Lack of innovation in the long run is also a potential cost to society, but monopolies can be a long-run benefit to society. Research and development is expensive, and it too can have economies of scale. A monopoly making above-normal profits has a pool of money that it can spend on developing and supporting innovation, as well as an available market to implement all this cutting-edge research, the result being lower costs and greater innovation over time. For example, when AT&T had a monopoly in telephone services in the United States, part of its profits went to supporting research and development, both at its dedicated research facilities (Bell Labs) and its production arm (Western Electric).