Economic effects of monopoly

Price, Output, and Efficiency:

In monopoly:

ü P exceeds MC

ü P exceeds lowest ATC

ü an effeciency loss (dead weight loss) occurs (sum of consumer surplus + producer surplus is less than maximum)

Income transfer:

ü transfers income from consumers to stockholders who own monopoly

ü monopoly charges a higher price than a PC firm with the same costs

· Can be seen as a "private tax" on consumers since the higher price generates higher economic profit that is distributed amongst shareholders of the company, who are mostly from high-income groups

· owners benefit at the expense of the consumers

ü Since owners have more income than the consumers, monopoly increases gap between rich and poor

· exception: when buyers are richer than owners of the monopoly, then income transfer from consumers to owners may decrease income inequality (usually not the case)

Cost Complications:

- A purely monopolistic industry will charge a higher price, produce a smaller output and allocate economic resoures less efficiently than a purely competitive industry assuming they have equal costs. This is because of the entry barriers that characterize monopoly.

- However, costs may not be the same for purely competitive producers and monopolistic producers: the unit cost that a monopolist has is either larger or smaller than a purely competitive firm's.

4 Reasons Why Costs May Differ:

Economics of scale:

ü Simultaneous consumption: a product's ability to satisfy a large number of consumers at the same time

ü Network effects are increases in the value of a product to each user

A factor called "X-inefficiency":X-efficiency occurs when a firm produces output, whatever its level, at higher than the lowest possible cost of producing it.

· The need for monopoly-preserving expenditures

ü Rent-seeking behavior: firms acquire monopoly granted by government through legislation

· The "very long run" perspective, which allows for technological advance

If the monopoly is achieved and sustained through anticompetitive actions, creates substantial economic inefficiency, and appears to be long-lasting, the government can file charges against the monopoly under the anti-trust laws. If found guilty of monopoly abuse, the firm can either be prohibited from engaging in certain business or be broken into two or more competing firms.

Assessment and policy options:

How should the government act towards monopolies in the real world?

· If the monopoly is achieved and sustained through anticompetitive actions, creates substantial economic inefficiency, and appears to be long-lasting, govt can file charges against the monopoly under anti-trust laws. Thus, government breaks up monopolies that are seen to be abusive

· If it is a natural monopoly, government will allow it to profit since it is better for society. Yet govt will also regulate the prices and operations of the monopoly to protect consumers

· If the monopoly is earning and lost and seems to be unsustainable, govt can ignore it since it has no potential threat to consumers.

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