Chapter Summary

Monopoly is the name given to the market structure in which a single firm serves the entire market. Four main factors, acting alone or in combination, give rise to monopoly: (1) control over key inputs, (2) economies of scale, (3) patents, and (4) government licences. In the long run, generally the most important of these is economies of scale.

Because the monopolist is the only seller in the market, his demand curve is the downward-sloping market demand curve. Unlike the perfect competitor, who can sell as much as he chooses at the market price, the monopolist must cut price in order to expand his output. The monopolist's rule for maximizing profits is the same as the one used by perfectly competitive firms. It is to expand output if the gain in revenue (marginal revenue) exceeds the increase in costs (marginal cost), and to contract if the loss in revenue is smaller than the reduction in costs. The pivotal difference is that marginal revenue is less than price for the monopolist, but equal to price for the perfect competitor.

When the monopolist can sell in several separate markets, he distributes output among them so that marginal revenue is the same in each. Here again, the familiar logic of cost-benefit analysis provides a convenient framework for analyzing the firm's decision about whether to alter its current behaviour.

Unlike the perfectly competitive case, the monopoly equilibrium generally does not exhaust the potential gains from exchange. In general, the value to society of an additional unit of output will exceed the cost to the monopolist of the resources required to produce it. This finding has often been interpreted to mean that monopoly is less efficient than perfect competition. But this interpretation is of only limited practical significance, because the conditions that give rise to monopoly-in particular, economies of scale in production-are rarely compatible with those required for perfect competition.

Our policy focus in the chapter was on the question of how the government should treat natural monopolies-markets characterized by downward-sloping long-run average cost curves. We considered five policy alternatives: (1) state ownership, (2) private ownership with government price regulation, (3) competitive bidding by private firms for the right to be the sole provider of service, (4) vigorous enforcement of competition laws designed to prevent monopoly, and finally (5) a complete laissez-faire, or hands-off, policy. Problems arise with each of these alternatives, and the best policy will in general be different in different circumstances. In markets where the monopolist employs the hurdle model of differential pricing, the laissez-faire approach is less inefficient and inequitable than it otherwise would be. Allowing buyers to decide for themselves whether to become eligible for a discount price reduces both the inefficiency and inequity costs of natural monopoly.