11.Eis Cost Reducing Monopoly Good for You?
11.eIs Cost Reducing Monopoly Good for You?
Conventional wisdom says that a competitive market is better for the consumer than a monopolistic market. Where a competitive firm's costs are the same as a monopolist's, that may be true.[1] However, it is possible (and likely) that a single firm monopoly will be able to enjoy economies of scale that competitive firms cannot. Figure 11.e.1 illustrates a market in which a monopolistic firm enjoys significant cost savings that competitive firms do not.
Figure 11.e.1: Gain in Social Welfare Generated by Cost-Reducing Monopoly
(Positive effect on price/output)
Figure 11.e.1 shows the profit maximizing price and output in two situations. The first is a competitive market with a marginal cost structure depicted by MCc. The second is a monopolized market with a marginal cost structure depicted by MCm. In the competitive market, industry-wide price and output are set at the intersection of demand and marginal cost, resulting in a price Pc and output Qc. In a monopolized market, price and output are set at the intersection of MCm and MR, resulting in a price Pm and output Qm.
Ordinarily, one would expect the monopolization of a market to result in: (a) a reduction of output; and (b) an increase in price. Yet the market shown in Figure 11.e.1 shows just the opposite—prices come down and output goes up. The reason for this is the large-scale reduction in cost, which results in MCm intersecting the MR curve to the right of the intersection of MCc and D.
The increase in social welfare resulting from the monopolization of this market is staggering. First, society benefits from the cost reductions (reflected by the blue shaded area A) resulting from the monopolist's lower cost structure. Society also benefits from the increased production, which after an offset of increased costs (reflected by the red shaded area C) results in more gain to society (reflected by the green shaded area B). The sum of areas A and B is the social benefit resulting from this market being monopolized.
The federal antitrust laws recognize this fact, and do not have a blanket prohibition on monopoly. Instead, Section 2 of the Sherman Act only prohibits the act of "monopolization," and insulates those firms that acquire monopoly through "superior skill, foresight, or industry," as well as those firms that have monopoly "thrust upon" them because of economies of scale (i.e., reduced costs at higher levels of production).
While the market depicted in Figure 11.e.1 results in lower costs and higher output, those conditions are not necessary for a monopoly to produce a net gain to society. Consider the following market:
Figure 11.e.2: Gain in Social Welfare Generated by Cost-Reducing Monopoly
(No effect on price/output)
Figure 11.e.2 shows a cost-reducing monopoly that has no effect on price or output. The intersection of MCc and D results in the same output as the intersection of MCm and MR. Price is driven by output, so there is no change in price if the market shown in Figure 11.e.2 is monopolized. There is a net gain to society reflected by the blue shaded area A. Since the monopolist has lower costs, consumers are getting the same goods at the same price, but manufacturers spend less producing them. The savings could be put to use in other markets, providing a net gain to social welfare. However, even if prices go up, and output is restricted, a monopoly may provide a social benefit.
Figure 11.e.3: Gain in Social Welfare Generated by Cost-Reducing Monopoly
(Negative effect on price/output)
Figure 11.e.3 shows a cost reducing monopoly that has increased price and reduced output. The cost-reducing aspect of the monopoly results in a savings that benefits social welfare (reflected by the blue shaded area A), more than it harms social welfare through restricting output and raising price (reflected by the red shaded area B, which is the loss of consumer surplus less the reduced cost of production (reflected by the green shaded area C). Thus, while consumers are harmed by the net reduction in consumer surplus (area B), the economy as a whole is better off, as the savings linked to the cost-reducing features of monopoly.
1
[1]See Chapter 11.d for an illustration of the deadweight cost of monopoly.