The Inefficiency of Monopolies

With the recent $39 billion offer by AT&T to purchase T-Mobile we thought we might say a little about the inefficiencies of monopolies. An article on 24/7 Wall St. explains what a monopolist is and lists ten companies in the U.S. that are effectively monopolists.

When economists investigate inefficiencies, we use the non-existent perfectly competitive market at the benchmark. In this market structure there are many buyers and sellers of a homogenous good and no barriers to entry. Individual firms are small and have no influence on the market price. When this is true, the marginal (incremental) cost of the last good produced is equal to the marginal benefit to the consumer and the sum of consumer and producer surpluses is maximized. (Consumer surplus is the total benefit received minus the total amount paid. Producer surplus is total revenue minus the variable cost of production) Price is equal to both marginal cost and marginal benefit.

In a monopoly, firms have the ability to set their price to maximize profits. Reducing the amount of output causes the product price to rise and the marginal cost of production to fall. A monopolist will produce until the marginal revenue is equal to the marginal cost. They will then set the price for that level of output to the maximum amount that consumers are willing to pay as determined by the marginal benefit.

At the profit maximizing level of output, the price equals the marginal benefit, but is higher than the marginal cost. The monopolist’s chosen output is less than the socially optimal level of output. There is a transfer of consumer surplus to the firm, and also a deadweight loss to society due to the monopolist’s output being below the socially optimal output level.

In the case of patent-protected monopolists, we are willing to accept the inefficiency, at least temporarily, since research and development tends to benefit society as a whole. Without the monopoly profits, firms would have no incentive to develop new products.

Unions are monopoly sellers of labour.