that the one under competitive markets and consumer surplus is not maximized. The monopoly can choose to differentiate different groups of consumers and charge them different prices. This way it can, in theoretical cases, capture all of consumer surplus. The government can try to regulate monopolies with antitrust laws, price control or even nationalization.
15.1. Why Monopolies Arise
Monopolies can arise due to government mandates, limited resources or larger efficiency.
A monopoly is a situation in market when there is only one firm that owns all demand.
This may arise for several reasons. Firstly, the monopoly may be the only one who can gain access to a resource, like DeBeers the diamond monopoly, which owns diamond, mines in South Africa. It is impossible to be in that market without access to the
resource therefore more firms cannot enter. Other monopolies are government made, when the government gives a mandate to a specific firm to be the only player in a market. Patents are an example of this. The government may say that a company, which owns this patent, is the only one who can produce the patented goods or sell it. Lastly, some monopolies are called natural monopolies, because they arise simply because one firm is a lot better at producing some good then others and thus can make it at a lower cost competing all other firms out.
15.2. How Monopolies Make Production and Pricing Decisions
Because the monopolist, by changing quantity, changes price, he equalizes marginal revenue to marginal costs to profit maximize, but this means that the price is above marginal costs.
If we look at the demand curves for a monopoly and a competitive firm, we can see that for the competitive firm the demand curve is a horizontal like since the firm cannot unilaterally affect the price hence for one price it can produce any quantity or not produce at all. A monopoly is the only firm in the market hence its demand curve is the market demand curve, which is downward sloping. So as the monopoly increases quantity produced it affects the price by decreasing it. Since price decreases with
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However for the competitive firm this equals price and for the monopoly price is above MC.
Example:
The market for drugs is interesting, because it usually starts out as monopoly and then becomes competitive. This is so, because one company develops the drug and then has a patent on it, which expires after some years. Then other companies quickly copy the drug and sell it. We can see that after a market becomes competitive the price quickly drops and the quantity quickly expands, however the monopolists does not lose all market power. Some people are not convinced that the generic drug is as good as the brand named original drug and continue to buy the much more expensive brand name drug.
15.3. The Welfare Cost of Monopolies
The monopolist charges above marginal costs, which means that a lot of consumers cannot afford their products, which causes deadweight losses.
In the absence of competition the monopoly can charge a price higher than its marginal costs to maximize profits. This is inefficient, because consumers are charged something more that the good costs and the profits are concentrated in the monopolists hands.
However the inefficiency ad deadweight loss stems not from the consumers paying above equilibrium. After all, this is consistent with their rational actions and wants. The inefficiency stems from those consumers who cannot afford the monopoly price and hence create a shortage of the good in society. Somebody’s needs aren’t met and therefore we have a deadweight loss.
15.4. Price Discrimination
With price discrimination the monopolist tries to charge different consumers different prices and capture consumer surplus.
In order to get profits as large as possible the monopolist may choose to price
discriminate, which is charge a different price to different consumers. If the monopolist would be able to identify the willingness to pay of each individual consumer and charge them that he would be able to capture all consumer surplus, but this is impossible. This type of discrimination is called perfect discrimination, but there are degrees of less perfect yet still profit increasing price discrimination. The important thing is to
distinguish groups of consumers according to their willingness to pay and some other
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characteristic. For example, students and the rest of the population. Students generally have less money than working individuals therefore the are less able and less willing to pay for various things therefore there are all sorts of student discounts even though providing a movie of entrance to a museum to a student and a working person costs exactly the same.
15.5. Public Policy toward Monopolies
The government can try to limit monopoly market power in several ways including price caps, antitrust laws and nationalization.
There are several things that a government can do to fix the market failure of a monopoly at least to some degree. Firstly with antitrust laws they can try to limit monopolies market power and allow new entrants to come in and start competing.
Second, the government can cap the prices a monopoly charges in various methods.
Thirdly, it can nationalize the monopoly by making it a state run non-profit institution.
This is the case with essential services such as water or electricity, which are usually state run and are monopolies. And of course if the market failure is not so large with the monopoly the government can simply let it be.