Effects of Monopoly on Consumers

EFFECTS OF MONOPOLIZATION ON THE WELFARE OF CONSUMERS

This page explains why a monopolized industry produces a lower output with a higher price to consumers than would the same industry should it be competitive.

Think about an industry with 100 little independent firms. Each one has a marginal cost (MC) curve. The MC curve of each firm constitutes that firm’s supply curve, because it shows how much that firm will supply at a given price (see p. 297 graph). Those individual firm supply curves are added together to get market supply. (See discussion on page 304.)

Suppose a big, bad monopolist comes along and gobbles up the 100 little competitive firms. Now there are not 100 different, independent firms but 100 plants of a single firm.

It is a matter of perspective on the part of the seller. You still add those 100 MC curves together, but now the sum of those 100 MC curves is not a market supply curve but rather the overall MC curve of a single firm, the monopolist, who wants to maximize profit.

Now look at the graph on page 329. If we had competition, the line labeled "Marginal Cost" would have been the market supply curve. It would have intersected the market demand curve as shown and would have established the market price and quantity at that point.

But now, with a monopolist, that point of intersection is irrelevant. The monopolist wants to maximize profits, and as usual he does so by comparing MR and MC. The MR (marginal revenue) curve for the monopolist is downward-sloping because in order to bring another buyer into the market he must lower price to all previous customers as well, and thus the addition to revenue (MR) is less than price, and continues to decline with additional sales. (At this point we are still dealing with the case of the single-price monopoly, where the monopolist cannot prevent arbitrage among his customers and so must charge the same price to all.)

Profits are maximized at that quantity where the MR line crosses the MC line (MR = MC), and that quantity is less than the quantity at which the MC line (= market supply curve for a competitive industry) crossed the market demand curve. Furthermore, the monopolist prices the product, according to the demand curve, so as to sell that quantity which maximizes profits (where MR = MC), and that price is higher than the competitive price would have been.

So all the way around, the monopoly produces less and charges more than the competitive industry with the same number of plants (= firms in the competitive industry). Even though the motives of the competitive firm and the monopolist are the same (they both want to maximize profits), the perspective of the monopolist is different (his actions influence the price he can charge, and thus his marginal revenue, in contrast to the competitive firm, whose actions have no effect on price or MR), and he will take this fact into account in deciding what output to produce and what price to charge. Monopolists are different from competitors, that’s all there is to it!

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This page was last updated on Friday, July 21, 2006.