THE MONOPOLY’S PROFIT: A SOCIAL COST?
It is tempting to decry monopolies for “profiteering” at the expense of the public.
And, indeed, a monopoly firm does earn a higher profit by virtue of its market
power. According to the economic analysis of monopoly, however, the firm’s profit
is not in itself necessarily a problem for society.
Welfare in a monopolized market, like all markets, includes the welfare of both
consumers and producers. Whenever a consumer pays an extra dollar to a producer
because of a monopoly price, the consumer is worse off by a dollar, and the producer
is better off by the same amount. This transfer from the consumers of the good to the
owners of the monopoly does not affect the market’s total surplus—the sum of consumer
and producer surplus. In other words, the monopoly profit itself does not
represent a shrinkage in the size of the economic pie; it merely represents a bigger
slice for producers and a smaller slice for consumers. Unless consumers are for some
reason more deserving than producers—a judgment that goes beyond the realm of
economic efficiency—the monopoly profit is not a social problem.
The problem in a monopolized market arises because the firm produces and
sells a quantity of output below the level that maximizes total surplus. The deadweight
loss measures how much the economic pie shrinks as a result. This inefficiency
is connected to the monopoly’s high price: Consumers buy fewer units
when the firm raises its price above marginal cost. But keep in mind that the profit
earned on the units that continue to be sold is not the problem. The problem stems
from the inefficiently low quantity of output. Put differently, if the high monopoly
price did not discourage some consumers from buying the good, it would raise
producer surplus by exactly the amount it reduced consumer surplus, leaving total
surplus the same as could be achieved by a benevolent social planner.
There is, however, a possible exception to this conclusion. Suppose that a monopoly
firm has to incur additional costs to maintain its monopoly position. For
example, a firm with a government-created monopoly might need to hire lobbyists
to convince lawmakers to continue its monopoly. In this case, the monopoly may
use up some of its monopoly profits paying for these additional costs. If so, the social
loss from monopoly includes both these costs and the deadweight loss resulting
from a price above marginal cost.