THE WELFARE COST OF MONOPOLY
Is monopoly a good way to organize a market? We have seen that a monopoly, in
contrast to a competitive firm, charges a price above marginal cost. From the standpoint
of consumers, this high price makes monopoly undesirable. At the same time,
however, the monopoly is earning profit from charging this high price. From the
standpoint of the owners of the firm, the high price makes monopoly very desirable.
Is it possible that the benefits to the firm’s owners exceed the costs imposed on consumers,
making monopoly desirable from the standpoint of society as a whole?
We can answer this question using the type of analysis we first saw in Chapter
7. As in that chapter, we use total surplus as our measure of economic well-being.
Recall that total surplus is the sum of consumer surplus and producer surplus.
Consumer surplus is consumers’ willingness to pay for a good minus the amount
they actually pay for it. Producer surplus is the amount producers receive for a
good minus their costs of producing it. In this case, there is a single producer: the
monopolist.
You might already be able to guess the result of this analysis. In Chapter 7 we
concluded that the equilibrium of supply and demand in a competitive market is
not only a natural outcome but a desirable one. In particular, the invisible hand of
the market leads to an allocation of resources that makes total surplus as large as
it can be. Because a monopoly leads to an allocation of resources different from
that in a competitive market, the outcome must, in some way, fail to maximize total
economic well-being.