According to general equilibrium economics, a monopoly can identify or create a rigid demand curve, restrict supply and cause deadweight loss to the economy. It results in the underprovision, or shortage of, goods or services – something known as a market failure. In theoretical economics, underprovision is measured against the concept of perfect competition.
General Equilibrium Monopoly
General equilibrium economics refers to a 20th-century model developed by neoclassical economists about a specific, yet unrealistic, notion of perfectly competitive markets. Classic monopoly theory was founded – and is normally still discussed today – in this tradition.
Per the theory, market failure results when power is concentrated into a monopoly (a single provider of a good or service), a monopsony (a single buyer of a good or service), a cartelized oligopoly (few large providers refusing to directly compete) or a natural monopoly (in which an unusual cost structure leads to an efficient single-firm outcome).
Typically, all of these possible outcomes are broadly covered by modern conceptions of monopoly. The fear is that monopoly firms will take advantage of their position to force consumers to pay prices that are higher than equilibrium.
Historical and Theoretical Challenges
Many economists and non-economists challenge the theoretical validity of general equilibrium economics because of the highly unrealistic assumptions in perfect competition models. Some of these criticisms also extend to its modern adaptation, dynamic stochastic general equilibrium.
Even if these challenges do not disprove the underlying arguments for monopoly-induced market failure, history provides almost no examples of market monopolies. In other words, the theory of monopoly market failure has a poor empirical track record.
Milton Friedman, Joseph Schumpeter, Mark Hendrickson and other economists suggested that the only monopolies that cause market failure are government-protected. A political or legal monopoly can charge monopoly prices because the state has erected barriers against competition. This form of monopoly was the basis of the mercantilist economic system in the 16th and 17th centuries. Modern examples of such monopolies exist to some extent in the sectors of utilities and education.