How Does a Monopoly Contribute to Market Failure?

According to general equilibrium economics, a free market is an efficient way to distribute goods and services, while a monopoly is inefficient. The inefficient distribution of goods and services is, by definition, a market failure.

In a free market, the prices of goods and services are determined by free and open competition between companies and individuals. Producers increase or decrease production and alter their products according to consumer demand, while consumers vote with their money, forcing producers to adapt to their needs and desires.

Key Takeaways

  • Some modern economists argue that a monopoly is by definition an inefficient way to distribute goods and services.
  • This theory suggests that it obstructs the equilibrium between producer and consumer, leading to shortages and high prices.
  • Other economists argue that only government monopolies cause market failure.

A Monopoly Controls the Market

In a monopoly, a single supplier controls the entire supply of a good or service. This gives the supplier excess control over the good or service and takes power away from consumers. If the product is a necessary commodity (e.g., gas, water, food, shelter, internet connection), then demand for the product can remain relatively stable no matter how high (or low) its price goes. As a result, the supplier can artificially restrict the supply of the product, thus creating scarcity and raising prices for consumers.

In the real world, the concern is that a monopoly will take advantage of its position to force consumers to pay higher prices than if the market was in equilibrium.

Monopolies Disrupt Perfect Competition

In theoretical economics, underprovision, or scarcity, fails to measure up against the concept of perfect competition, which might be described as a balance of power between buyer and seller. Competitive pressure keeps prices "normal," with consumer demand for the product or service establishing that norm. The demand curve is elastic, rising or falling in response to price.

General equilibrium economics is a 20th-century neoclassical theory that describes a specific—although admittedly unrealistic—notion of perfectly competitive markets.

The perfect competition model is criticized as being unrealistic and unachievable.

According to this theory, market failure results when power is concentrated in too few hands. A monopoly is a single provider of a product or service. A monopsony is a single buyer of a product or service. A cartelized oligopoly consists of a few large providers agreeing not to compete directly. A natural monopoly is an unusual cost structure that leads to efficient control by a single entity.

In the real world, all of these variations are broadly covered by the concept of monopoly. The concern is that a monopoly will take advantage of its position to force consumers to pay prices that are higher than they would be in a market that is in equilibrium.

Opposing Views

Many economists challenge the theoretical validity of general equilibrium economics because of the highly unrealistic assumptions made in perfect competition models. Some of these criticisms also extend to its modern adaptation, dynamic stochastic general equilibrium.

Milton Friedman, Joseph Schumpeter, Mark Hendrickson, and other economists have suggested that the only monopolies that cause market failure are government-protected.

The Legal Monopoly

A political or legal monopoly, on the other hand, 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 utilities and education sectors.

Frequently Asked Questions

What Is the Inefficiency of a Monopoly?

Monopolies do not supply enough output to be allocationally efficient, where all goods and services are distributed among buyers in an economy. This is where optimal output meets marginal benefit and cost.

Why Are Monopolies Inefficient Compared to Perfect Competition?

A monopoly produces less and can charge what it wants. In a perfectly competitive market, competition creates more products to serve more buyers in an economy, encouraging growth.

What Are the Weaknesses in Monopoly?

A monopoly can fix prices, produce low-quality products, and push inflation higher.

The Bottom Line

Monopolies contribute to market failure because they limit efficiency, innovation, and healthy competition. In an efficient market, prices are controlled by all players in the market because supply and demand swing more toward equilibrium. A monopoly can control the supply of a good or service, thus artificially increasing or decreasing prices to suit its needs rather than contributing to the well-being of the market it is part of.

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