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. Inefficient distribution of goods and services is, by definition, a market failure.

In a free market, the prices of goods and services is determined by open competition. Producers increase or decrease production according to consumer demand.

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.

In a monopoly, a single supplier controls the entire supply of a product. This creates a rigid demand curve. That is, demand for the product remains relatively stable no matter how high (or low) its price goes. Supply can be restricted to keep prices high. This leads to underprovision, or scarcity.

Thus, according to general equilibrium economics, a monopoly can cause deadweight loss, or a lack of equilibrium between supply and demand.

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, admittedly unrealistic, notion of perfectly competitive markets. Classic monopoly theory was founded—and is normally still discussed today—in this tradition.

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

According to this theory, market failure results when power is concentrated into 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 who agree not to directly compete. 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 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.

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