The Economics Book

96 MONOPOLIES

might be expected. Similarly,
some historians have viewed the
guilds of the medieval era as an
example of privileged craftsmen
attempting to shut out competition
from other workers.
From the late 1890s British
economist Alfred Marshall (p.110)
rigorously analyzed the effects of
monopolies on prices and on
consumers’ welfare. Marshall was
interested in determining whether
the higher price and lower output
that result from monopolies cause
a loss in total welfare for society.
In his Principles of Economics,
Marshall formulated the concept
of consumer surplus. This is the
difference between the maximum
amount that a consumer would be
willing to pay for a good and the
amount he actually pays. Suppose
the consumer buys an apple for
20 cents when he would have
been willing to pay 50 cents.

His consumer surplus from the

purchase of the apple is 30 cents.

In a market with many firms, they

compete on price and together

supply an amount of apples that

generates a certain amount of

overall consumer surplus. For an

apple sold to the last consumer his

willingness to pay will equal the

price, and no more apples can

be sold. The welfare loss of

monopoly comes from the fact that

fewer apples are sold compared

to the amount that would have

been sold in perfectly competitive

markets. Essentially, this means

that there are apples that could be

supplied to the market, that would

generate consumer surplus, but

they never appear on the market.

Advantages of monopoly

Monopolies also create more

complex price and welfare effects.

Marshall suggested that a

monopolist might actually cut its

prices to attract customers to

its phone network, for example,

since people will likely keep using

the service once it is connected,

even though rival technologies such

as cell phones offer alternatives that

are at least as good.

Some economists have pointed

out that monopolies can have

benign effects. In many markets

a monopoly would have lower costs

than the total costs of a set of

smaller firms because a monopolist

would spend less on advertising

and make full use of economies

of scale. For these reasons a

monopolist may enjoy higher

profits even when its price is lower

than would be the case if many

firms—with higher costs—were

competing. In this case the lower

prices might help consumers and

help to drive economic growth.

In a similar fashion large firms

can attempt to gain monopoly

profits, driving out rivals by

aggressively cutting prices in the

short run. Economists call this

predatory pricing. In the long run it

can hurt consumers as the market

becomes monopolized. However,

in the 1950s and 60s US economist

William Baumol claimed that it

Monopolists, by keeping

the market constantly

understocked... sell their

commodities much above

the natural price.

Adam Smith

The lower the price of a good, the greater

the demand for it. In a theoretical state of perfect

competition between firms, a good will sell at the

price it costs to produce. This is the highest demand

and lowest price possible. In a monopoly, the price is

set at a higher level and demand is reduced.

PRICE

QUANTITY

Monopoly

Monopoly

Perfect
competition

Perfect competition

Demand

will always

be higher

at lower

prices

Supply in

monopoly

Supply in perfect

competition

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