“Economic progress, in capitalist society, means turmoil.” Joseph Schumpeter
Each good has its own set of buyers and sellers, which constitute the market of that good. One very special kind of market structure is what is known as a monopoly. A monopoly is basically a market structure where there is only one firm producing in the market. This particular situation gives the producer (the sole supplier) in question full power over the quantities provided or the price it establishes. There are a lot of examples of monopoly, from the Portuguese electricity market monopoly power of EDP in the 20th century to Monsanto’s dominance of the US seed industry.
This monopolist will not choose to supply the market in terms of quantity or price randomly. As it is the sole firm on the supply side, it will take on this advantageous situation to choose one that, in theory, most benefit it; theoretically the one that gives the highest profit. To do so, it usually sets a higher price compared to the one that would be verified with normal competition conditions at the cost of less units sold. This is will make the firm better off as it will largely increase its profits. Conversely, consumers will buy less of that good and will pay a higher price. This will make them worse-off under these circumstances.
On the one hand, such type of static analysis of monopoly markets, i.e., analysis done in contemporaneous terms, leads to the idea that competition is better than having just one firm and that more firms on the supply side will produce lower prices in the market, thus making consumers better off. Because of this, there’s competition law and market regulation in many countries in the world, believing that market inefficiency brought about by the monopoly can be corrected via governmental intervention. Examples of such intervention may be, for instance in our case, liberalising the electricity market in Portugal or enacting stricter regulations on Monsanto’s activity.
One of the most well-known legislations regarding market competition is, actually, one of the oldest ones. The Sherman Act Law passed in the US in 1890 paved the way for governmental overseeing of market structures in modern economies preventing mergers and acquisitions that can lead to nefarious firm concentration. By doing this, governments ensure that prices of goods are naturally driven down by competition forces, benefiting consumers overall.
On the other hand, do monopolies actually cause welfare losses? The static analysis referred to in previous paragraphs do not take into account future implications implied to the monopolised market structure. Joseph Schumpeter believed, for example, there was a high correlation between market power and innovation. Let us take for instance the example of pharmaceutical drugs. One of the main incentives to innovation and invention of new drugs and ways of producing them is patents. Patents give to the owner the exclusive right to produce, use and sell the patented drug. In this sense, the patent owner becomes monopolist of the patented drug. Nevertheless, this monopoly situation provided by the patent is not permanent. Patents are usually limited in time in order to take into account the costs of short term market inefficiency associated to the monopoly.
To come up with this new drug, the pharmaceutical had to incur into large costs of R&D. It did so because it had the incentive of possessing monopolistic profits after the invention, acting differently if that were not the case. The profits provided by the monopoly enable the pharmaceutical to support new R&D costs, maintaining the momentum of innovation. Another aspect of patents is disclosure. That means that the details of the invention must be made available to general public. This type of knowledge spreads beyond the pharmaceutical sector, reaching all the economy, benefiting it as a whole. Since knowledge is key to technical progress and technical progress is one of the main ways to promote economic growth, we can argue that although monopolies, in the short run, are associated with welfare losses, they may be at the core of economic growth in the long term, due to their role in R&D and creation of new goods. An undesirable situation in the short term may then lead to a better future economic standpoint.
In conclusion, the global effect of monopolies on consumers and the economy is ambiguous. The inefficiency it causes, verified in the static analysis, contrasts with the sub sequential dynamic efficiency it promotes on the long term. Hence, antitrust policies, competition law and the patent system should be devised so that innovative capacity is not harmed while protecting consumers.
Varian, H. R. (2010). Intermediate Microeconomics: A Modern Approach, W.W. Norton & Company.