Monopoly and prices
By DaveLevy on Aug 26, 2009
Monopolies restrict supply and offer their goods at prices above equilibrium price, the opportunity cost of the resources used to make the goods. I am writing a short paper about this since it is a piece of thinking I revisited while developing my thoughts on free software, but is not central to those thoughts. There remain those who still think that monopolistic domination of markets is a legitimate business goal and that public policy and regulation should not inhibit this "free" market tendency. A review of the theory of the firm shows that monopolies restrict supply, raise prices and make super-profits.
Firms seek to maximise profit. As prices fall, demand increases. As output increases, average costs fall and then may rise due to economies of scale and then diminishing returns. In a "perfect" market, all firms are price takers. Business failure means that expensive suppliers leave the market, and super-profits caused by the difference in a given price and superior cost structures of the survivors encourage new entrants to bid down the price. In a perfect market, there are no super-profits and prices are equal to average costs. In a monopolistic or imperfect market, defined as where a firm's output decisions affect price, a firm's maximum profit occurs where its marginal cost is equal to its marginal revenue. No matter if dis-economies of scale are trivial or important, this will always be a lower output and a higher price than the opportunity cost price/output position.
I am writing a longer essay about this, which I hope to post on this blog, but I shall mirror it on my personal site downloads page. I doubt that there's anything original in the essay, but having it one place is useful to me and it'll help me write my essay/presentation that I promised Dominc Kay on "Why free is the right price for software?".