The Costs of Monopoly: A New View

James A. Schmitz, Senior Research Economist

July 2016 | Federal Reserve Bank of Minneapolis, The Region

Economists overwhelmingly agree that the actual costs of monopoly are small, even trivial. This consensus is based on a theory that assumes monopolies are well-run businesses that limit their output in order to drive up prices and maximize profit. And because empirical studies have found that monopolists do not restrict output or raise prices by very much, most economists have concluded that monopolies inflict relatively little harm on the economy.

In this essay, I review recent research that upends both the theoretical and empirical elements of this consensus view.2 This research shows that monopolies are not well-run businesses, but instead are deeply inefficient. Monopolies do drive up prices, as conventional theory suggests, but because they also reduce productivity, they often ultimately destroy most of an industry’s profits. These productivity losses are a dead-weight loss for the economy, and far from trivial.

The new research also shows that monopolists typically increase prices by using political machinery to limit the output of competing products—usually by blocking low-cost substitutes. By limiting supply of these competing products, the monopolist drives up demand for its own. Thus, in contrast to conventional theory, the monopolist actually produces more of its own product than it would in a competitive market, not less. But because production of the substitutes is restricted, total output falls.

The reduction in productivity exacts a toll on all of society. But the blocking of low-cost substitutes particularly harms the poor, who might not be able to afford the monopolist’s product. Thus, monopolies drive the poor out of many markets.