How Do Monopolies Lead To A
Market Failure?
Monopoly Monopoly Review
1. Draw a monopoly making a profit. Label
price, output, and profit.
2. Identify three specific reasons why
monopolies are bad.
3. Label the Fair Return price and output.
4. Label the Socially Optimal price and
output.
5. Explain why taxing a monopoly is a bad
idea.
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I. Antitrust Laws
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What are Antitrust laws?
Antitrust Laws- Laws designed to prevent
monopolies and promote competition.
•After the Civil War, advances in technology and
transportation lead to national markets.
•Eventually only a few firms began to dominate
industries: Railroads, Steel, meatpacking, coal, etc.
•Sherman Act of 1890- “Every person who shall
monopolize …or conspire to monopolize…shall be
deemed guilty of a felony.”
Why are monopolies a Market Failure?
•Monopolies destroy the key ingredient of the free
market system- Competition.
•To fix this MARKET FAILURE the government must
get involved.
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II. Regulating
Monopolies
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Why Regulate?
Why would the government regulate an
monopoly?
1. To keep prices low
2. To make monopolies efficient
How do they regulate?
•Use Price controls: Price Ceilings
•Why don’t taxes work?
•Taxes limit supply and that’s the problem
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Where should the government place
the price ceiling?
1.Socially Optimal Price
P = MC (Allocative Efficiency)
OR
2. Fair-Return Price (Break–Even)
P = ATC (Normal Profit)
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Natural Monopoly
One firm can produce the socially optimal quantity
at the lowest cost due to economies scale.
P
It is better to have only
one firm because ATC is
falling at socially optimal
quantity
MC
ATC
MR
D
Qsocially optimal Q
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Natural Monopoly
Unregulated
P
Fair Return
Socially
Optimal
PM
MC
PFR
ATC
QSO
MR
QM
D
QFR Qsocially optimal Q
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Regulating a Natural Monopoly
What happens if the government sets a price ceiling
to get the socially optimal quantity?
P
The firm would make a
loss and would require a
subsidy
MC
ATC
Pso
MR
D
Qsocially optimal Q
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