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?”.
Originally published on my sun/oracle blog.