When are Monopolies Good for the Economy? - dummies

When are Monopolies Good for the Economy?

By Sean Masaki Flynn

In some cases, the economic benefits of monopolies actually outweigh their costs. Take a closer look at these instances in the economy, where the goal is to encourage innovation, cut redundancy, and keep costs low.

Encouraging innovation and investment in the economy with patents

The most obvious place where monopolies do society a lot of good is patents. Patents give inventors the exclusive right to market their inventions for 20 years, after which time their inventions become public property. That is, patents give inventors the right to run a monopoly for 20 years.

Without patents, an inventor is unlikely to ever see any financial reward for her hard work because copycats will steal her idea and flood the market with rip-offs, thereby collapsing the price. Consequently, in a world without patents, far fewer people would bother to put in the time, effort, and money required to come up with new inventions.

To remedy this situation, nations all over the world have established patent offices to issue patents to inventors. The result is faster innovation, much more rapid economic growth, and much faster increases in living standards. Indeed, it’s hard to think of any more socially beneficial monopolies than those that arise from patents.

Reducing annoyingly redundant competitors in the economy

Societies have also stepped in to create monopolies in situations where competition means annoying redundancies. Consider the following examples:

  • Trash hauling: Garbage trucks are extremely loud and annoying. If one company has a monopoly on hauling trash, you have to endure a loud, annoying truck only once per week. But if, say, seven different trash-hauling companies compete, you may have to endure one each day if you and six of your neighbors each choose to use a different company that picks up on a different day of the week.
  • Fiber-optic Internet access: If ten different companies offering fiber-optic Internet access competed for your business, neighborhoods would have to have ten different sets of fiber-optic cables running through them — at much greater expense than running just one set of cables.
  • Natural gas: Laying the pipes that deliver natural gas is expensive, and laying down multiple grids of gas pipe in one area would be wasteful.

Consequently, most towns and cities have decided that there will be only one trash-hauling company, one company laying fiber-optic cables, and one natural gas company. Each company is given a monopoly and is then regulated to make sure that it doesn’t exploit customers.

Keeping costs low in the economy with natural monopolies

Another place where society may decide it’s better to have a monopoly rather than competition is in the case of what economists refer to as natural monopoly industries, or natural monopolies. An industry is a natural monopoly if one large producer can produce output at a lower average cost per unit than many small producers. A good example is electric power generation. Due to engineering constraints, a 10-megawatt power plant can produce energy at a far lower per-unit cost than a 1-megawatt power plant can.

To see how this leads to a natural monopoly, imagine that a town needing 10 megawatts of power is initially served by ten of the small, 1-megawatt power plants. But then a big corporation comes along and builds a 10-megawatt power plant. Because the big plant can produce at a lower per-unit cost than the smaller, less efficient plants, the big plant offers lower prices and steals all the customers — meaning that the smaller plants quickly go bankrupt.

Such an industry is called a natural monopoly because it naturally becomes dominated by a single, low-cost producer. The perplexing problem here for policymakers is what to do with a natural monopoly. On one hand, everyone welcomes the fact that the big plant is much more efficient: It burns less fuel and causes less environmental damage. But because it has crushed all competition, people now have to worry that the new monopoly will charge high prices and produce less than the socially optimal output level.

These conflicting good and bad points typically mean that governments allow the natural monopoly to stay in business as the only firm in its industry, but at the same time, they regulate it so that people don’t have to worry about high prices or low output levels. By doing so, society gets the benefits brought by the most efficient production method without having to worry about the problems that would otherwise result if the monopoly were left unregulated.