Monopoly and efficiency

In standard economic theory (see analysis above), a monopoly will sell a lower quantity of goods at a higher price than firms would in a purely competitive market. In this way the monopoly will secure monopoly profits by appropriating some or all of the consumer surplus, as although the higher price deters some consumers from purchasing, most are willing to pay the higher price. Assuming that costs stay the same, this does not lead to an outcome which is inefficient in the sense of Pareto efficiency; no-one could be made better off by shifting resources without making someone else worse off. However, total social welfare declines compared with perfect competition, because some consumers must choose second-best products.

It is also often argued that monopolies tend to become less efficient and innovative over time, becoming "complacent giants", because they don't have to be efficient or innovative to compete in the marketplace. Sometimes this very loss of efficiency can raise the potential value of a competitor enough to overcome market entry barriers, or provide incentive for research and investment into new alternatives.

The theory of contestable markets argues that in some circumstances (private) monopolies are forced to behave as if there were competition, because of the risk of losing that monopoly to new entrants. This is likely to happen where a market's barriers to entry are low. It might also be because of the availability in the longer-term of substitutes in other markets. For example, a canal monopoly in the late eighteenth century United Kingdom was worth a lot more than in the late nineteenth century, because of the introduction of railways as a substitute.

Some argue that it can be good to allow a firm to attempt to monopolize a market, since practices such as dumping can benefit consumers in the short term; and once the firm grows too big, it can then be dealt with via regulation. (This is a rather optimistic view of how effectively regulation can substitute for competition.) When monopolies are not broken through the open market, often a government will step in to either regulate the monopoly, turn it into a publicly owned monopoly, or forcibly break it up (see Antitrust law).

Public utilities, often being natural monopolies and less susceptible to efficient breakup, are often strongly regulated or publicly owned. AT&T and Standard Oil are debatable examples of the breakup of a private monopoly. When AT&T was broken up into the "Baby Bell" components, MCI, Sprint, and other companies were able to compete effectively in the long-distance phone market and started to take phone traffic from the less efficient AT&T.

The mathematician Harold Hotelling came up with Hotelling's law which showed that there exist cases where monopoly has advantages for the consumer. If there is a beach where customers are distributed evenly along it, an entrepreneur setting up an ice cream stand would naturally place it in the middle of the beach.

A competing ice cream seller would do best to place his competing ice cream stand next to it to gain half the market share, but two stalls right next to each other is not an ideal situation for the people on the beach. A monopolist who owns both stalls on the other hand, would distribute his ice cream stalls some distance apart.