Quantity per time period

This situation presents a dilemma. Economic efficiency could be enhanced by restricting the number of producers to a single firm. However, this entails risk because monopolists tend to underproduce and earn economic profits. Although such profits give powerful incentives for efficiency, they are difficult to justify when they result from market power rather than from exceptional performance.

Underproduction occurs when the firm curtails production to a level at which the marginal value of resources needed to produce an additional unit of output (marginal cost) is less than the benefit derived from the additional unit. For example, at output levels just greater than Q in Figure 13.2, consumers are willing to pay approximately P dollars per unit, so the value of additional units is P. However, the marginal cost of producing an additional unit is slightly less than M dollars and well below P, so marginal cost does not equal marginal value. Society would find an expansion of output desirable.

Natural monopoly poses a dilemma because monopoly has the potential for greatest efficiency, but unregulated monopoly can lead to economic profits and underproduction. One possible solution is to allow natural monopoly to persist but to impose price and profit regulations.

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