Competition, Economic Profit, and Political Capture

This paper gives a revised theory of monopoly, on the assumption that the monopolist receives political favours in exchange for extending political support. In one case, the monopoly profit just equals the value of the monopoly's contribution to the government's support. Monopoly output may be higher or lower than the output associated with marginal-cost pricing, and higher or lower than this sector would supply in a reference economy operating under all-around perfect competition. The monopolist may also use more labour and/or capital, even if its output is lower. In general, the monopoly does not minimize the cost of its output, and it may waste resources in production, as well as in rent-seeking. A shift of product demand away from the monopoly does not necessarily cause the monopolist to release resources that it is wasting. On a more positive note, there are conditions under which the economy with one monopoly and one competitive sector will reach a second-best solution, or an optimum taking the level of monopoly profit as given, but these conditions are severe and the cost of monopoly may still be high.