Monopoly, economic efficiency and unemployment

a r t i c l e i n f o The objective of this paper is to analyze the efficiency consequences of monopoly from the perspective of an efficiency-wage model of unemployment based on Shapiro and Stiglitz (1984). An important feature of our model is that a firm can raise the probability that a shirking worker is detected by increasing its effort or investment in the monitoring of workers. Using this model we study how a monopolist's decision with regard to employment, output and monitoring is affected by exogenous variables such as job separation rate, technological advances, market size, and unemployment benefits. Furthermore, by comparing with the competitive equilibrium we find that monopoly is associated with higher unemployment rate, smaller output, and less monitoring. Surprisingly, however, monopoly does not necessarily lead to lower welfare level. It is well-known that monopoly causes inefficient allocation of resources. As illustrated by the standard textbook model of monopoly, deadweight losses arise because a monopolist sets its price above the marginal cost of production. In addition, productive inefficiencies and rent seeking activities have also been cited as reasons for efficiency losses of monopoly. However, there is one area of potential efficiency losses of monopoly that so far has rarely been explored in microeconomic theory, that is, the effects of monopoly on unemployment. Since unemployment represents unutilized labor resource, it can be argued that an increase in unemployment rate, ceteris paribus, causes additional efficiency losses. Given that output is an increasing function of labor, reduction in output by a monopoly will normally cause a reduction in labor employed in the monopolized industry. To the extent that the surplus labor released by the monopolized industry is not entirely absorbed by other industries in the economy, more unemployment will result. Therefore, it seems plausible that monopoly may cause higher rate of unemployment. Indeed, it has been argued by some economists (see Layard et al., 2005; Geroski et al., 1995 for examples) that competition in the product market reduces unemployment. However, while the issue of unemployment figures prominently in other fields of economics such as macro and labor economics, microeconomic analysis of monopoly is still confined to an equilibrium framework that, by its implicit assumption of a perfectly flexible labor market, is incapable of handling unemployment. The main objective of this paper is to analyze the efficiency and employment consequences of monopoly from the perspective of an efficiency …