Monopoly and Technical Change

Having made a comparison between the behaviour of a monopoly and a perfectly competitive industry, we discovered two things: (1) a monopoly will tend to restrict output and drive up prices; and (2) in consequence a monopoly will tend to make economic profits in the short run, and need not fear the erosion of these profits by entrants in the long run.

Joseph Schumpeter (1883-1950) argued that this comparison might be misleading because it ignores the possibility of technical advances, which reduce costs and may allow price reductions and output expansion. If banks are unwilling to lend money for risky research projects, a large monopolist with steady profits may find it much easier to fund internally the research and development (R & D) necessary to make cost-saving breakthroughs. Second, and completely distinct, a monopolist may have a greater incentive to undertake R & D.

In a competitive industry a firm with a technical advantage has only a temporary opportunity to earn high profits to recoup its research expenses. Imitation by existing firms and new entrants gradually compete away any supernormal profits. In contrast, by shifting down all its cost curves, a monopoly may be able to enjoy higher supernormal profits for ever. Schumpeter argued that these two forces - greater resources available for R & D and a higher potential return on any successful venture - tend to make monopolies more innovative than competitive industries. Taking a dynamic long-run view, rather than a snapshot static picture, monopolists tend to enjoy lower cost curves which lead them to charge lower prices thereby increasing the quantity demanded.

This argument has some substance. Very small firms typically do little R & D, whereas many of the largest firms have excellent research departments. Many small firms com­plain about the problem of trying to raise bank loans for risky research projects. Nevertheless, the Schumpeter argument may overstate the case in two respects.

Most Western economies operate a patent system. Inventors of new processes acquire a temporary legal monopoly of the process for a fixed period. By temporarily excluding entry and imitation the patent laws increase the incentive to conduct R & D without establishing a monopoly in the long run. Over the patent life the inventor can charge a higher price and make handsome profits. Eventually the patent expires and competition from other firms leads to higher output and lower prices. The real price of copiers and micro computers fell significantly when the original patents of Xerox and IBM expired.

The patent laws can provide an R & D incentive even in industries that are not per­manent monopolies. Nor does the empirical evidence show unusually high R & D expen­diture in industries that are monopolies. What the evidence does show is that small firms do little research. But above a certain size of firm there is no further correlation between the size of the firm and its research expenditure. 2496 digits

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