Originally posted on November 9, 2012.
In our chapter on monopoly in Modern Principles, Tyler and I give an intuitive account of the double marginalization problem.
Monopolies are especially harmful when the goods which are monopolized are used to produce other goods. In Algeria, for example, a dozen or so army generals each control a key good. Indeed, the public ironically refers to each general by the major commodity that they monopolize—General Steel, General Wheat, General Tire, and so forth.
Steel is an input into automobiles, so when General Steel tries to take advantage of his market power by raising the price of steel, this increases costs for General Auto. General Auto responds by raising the price of automobiles even more than he would if steel were competitively produced. Similarly, General Steel raises the price of steel even more than he would if automobiles were competitively produced. Throw in a General Tire, a General Computer and, let’s say, a General Electric and we have a recipe for economic disaster. Each general tries to grab a larger share of the pie, but the combined result is that the pie gets much, much smaller.
In our course on Development Economics at MRUniversity we provide a more detailed explanation using graphs. This material is a bit advanced for a typical principles class but it would be useful in a course on industrial organization or for advanced students interested in more detail. Fell free to use the video in any way that you find useful.