Innovation and the Opportunity Cost of Monopoly

Innovation enables monopolists to lower their costs, expand their outputs, and reduce their prices. It is conventional to conclude that social welfare unambiguously increases as a result. Assuming linear demand and marginal cost, this paper shows, however, that innovation raises the opportunity cost of monopoly: as a firm enjoying market power becomes more efficient, greater amounts of surplus are sacrificed by consumers because of the progressive monopolist's failure to produce the new, larger competitive output. Innovation, in other words, increases the social value of competition by raising the deadweight cost of monopoly. Copyright (C) 2008 John Wiley & Sons, Ltd.