And now for the moment you've been waiting for. Are you ready? Having determined that unregulated, private markets will not maximize society's happiness when a monopoly problem exists, we now ask the question: Is there anything the government can do to make things better? Any way that it could intervene in this market to make society better off? Finally, a mere 44 chapters into our book, we are able to say...YES!

The last chapter demonstrated that the problem with monopolies is that they produce too little. Therefore, if the government wants to make society better off, it has to get the monopolist to produce more output. One obvious possibility is to subsidize the monopolist, so that it will find it profitable to expand production. However, taxpayer-funded subsidies to monopolists tend not to be very popular with voters. A more politically sensitive solution, and the one that is by far more commonly employed, is to impose a ceiling on the price that the monopolist is allowed to charge its customers.

In our example, we could imagine that lawyers from the Antitrust Division of the Justice Department (perhaps in conjunction with agents from the Federal Trade Commission and the U.S. Department of Agriculture) might arrange to meet young Mr. Rockefeller one day after school. After patiently appealing to his youthful idealism and patriotic fervor--and after explaining how they would confiscate his lemonade stand and throw him in jail if he chose to disobey them, these government agents would help our fledgling entrepreneur to see the error of his ways. To correct the monopoly problem, the monopoly regulators impose a price ceiling of 50¢ a cup. As we shall see, this price ceiling changes J.D.'s profit-maximizing strategy. The table below represents the relevant price, cost, and profit information for Rockefeller's Lemonade Stand after the government imposes a price ceiling on lemonade of 50¢ a cup.

Column (1) shows the immediate effect of the price ceiling. Before the price ceiling, J.D. could charge 80¢ for lemonade if he restricted output to 1 cup. After the price ceiling, J.D. can't charge any more than 50¢ per cup. This produces a number of other changes in the table. In fact, inspection of Column (5) shows that the new profit-maximizing level of output for J.D. is now two cups of lemonade, in contrast to the one cup which maximized profits before the price ceiling.

Let's get this straight. Are we saying that A PRICE CEILING CAN CAUSE A MONOPOLIST TO PRODUCE MORE OUTPUT? Yes, we are. Does this strike you as a strange result? It should. Price controls almost always result in less, not more, output being produced. The exception to this rule occurs with monopoly.

How can a price control get a monopolist to produce more output? Look at the effect of the price ceiling on the firm's Revenues in the table below. A comparison of Columns (3) and (6) shows that--before the price control--an increase in Quantity from 1 to 2 cups caused Total Revenue to increase by only 20¢. In contrast, after the price ceiling, the increase in Total Revenue associated with the second cup of lemonade was 50¢! Thus, the price ceiling has the effect of increasing the additional Revenue associated with producing more output. This provides an incentive for the firm to expand production.

This greater incentive to produce is illustrated in the Profit Table below. As before, we represent the relevant Revenue and Cost information for J.D. as he decides whether to produce a second cup of lemonade. Before the price ceiling, J.D. found that increasing production from 1 to 2 cups of lemonade resulted in a 5¢ loss in Profit. After the price ceiling, the same increase in production produced a 25¢ gain in Profit. All because the price ceiling increased the Revenue associated with the second cup from 20¢ to 50¢.¹

In conclusion, when a monopoly problem exists--that is, when a firm has a significant degree of market power--government intervention can increase society's happiness. Under the right circumstances, a price ceiling will cause a monopolist to produce more output. Since the problem with monopoly is that the firm produces too little output, this improves the allocation of society's resources. However, this raises a question. Can we be assured that the government intervention will increase society's happiness? Is it possible that government intervention could make us worse off than if we just left the monopoly problem alone? We explore this subject in the next chapter.