We have seen that, in general, equilibrium in a competitive market with no externalities is efficient. On the other hand, imperfectly competitive markets—for example, those with a monopoly or an oligopoly—generally create inefficient outcomes. Concern about the higher prices, lower quantities, and lower quality of goods that can result from imperfect competition has led to public policies to promote competition. These policies include antitrust laws and direct government regulation.

Public policy toward monopoly depends crucially on whether or not the industry in question is a natural monopoly. The most common approach to a natural monopoly is for the government to allow one firm to exist but to regulate that firm to increase the quantity and lower the price relative to the monopoly outcome.

In this module, we first focus on ways to promote competition in cases that don’t involve natural monopolies. If the industry is not a natural monopoly, the best policy is to prevent a monopoly from arising or to break it up if it already exists. These policies are carried out through antitrust laws. Later in this module we will turn to the more difficult problem of dealing with a natural monopoly.