A monopoly (from Greek and ) is a market in which one person or company is the only supplier of a particular good or service. A monopoly is characterized by a lack of economic competition to produce a particular thing, a lack of viable substitute goods, and the possibility of a high monopoly price well above the seller's marginal cost that leads to a high monopoly profit. The verb monopolise or monopolize refers to the process by which a company gains the ability to raise prices or exclude competitors. In economics, a monopoly is a single seller. In law, a monopoly is a business entity that has significant market power, that is, the power to charge overly high prices, which is associated with unfair price raises. Although monopolies may be big businesses, size is not a characteristic of a monopoly. A small business may still have the power to raise prices in a small industry (or market).
A monopoly may also have monopsony control of a sector of a market. A monopsony is a market situation in which there is only one buyer. Likewise, a monopoly should be distinguished from a cartel, in which several providers act together to coordinate services, prices or sale of goods. Monopolies, monopsonies and oligopolies are all situations in which one or a few entities have market power and therefore interact with their customers, or suppliers in ways that distort the market.
Monopolies can be formed by mergers and integrations, form naturally, or be established by a government. In many jurisdictions, competition laws restrict monopolies due to government concerns over potential adverse effects. Holding a dominant position or a monopoly in a market is often not illegal in itself; however, certain categories of behavior can be considered abusive and therefore incur legal sanctions when business is dominant. A government-granted monopoly or legal monopoly, by contrast, is sanctioned by the state, often to provide an incentive to invest in a risky venture or enrich a domestic interest group. Patents, copyrights, and trademarks are sometimes used as examples of government-granted monopolies. The government may also reserve the venture for itself, thus forming a government monopoly, for example with a state-owned company.
Monopolies may be naturally occurring due to limited competition because the industry is resource intensive and requires substantial costs to operate.
Market structures
Market structure is determined by the following factors: Barriers to entry: Competition within the market will determine the firm's future profits, and future profits will determine the entry and exit barriers to the market. Estimating entry, exit and profits are decided by three factors: the intensity of competition in short-term prices, the magnitude of sunk costs of entry faced by potential entrants, and the magnitude of fixed costs faced by incumbents. The number of companies in the market: If the number of firms in the market increases, the value of firms remaining and entering the market will decrease, leading to a high probability of exit and a reduced likelihood of entry. Product substitutability: Product substitution is the phenomenon where customers can choose one product over another. This is the main way to distinguish a monopolistic competition market from a perfect competition market.
In economics, the idea of monopolies is important in the study of management structures, which directly concerns normative aspects of economic competition, and provides the basis for topics such as industrial organization and economics of regulation. There are four basic types of market structures in traditional economic analysis: perfect competition, monopolistic competition, oligopoly, and monopoly. A monopoly is a structure in which a single supplier produces and sells a given product or service. If there is a single seller in a certain market and there are no close substitutes for the product, then the market structure is that of a "pure monopoly". Sometimes, there are many sellers in an industry or there exist many close substitutes for the goods being produced, but nevertheless, companies retain some market power. This is termed "monopolistic competition", whereas in an oligopoly, the companies interact strategically.
In general, the main results from this theory compare the price-fixing methods across market structures, analyze the effect of a certain structure on welfare, and vary technological or demand assumptions in order to assess the consequences for an abstract model of society. Most economic textbooks follow the practice of carefully explaining the "perfect competition" model, mainly because this helps to understand departures from it (the so-called "imperfect competition" models).
The boundaries of what constitutes a market and what does not are relevant distinctions to make in economic analysis. In a general equilibrium context, a good is a specific concept including geographical and time-related characteristics. Most studies of market structure relax a little their definition of a good, allowing for more flexibility in the identification of substitute goods.
Characteristics
A monopoly has at least one of these five characteristics: Profit maximizer: monopolists will choose the price or output to maximise profits at where MC=MR. This output will be somewhere over the price range, where demand is price elastic. If the total revenue is higher than total costs, the monopolists will make abnormal profits. Price maker: Decides the price of the good or product to be sold, but does so by determining the quantity in order to demand the price desired by the firm. High barriers to entry: Other sellers are unable to enter the market of the monopoly. Single seller: In a monopoly, there is one seller of the good, who produces all the output.Binger and Hoffman (1998), p. 391. Therefore, the whole market is being served by a single company, and for practical purposes, the company is the same as the industry. Price discrimination: A monopolist can change the price or quantity of the product. They sell higher quantities at a lower price in a very elastic market, and sell lower quantities at a higher price in a less elastic market.
Market power can be estimated with Lerner index. High profit margins might be caused by different factors, such as risk premiums or monopoly profits.
Monopolies can cause corruption or political bias and reduce labor share.
Sources of monopoly power
Monopolies derive their market power from barriers to entry – circumstances that prevent or greatly impede a potential competitor's ability to compete in a market. There are three major types of barriers to entry: economic, legal, and deliberate. Elasticity of demand: In a complete monopolistic market, the demand curve for the product is the market demand curve. There is only one firm within the industry. The monopolist is the sole seller, and its demand is the demand of the entire market. A monopolist is the price setter, but it is also limited by the law of market demand. If he/she sets a high price, the sales volume will inevitably decline; if they expand the sales volume, the price must be lowered, which means that the demand and price in the monopoly market move in opposite directions. Therefore, the demand curve faced by a monopoly is a downward-sloping curve or a negative slope. Since monopolists control the supply of the entire industry, they also control the price of the entire industry and become price setters. A monopolistic firm can have two business decisions: sell less output at a higher price or sell more output at a lower price. There are no close substitutes for the products of a monopolistic firm. Otherwise, other firms can produce substitutes to replace the monopoly firm's products, and a monopolistic firm cannot become the only supplier in the market. So consumers have no other choice. Economic barriers: Economic barriers include economies of scale, capital requirements, competitive advantages, de facto standards, network effects, strategic entry deterrence, switching barriers, vendor lock-in, vertical integration and technological superiority. Economies of scale: Decreasing unit costs for larger volumes of production. Decreasing costs coupled with large initial costs, If for example, the industry is large enough to support one company of minimum efficient scale then other companies entering the industry will operate at a size that is less than MES, and so cannot produce at an average cost that is competitive with the dominant company. And if the long-term average cost of the dominant company is constantly decreasing, then that company will continue to have the least cost method to provide a good or service.Frank (2009), p. 274. Capital requirements: Production processes that require large investments of capital, perhaps in the form of large research and development costs or substantial sunk costs, limit the number of companies in an industry:Samuelson & Marks (2003), p. 365. this is an example of economies of scale. Technological superiority: A monopoly may be better able to acquire, integrate, and use the best possible technology in producing its goods while entrants either do not have the expertise or are unable to meet the high fixed costs (see above) needed for the most efficient technology. Thus one large company can often produce goods cheaper than several small companies. No substitute goods: A monopoly sells a good for which there is no close substitute. The absence of substitutes makes the demand for that good relatively inelastic, enabling monopolies to extract positive profits. Control of natural resources: A prime source of monopoly power is the control of resources (such as raw materials) that are critical to the production of a final good. Network externalities: The use of a product by a person can affect the value of that product to other people. This is the network effect. There is a direct relationship between the proportion of people using a product and the demand for that product. In other words, the more people who are using a product, the greater the probability that another individual will start to use the product. This reflects fads and fashion trends,Pindyck and Rubinfeld (2001), p. 127. social networks, etc. It can also play a crucial role in the development or acquisition of market power. The most famous current example is the market dominance of the Microsoft Office suite and operating system in personal computers. Legal barriers: Legal rights can provide the opportunity to monopolize the market in a good. Intellectual property rights, including patents and copyrights, give a monopolist exclusive control of the production and sale of certain goods. Property rights may give a company exclusive control of the materials necessary to produce a good. Advertising: Advertising and brand names with a high degree of consumer loyalty may prove a difficult obstacle to overcome. Manipulation: A company wanting to monopolize a market may engage in various types of deliberate action to exclude competitors or eliminate competition. Such actions include collusion, lobbying governmental authorities, and force (see anti-competitive practices). First-mover advantage: In some industries, such as electronics, the pace of product innovation is so rapid that the existing firms will be working on the next generation of products whilst launching the current ranges. New entrants are destined to fail unless they have original ideas or can exploit a new market segment. Monopolistic price: It may be possible for existing firms to ride on the existence of abnormal profit by what is called entry limit pricing. This involves deliberately setting a low price and temporarily abandoning profit maximization in order to force new entrants out of the market.