Monopoly

The monopolist as depicted by Puck magazine in 1909

The dismal science Economics

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A Monopoly is a state of market competition when there is only one supplier of a particular good or service.

Theory

A monopoly exists when there is only one company or entity supplying some product on the market. Economists view monopolies as inefficient because they face no competition, and can thus charge higher prices (PM) than the market rate otherwise might be (PC). They also tend to reduce output as well. This creates a large amount of deadweight loss and enhances producer surplus at the expense of consumer surplus. Monopolies may not always be a bad thing. They can take advantage of economies of scale and keep prices low, at least for a while. The economist Joseph Schumpeter suggested monopolies could have advantages, such as the ability to conduct more research than other smaller firms do relative to their size.

But what causes a monopoly? There are at least two answers for this question. The first is thesize of the minimum efficient scale (MES), the level of output that minimizes average cost, relative to the size of demand. In competitive markets, there is room for many firms, each charging, while in monopolistic markets, only one firm can make positive profits.

In other words, the shape of the average cost curve, dictated by the basic technology employed, is an important aspect in determining whether the market will function competitively or monopolistically. If the minimum efficient production scale – the level of production that minimizes average costs – is small relative to the size of the market, we can expect competitive conditions to prevail.

It is important to mention that this statement is relative: what matters is the relationship between scale and market size.There isn't much to do about the minimum scale of efficiency, as it is determined by technology. But economic policy can influence market size. If a country chooses a non-restrictive foreign trade policy, so that domestic companies face foreign competition, these companies will have much less ability to influence prices. On the contrary, if a country adopts a restrictive foreign trade policy, which limits the size of the market for that country, the occurrence of monopolistic practices will become more likely.

The second reason why monopolies might occur is when firms collude as cartels, restricting their output in order to raise prices and thereby increase their profits.

Problems caused by monopolies

Ineffiency and deadweight losses

Monopolies cause deadweight losses.

While competitives companies operate at a point where price equals marginal cost, the monopolized firms operates where price is greater than marginal cost. As a result, in general, the price will be higher and the output lower when the firm behaves monopolistically rather than competitively. As a result, consumers will generally be worse off in an industry organized as a monopoly than in one organized competitively, since they won't pay the price for these goods and services. And why don't the monopolistic producers increase the production and/or lower the prices, so it can sell to these consumers? Because, to do so, it would have to lower the price to everyone, which would end up lowering its profits instead.

In other words, since a monopolist charges a price in excess of marginal cost, it will produce an inefficient amount of output. The size of the inefficiency can be measured by the deadweight loss – the net loss of consumers’ and the producer’s surplus.

Political economy

The amount of market power an unaccountable private firm may have coupled with the political influence it can gain is often deemed as something dangerous to free enterprise and democracy.

Examples

Contrary to popular belief, firms with substantial monopoly power are rare, since few goods are actually unique and don't have similar substitutes. Globally, the De Beers Mining company is thought of as the closest thing to a genuine international monopoly that has ever existed. From the 1940s to 1970s world oil was dominated by the "Seven Sisters" a small cartel of private oil producers. Since the mid-1970s OPEC has come to dominate world oil production and state-run energy enterprises have taken on a much greater burden of oil production. Despite coming close, and sometimes being referred to as monopolies, neither the Seven Sisters nor OPEC are true monopolies; rather, they are closer to oligopolies.

Government response

There are many answers to the monopoly problem. Unsurprisingly, all of them have advantages and shortcomings.

Increasing competition with antitrust laws

One of the most commons ways to fight monopolies is with antitrust laws, such as the Sherman Act, in the US. The antitrust laws give the government various ways to promote competition, such as preventing merges, allowing the government to break up a large company into a group of smaller ones and preventing companies from coordinating their activities in ways that make markets less competitive.

They do have, however, costs. Companies will often merge not to reduce competition but to lower costs through a more efficient joint production. For example, many U.S. banks have merged over the last few years, and by combining operations, have been able to reduce administrative expenses. If antitrust laws are to raise social welfare, the government must be able to determine which mergers are desirable and which are not. It is often hard for the government to perform the necessary cost–benefit analysis with sufficient accuracy.

Regulation

Governments can also deal with monopolies with regulations, especially with natural monopolies. One example of this regulation is when the government set prices for water and electric companies. Natural monopolies have declining average total cost. If the government sets a price equal to marginal cost, that price would be less than the firm’s average total cost and the firm would end up losing money. Instead of charging such a low price, the monopoly firm would just exit the industry. There are some ways to answer to this problem, but all of them also have problems. The government can subsidize the monopolistpicking up the losses inherent in marginal-cost pricing. Yet to pay for the subsidy, the government needs to raise money through taxation, which itself generates deadweight losses, the same problem that monopolies produce.

Public ownership

Another solution that the government uses to deal with monopoly is public ownership. In other words, rather than regulating a natural monopoly run by a private firm, the government can run the monopoly itself. The problem of this solution is the fact that private owners have an incentive to minimize costs as long as they reap part of the benefit in the form of higher profit. If the firm’s managers do a bad job of keeping costs down, the firm’s owners will fire them. On the other hand, if the government bureaucrats who run a monopoly do a bad job, the losers are the customers and taxpayers, whose only recourse is the political system. The bureaucrats may become a special-interest group and attempt to block cost-reducing reforms. Put simply, as a way of ensuring that firms are well run, the voting booth is less reliable than the profit motive.

Doing nothing

Some economists argue that it is often best for the government not to try to remedy the inefficiencies of monopoly pricing, as the government will often makes things worse.

According to Nobel Memorial Prize laureate George Stigler:

A famous theorem in economics states that a competitive enterprise economy will produce the largest possible income from a given stock of resources. No real economy meets the exact conditions of the theorem, and all real economies will fall short of the ideal economy—a difference called "market failure." In my view, however, the degree of "market failure" for the American economy is much smaller than the "political failure" arising from the imperfections of economic policies found in real political systems. The merits of laissez-faire rest less upon its famous theoretical foundations than upon its advantages over the actual performance of rival forms of economic organization.

Natural monopoly

Waste disposal tends to be a natural monopoly.

A natural monopoly is one that is considered unavoidable, or almost so. Often it can take advantage of economies of scale, supplying a large number of customers something as average costs decrease with each additional unit of output. Utilities (gas, water, electric, sewage) are generally thought of as natural monopolies. Multiple competing sewage networks in the same dense urban environment is simply impractical. At the same time, because of the costs of building a sewage network and extending it to remote rural areas with small populations who wouldn't be able to reimburse the firm, utilities often end up being government-owned or heavily regulated in most communities. In some instances it may be more costly to have competition and so having one firm provide everything is seen as more natural.

Government-granted monopoly

Occasionally governments and societies want monopolies and will grant them to firms. One of the most common types of government granted monopolies are patents - intellectual property that gives one firm the exclusive right to sell a certain type of product. Pharmaceutical patents are a common example. Because the costs of producing a new drug are often very high, governments are typically willing to allow the company a period of exclusivity. While this does mean the drug will be more expensive, the patent serves as an incentive to encourage innovation. Controversially, pharmaceuticals companies often argue the need for strong patent laws, while consumers and some economists have suggested alternatives. In communist countries like the Soviet Union, virtually every enterprise was a state-owned monopoly.

As previously mentioned, utilities are often government monopolies. Governments may use contracts with private firms to get them to achieve some socially-beneficial goal, like ensuring that even people in the remote outskirts of a city or town can still have water or electricity. By granting a power-company a monopoly on providing electricity or telephone service in a city, the government does give them a large amount of power. Via regulation or contract, however, the government will often manage prices to ensure the firm does not abuse its privileged position.

In the Age of Discovery, the kingdoms of Iberia (Spain and Portugal) set up trading monopolies for themselves, declaring that they had exclusive rights to exploit resources (precious metals and human resources) and to plunder in Asia, Africa, and the Americas. This had the effect of encouraging French, Dutch, and English pirates/privateers, smugglers, and colonists to disrupt the market in the interests of international fairness.

See also

• Perfect competition
• Oligopoly
• Microsoft: Accused of anti-competitive practices.