Monopoly

This article is about the state of a player in economics. For the Parker Brothers board game see Monopoly (game).

In economics, a monopoly (from the Latin word monopolium - Greek language monos, one + polein, to sell) is defined as a persistent market situation where there is only one provider of a product or service. Monopolies are characterized by a lack of economic competition for the good or service that they provide and a lack of viable substitute goods.

Monopoly should be distinguished from monopsony, in which there is only one buyer of the product or service; it should also, strictly, be distinguished from the (similar) phenomenon of a cartel. In a monopoly a single firm is the sole provider of a product or service; in a cartel a centralized institution is set up to partially coordinate the actions of several independent providers (which is a form of oligopoly).

Forms of monopoly

Monopolies are often distinguished based on the circumstances under which they arise; the broadest distinction is between monopolies that are the result of government intervention and those that arise without it e.g. sole access to a resource, economies of scale, or consistently outcompeting all other firms. Thus the two broadest categories are de jure monopoly (also called legal monopoly and statutory monopoly) which is one that is protected from competition by government, and de facto monopoly which is one that exists without government protection.

Legal monopoly, statutory monopoly, or de jure monopoly

Main article: legal monopoly

A form of monopoly based on laws explicitly preventing competition is a legal monopoly or de jure monopoly. When such a monopoly is granted to a private party, it is a government-granted monopoly; when it is operated by government itself, it is a government monopoly or state monopoly. A government monopoly may exist at different levels (eg just for one region or locality); a state monopoly is specifically operated by a national government.

An example of a monopoly is AT&T, which was granted monopoly power by the US government, only to be broken up in 1982 following a Sherman Antitrust suit. Another example is the United States Post Office which has a legally protected monopoly on nonurgent letter mail delivery.

In many countries, almost all public utilities operate as monopolies granted by state and local governments. These include electricity, water, sewer, natural gas, cable television, and telephone services. It is believed by some that these services must be provided through legal monopoly because the costs to a nation or economy to have multiple providers is greater than the cost of only having one provider (see natural monopoly). For example, it is claimed that the cost of running dual water lines to every home in a community would be a waste of resources.

Governments grant legal monopolies in the form of patents, trademarks, and copyrights. Holders of these de jure monopolies enjoy the protection of federal law when marketing or licensing the products and services to which they apply.

Laws Against Monopolies

The barriers for business or organizations to become a monopoly are great. There are two acts in the United States that have attempted to "prevent," or slow down potential monopolies: The Sherman Anti-Trust Act and the Clayton Act. The Sherman Anti-Trust Act was the first U.S. federal government action to limit monopolies. It was enacted on July 2, 1890. The Clayton Anti-Trust Act was enacted in 1914 to remedy deficiencies in anti-trust law created under the Sherman Anti-Trust Act that allowed corporations to dissolve labor unions. The Clayton Act filled in the gaps of the Sherman Anti-Trust Act by preventing price discriminations, and from people being involved in two competing organizations.

Efficiency monopoly

An efficiency monopoly (or monopoly of efficiency) exists because one firm is doing such a good job at satisfying consumers, that no one is willing to buy competing products offered by other firms.

Natural monopoly

Main article: Natural monopoly

The term natural monopoly is used to refer to two different things. This has been a source of some ambiguity in discussions of "natural monopoly." The two definitions follow:

• An industry is said to be a natural monopoly if one firm can produce a desired output at a lower cost to the industry than two or more firms. Unlike in the ordinary understanding of a monopoly, a natural monopoly situation does not mean that only one firm is providing a particular kind of good or service. Rather it is the assertion about an industry, that multiple firms providing a good or service is less efficient (more costly to a nation or economy) than would be the case if a single firm provided a good or service. There may, or may not be, a single supplier in a natural monopoly industry. Claims of natural monopoly are often used to justify the creation of statutory monopolies, where government prohibits competition by law. Examples of claimed natural monopolies include telecommunications, water services, electricity, and mail delivery.

• An industry is said to be a natural monopoly if only one firm is able to survive in the long run, even in the absence of legal regulations or "predatory" measures by the monopolist. " It is said that is the result of high fixed costs of entering an industry which causes long run average costs to decline as output expands (private economies of scale).

Local monopoly

A local monopoly is a monopoly of a market in a particular area, usually a town or even a smaller locality: the term is used to differentiate a monopoly that is geographically limited within a country, as the default assumption is that a monopoly covers the entire industry in a given country. This may include the ability to charge (to some extent) monopoly pricing, for example in the case of the only gas station on an expressway rest stop, which will serve a certain number of motorists who lack fuel to reach the next station and must pay whatever is charged.

Coercive monopoly

Main article: coercive monopoly

In economics and business ethics, a coercive monopoly is the exclusive control over a vitally needed resource, good, or service such that the community is at the mercy of the controller. In such a situation the monopolist is able to make pricing and production decisions independent of competitive forces because all potential competition is barred from entering the market. A coercive monopoly may be result of legal prohibitions against competition by the establishment of a statutory monopoly. Or it may result from private coercive activity.

Horizontal versus vertical monopoly

Large corporations often attempt to monopolize markets through horizontal integration, in which a parent company consolidates control over several small, seemingly diverse companies (sometimes even using different branding to create the illusion of marketplace competition). Such a monopoly is known as a horizontal monopoly. A magazine publishing firm, for example, might publish many different magazines on many different subjects, but it would still be considered to engage in monopolistic practices if the intent of doing this was to control the entire magazine-reader market, and prevent the emergence of competitors. A monopoly arrived at through vertical integration is called a vertical monopoly. A common example is vertical integration of electricity distribution with electricity generation, which is common because it reduces or eliminates certain costly risks.

Economic analysis

Primary characteristics of a monopoly

• Single Sellers

A pure monopoly is an industry in which a single firm is the sole producer of a good or the sole provider of a service. This is usually caused by barriers to entry.

• No Close Substitutes

The product or service is unique in ways which go beyond brand identity, and cannot be easily replaced (a monopoly on water from a certain spring, sold under a certain brand name, is not a true monopoly; neither is Coca-Cola, even though it is differentiated from its competition in flavor).

• Price Maker

In a pure monopoly a single firm controls the total supply of the whole industry and is able to exert a significant degree of control over the price, by changing the quantity supplied (an example of this would be the situation of Viagra before competing drugs emerged). In subtotal monopolies (for example diamonds or petroleum at present) a single organization controls enough of the supply that even if it limits the quantity, or raises prices, the other suppliers will be unable to make up the difference and take significant amounts of market share.

• Blocked Entry

The reason a pure monopolist has no competitors is that certain barriers keep would-be competitors from entering the market. Depending upon the form of the monopoly these barriers can be economic, technological, legal (e.g. copyrights, patents), violent (competing businesses are shut down by force), or of some other type of barrier that completely prevents other firms from entering the market.

Price setting for unregulated monopolies

diagram showing how a monopoly sets prices

In economics a company is said to have monopoly power if it faces a downward sloping demand curve (see supply and demand). This is in contrast to a price taker that faces a horizontal demand curve. A price taker cannot choose the price that they sell at, since if they set it above the equilibrium price, they will sell none, and if they set it below the equilibrium price, they will have an infinite number of buyers (and be making less money than they could if they sold at the equilibrium price). In contrast, a business with monopoly power can choose the price they want to sell at. If they set it higher, they sell less. If they set it lower, they sell more.

In most real markets with claims, falling demand associated with a price increase is due partly to losing customers to other sellers and partly to customers who are no longer willing or able to buy the product. In a pure monopoly market, only the latter effect is at work, and so, particularly for inflexible commodities such as medical care, the drop in units sold as prices rise may be much less dramatic than one might expect.

If a monopoly can only set one price it will set it where marginal cost (MC) equals marginal revenue (MR) as seen on the diagram on the right. This can be seen on a big supply and demand diagram for many criticism of monopoly. This will be at the quantity Qm; and at the price Pm;. This is above the competitive price of Pc and with a smaller quantity than the competitive quantity of Qc. The offensive monopoly gains is the shaded in area labeled profit (note that this diagram looks only at the case where there is no fixed cost. If there were a fixed cost, the average cost curve should be used instead).

As long as the price elasticity of demand (in absolute value) for most customer is less than one, it is very advantageous to increase the price: the seller gets more money for less goods. With an increase of the price, the price elasticity tends to rise, and in the optimum mentioned above it will be above one for most customers. A formula gives the relation between price, marginal cost of production and demand elasticity which maximizes a monopoly profit: ${\frac {P}{MC}}={\frac {1}{1+1/e}}$ (known as Lerner index). The monopolist's monopoly power is given by the vertical distance between the point where the marginal cost curve (MC) intersects with the marginal revenue curve (MR) and the demand curve. The longer the vertical distance, (the more inelastic the demand curve) the bigger the monopoly power, and thus larger profits.

The economy as a whole loses out when monopoly power is used in this way, since the extra profit earned by the firm will be smaller than the loss in consumer surplus. This difference is known as a deadweight loss.

Calculating monopoly output

The single price monopoly profit maximisation problem is as follows:

The monopoly's profit is its total revenue less its total cost. Let the price it sets as a market response be a function of the quantity it produces (Q) $P(Q)$ and let its cost function be as a function of quantity $C(Q)$. The monopoly's revenue is the product of the price and the quantity it produces. Hence its profit is:

$\Pi \ =P(Q)\cdot Q-C(Q)$

Taking the first order derivative with respect to quantity yields:

${\frac {d\Pi \ }{dQ}}=P'(Q)\cdot Q+P(Q)-C'(Q)$

Setting this equal to zero for maximisation:

${\frac {d\Pi \ }{dQ}}=P'(Q)\cdot Q+P(Q)-C'(Q)=0$

${\frac {d\Pi \ }{dQ}}+C'(Q)=P'(Q)\cdot Q+P(Q)=C'(Q)$

i.e. marginal revenue = marginal cost, provided

${\frac {d^{2}\Pi \ }{dQ^{2}}}=P''(Q)\cdot Q+2\cdot P'(Q)-C''(Q)<0$

(the rate of marginal revenue is less than the rate of marginal cost, for maximisation).

This procedure assumes that the monopolist knows exactly the demand function.

Monopoly and efficiency

In standard economic theory (see analysis above), a monopoly will sell a lower quantity of goods at a higher price than firms would in a purely competitive market. In this way the monopoly will secure monopoly profits by appropriating some or all of the consumer surplus, as although the higher price deters some consumers from purchasing, most are willing to pay the higher price. Assuming that costs stay the same, this does not lead to an outcome which is inefficient in the sense of Pareto efficiency; no-one could be made better off by shifting resources without making someone else worse off. However, total social welfare declines compared with perfect competition, because some consumers must choose second-best products.

It is also often argued that monopolies tend to become less efficient and innovative over time, becoming "complacent giants", because they don't have to be efficient or innovative to compete in the marketplace. Sometimes this very loss of efficiency can raise the potential value of a competitor enough to overcome market entry barriers, or provide incentive for research and investment into new alternatives. The theory of contestable markets argues that in some circumstances (private) monopolies are forced to behave as if there were competition, because of the risk of losing that monopoly to new entrants. This is likely to happen where a market's barriers to entry are low. It might also be because of the availability in the longer-term of substitutes in other markets. For example, a canal monopoly in the late eighteenth century United Kingdom was worth a lot more than in the late nineteenth century, because of the introduction of railways as a substitute.

Some argue that it can be good to allow a firm to attempt to monopolize a market, since practices such as dumping can benefit consumers in the short term; and once the firm grows too big, it can then be dealt with via regulation. (This is a rather optimistic view of how effectively regulation can substitute for competition.) When monopolies are not broken through the open market, often a government will step in to either regulate the monopoly, turn it into a publicly owned monopoly, or forcibly break it up (see Antitrust law). Public utilities, often being natural monopolies and less susceptible to efficient breakup, are often strongly regulated or publicly owned. AT&T and Standard Oil are debatable examples of the breakup of a private monopoly. When AT&T was broken up into the "Baby Bell" components, MCI, Sprint, and other companies were able to compete effectively in the long-distance phone market and started to take phone traffic from the less efficient AT&T.

The mathematician Harold Hotelling came up with Hotelling's law which showed that there exist cases where monopoly has advantages for the consumer. If there is a beach where customers are distributed evenly along it, an entrepreneur setting up an ice cream stand would naturally place it in the middle of the beach. A competing ice cream seller would do best to place his competing ice cream stand next to it to gain half the market share, but two stalls right next to each other is not an ideal situation for the people on the beach. A monopolist who owns both stalls on the other hand, would distribute his ice cream stalls some distance apart.

Historical examples of alleged de facto monopolies

• Salt; until common salt (sodium chloride) was mined in quantity in comparatively recent times, its availability was subject to the vagaries of climate and environment. A combination of strong sunshine and low humidity or an extension of peat marshes was necessary for winning salt from the sea - the most plentiful source - by solar evaporation or boiling. Mines server and inland salt springs being scarce and often located in hostile areas like the Dead Sea or the salt mines in the Sahara desert, they required well-organised security for transport, storage and highly monopolised distribution. Changing sea levels flooded many of these sources during certain periods and caused salt "famines" and communities were left to the mercy of those who monopolised these few inland sources. The "Gabelle", a notoriously high tax levied upon salt, played a role in the start of the French Revolution and is possibly the most cruel example in recent history. Anyone was allowed to purchase salt; however, strict legal controls were in place over who was allowed to sell and distribute salt. Advocates of laissez-faire capitalism, such as the Austrian school, maintain that a salt monopoly would never develop without such government intervention.
• Carnegie Steel Company
• Standard Oil (Jones; Eliot. The Trust Problem in the United States 1922. Chapter 5)
• National Football League [2] [3]
• Major League Baseball [4] [5]
• DeBeers control of the world diamond markets.

Companies that are alleged monopolists

• Microsoft [6] (Apple Computer and free OS's such as Linux are competitors)

See also

• Market form, Duopoly, Triopoly
• Perfect competition
• Competition regulator
• Monopsony
• Bilateral monopoly
• Oligopoly
• Free market
• The Long Tail
• Price discrimination
• zone pricing
• List of economics topics
• Cartel
• Revolution in monopoly theory

External links

• Monopoly by Elmer G. Wiens: Online Interactive Models of Monopoly (Public or Private) and Oligopoly