Monopoly (Economics) - Explained
What is a Economic Monopoly?
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What is a Monopoly?
A monopoly is a term used to refer to a market structure, where one entity, like a company, dominates the market with its products or services. Monopoly comes into existence when there is extreme free-market capitalism. In free-market capitalism, there are usually no restrictions. A single company can enlarge, hence dominating the entire market with a given product or service.
Generally, the motive of monopolists is to maintain high profits in the long run. However, under perfect competition, this becomes a rare case. In case of abnormal profits in such markets, many new firms will find their entry into the market, hence bringing stiff competition. Once the competition is in the market, it gets rid of the abnormal profits that monopolists have been enjoying.
How Monopolies Arise
In a monopoly market, competition does not exist as one seller dominates the market. That single seller becomes the sole seller of a particular product, and in most cases, there are usually no close substitutes for his product or service. Also, there are so many restrictions related to market entry, ranging from government license, copyright/patent, ownership of resources, as well as high costs of starting a business. All these factors restrict new entry into the market hence encouraging monopoly. In addition, monopoly firms possess specific information, that other firms dont have, a situation that gives them a competitive advantage over other firms. Generally, in a monopoly market, a single entity controls the market, and this includes determining the prices of goods and services. The entity also enjoys the liberty of setting a price to its goods and services. It means that it can single-handedly influence the prices of products and services in the market. Generally, monopolies are known to be big businesses. However, it is worth noting that size is not one of the characteristics that define a monopoly. Remember, a small business can still monopolize the market where it has the power to raise prices of goods and services in a small market or industry. A monopoly is the ability of an entity to take full control of the market regardless of its size.
Characteristics of a Monopoly Market
The following are typical characteristics that define a monopoly market:
- Lack of substitutes: In a monopoly market, a single firm produces a product or offers a service that has no close substitutes. The products are usually exceptional (unique).
- Price Maker: Monopolists are the ones who decide how much a product or service should cost in a given market. In other words, they are price setters, and consumers are usually at their mercy.
- High barriers to entry: A monopoly is also characterized by barriers to market entry. There are regulations that restrict the entry of new firms into a monopoly market. The restrictions ensure that monopolists do not face any competition and that they continue to enjoy control over the market.
- Price discrimination: In a monopoly market, sellers are at liberty to change prices and quantity their products and services at any given time. For instance, if the demand for a given product increases, the monopolists are likely to revise the price of that particular product upwards. Generally, price changes are always as a result of market conditions.
- Single seller: A monopoly market is always served by one seller. It means that a single business entity is the same as the market it serves. In this type of market, one business entity is the sole producer of all the output for a good or service.
- Profit maximizer: The motive that guides monopolists is revenue maximization. They do this either by increasing the prices of their products and services in the market or expanding their production scales.
Sources of Monopoly Power
In a market an individual's power to control the market is generated by specific sources. Some of these sources include:
- Capital requirement
- Network externalities
- Control of natural resources
- Economies of scale
- The existing legal barriers
- Lack of substitute goods or services
- Technological superiority
- Deliberate actions
Reasons why Monopolies are Illegal
Monopolies are illegal because of the following reasons:
- Due to the lack of competition in the market, monopolists produce inferior products and services to consumers, a behavior that can be termed as corrupt
- A monopoly leads to exaggerated costs on products and services, a move that exploits consumers. It also denies consumers the right to use a competitor.
- Also, in a monopoly market, sellers create artificial scarcities to enable them to fix prices and circumvent the existing laws of supply and demand
Antitrust Laws and Consumer Protection
To limit monopolies in the market, the Sherman Antitrust Act was passed in 1980 by the U.S. Congress. It was the first legislation law to pass that put a limit to monopolies. The act got strong support from the Congress members through votes where there were 51votes against 1. The same law also passed in the House of Representatives unanimously with 242 votes against 0. There were two additional antitrust laws introduced in 1914, which got the support of the Congress. The enactment of the two laws was for the purpose of protecting consumers and preventing monopolies. There was an establishment of new rules under the Clayton Antitrust Act that applied to mergers and corporate. The rules gave specific example practices that would be considered a violation of Shermans Act. There is also another act known as the Federal Trade Commission established by the Federal Trade Commission. The act sets business-standard practices and also enforces the other antitrust acts. All this is done in conjunction with the Antitrust Division of the United States Department of Justice. The laws are intentionally established so as to help preserve competition and also give small companies opportunities to enter the market.
- Market Structure
- Perfect Competition
- Bidding War
- Substitution Effect
- Imperfect Competition
- Market Power
- Price Takers
- Price Makers
- Perfect Competition and Decision Making
- Captive Market
- Contestable Market Theory
- Highest Profit Point in a Perfectly Competitive Market
- Using Marginal Revenue and Marginal Costs to Maximize Profit
- Marginal Revenue Curve
- Profit Margin and Average Total Cost
- Break Even Point - Cost Curve
- Shutdown Point - Cost Curve
- Short-Run Decisions Based Upon Costs in a Perfectly Competitive Market
- Marginal Costs and the Supply Curve for a Perfectively Competitive Firm
- Decisions to Enter or Exit a Market in the Long Run
- Long-Run Equilibrium in a Perfectly Competitive Market
- Constant, Increasing, and Decreasing Cost Industries
- Productive and Allocative Efficiency in Perfectly Competitive Markets
- Market Efficiency
- Market Inefficiency
- Pareto Efficiency
- Search Theory
- Natural Monopoly
- Legal Monopoly
- Bilateral Monopoly
- Promoting Innovation through Intellectual Property
- Predatory Pricing
- How Monopolists Set Price with the Demand Curve
- Total Cost and Total Revenue for a Monopolist
- Marginal Revenue and Marginal Cost for a Monopolist
- Inefficiency of Monopoly
- Perfectly Competitive Market
- Monopolistic Competition
- Differentiated Products
- Perceived Demand for a Monopolistic Competitor
- Monopolistic Competitors Choose Price and Quantity
- Monopolistic Competitors and Entry
- Monopolistic Competition and Efficiency
- Cartel (Economics)
- Game Theory
- Traveler's Dilemma
- Prisoner's Dilemma
- Iterated Prisoner's Dilemma
- Nash Equilibrium
- Diner's Dilemma
- Trembling Hand Perfect Equilibrium
- Gambler's Fallacy
- Arrows Impossibility Theorem
- Backward Induction
- Tournament Theory
- Oligopoly and the Prisoner’s Dilemma
- Forcing Cooperation in a Prisoner’s Dilemma
- Cooperation and the Kinked Demand Curve
- Corporate Merger or Acquisition
- Antitrust Laws
- Herfindahl-Hirschman Index
- Concentration Ratio
- Other Approaches to Measuring Monopoly Power in an Industry
- Restrictive Practices under Antitrust Law
- Natural Monopoly
- Cost-Plus Regulation
- Price Cap Regulation
- Regulatory Capture