A monopoly (from Greek monos, one + polein, to sell) is defined as a persistent market situation where there is only one provider of a product or service, in other words a firm that has no competitors in its industry. Monopolies are characterized by a lack of economic competition for the good or service that they provide and a lack of viable substitute goods. ^[1]

Monopoly should be distinguished from monopsony, in which there is only one buyer of the product or service; monopolies often have monopsony control of a sector of a market. Likewise, monopoly should also be distinguished from the 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).

A government-granted monopoly, or legal monopoly is sanctioned by the state, often to provide a greater reward and incentive to invest in a risky venture. The government may also reserve the venture for itself, which is called a government monopoly.

It is argued in contemporary monopoly theory that if a monopoly is not protected from competition by government restrictions, then it is subject to potential competition and therefore is not able to gouge consumers without causing competitors to enter the field to take advantage of profit opportunities.

Economic analysis

Primary characteristics of a monopoly

• Single seller: For a pure monopoly to take place, only one company can be selling the goods or service. A company can have a monopoly on certain goods and services but not on others.
• No close substitutes: Monopoly is not merely the state of having control over a product; it also means that there are no close substitutes available that fill the same function as the monopolized good.
• Price maker: Because a single firm controls the total supply in a pure monopoly, it is able to exert a significant degree of control over the price by changing the quantity supplied.

Other common assumptions in modeling monopolies include the presence of multiple buyers (if the firm is the only buyer, it also has a monopsony), an identical price for all buyers, and asymmetric information.

These conditions mean that the company with monopoly does not undergo price pressure from competitors, because there are no competitors. However, it may face pricing pressure from potential competition; if the company raises prices too high, then other firms are enticed to begin competing with the monopoly if they are able to provide the same good, or a substitute good, at a lower price. ^[2] The idea that monopolies in markets with easy entry need not be regulated against is known as the "revolution in monopoly theory".

Price setting for irregulated monopolies

In economics, a firm is said to have monopoly power if it is not facing a horizontal demand curve (see supply and demand). This is in contrast to a price-taking firm which always faces a horizontal demand curve, and therefore sells little or nothing at prices above equilibrium. In contrast, a business with monopoly power can choose the price at which it wants to sell. If it sets a high price, it may sell less; if it sets a lower price, it will likely sell more; however, this difference is much smaller.

In most markets, falling quantity demanded 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. Therefore, the drop in units sold as prices rise may be much less dramatic than one might expect, especially for necessary commodities such as medical care. However, unless the monopoly is a coercive monopoly, there is also the risk of competition arising if the firm sets its prices too high.

If a monopoly can set only one price, it will produce a quantity where marginal cost (MC) equals marginal revenue (MR), as seen on the diagram at right. The monopolist will then set the highest price possible in which the quantity can be sold. It is above the competitive price (Pc) and below the competitive quantity (Qc). This is the optimal price as determined by supply and demand.

As long as the price elasticity of demand (in absolute value) for most customers is less than one, it is advantageous for a firm to increase its prices: it then receives more money for fewer goods. With a price increase, price elasticity tends to rise, and in the optimum mentioned above it will be greater than one for most customers. The following formula gives the relation among price, marginal cost of production and demand elasticity that maximizes a monopoly profit: where (e) is the negative elastic of demand. A monopoly's power is given by the vertical distance between the point at which the marginal cost curve (MC) intersects with the marginal revenue curve (MR) and the demand curve. The longer the vertical distance, (i.e., the more inelastic the demand curve) the greater the monopoly's power, and thus, the larger its profits.

The economy as a whole suffers when monopoly power is used in this way because the extra profit earned by the monopoly 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 maximization 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) and let its cost function be as a function of quantity . The monopoly's revenue is the product of the price and the quantity it produces. Hence its profit is:

Taking the first order derivative with respect to quantity yields:

Setting this equal to zero for maximization:

i.e. marginal revenue = marginal cost, provided

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

This procedure assumes that the monopolist knows the exact demand function. ^[3]

Monopoly and efficiency

According to 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: 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 that 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, overall social welfare declines, because some consumers must choose second-best products.

Negative aspects

It is often argued that monopolies tend to become less efficient and innovative over time, becoming "complacent giants", because they do not have to be efficient or innovative to compete in the marketplace. Sometimes this very loss of efficiency can raise a potential competitor's value 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 their 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, while worth a great deal in the late eighteenth century United Kingdom, was worth much less in the late nineteenth century because of the introduction of railways as a substitute.

Positive aspects

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 be dealt with via regulation. When monopolies are not broken through the open market, often a government will step in, either to 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 began to take phone traffic from the less efficient AT&T.

Hotelling's law

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.^[4]

The "natural monopoly" problem

A natural monopoly is defined as a situation in which production is characterized by falling long-run marginal cost throughout the relevant output range. In such situations, a policy of laissez-faire must result in a single seller. The conventional Paretian solution to market failure of this kind is public regulation (in the United States) or public enterprise (in the United Kingdom). Liberals reject both alternatives as being incompatible with important freedoms.^[5].

Historical monopolies

Common salt (sodium chloride) historically gave rise to natural monopolies. Until recently, 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. Changing sea levels periodically caused salt "famines" and communities were forced to depend upon those who controlled the scarce inland mines and salt springs, which were often in hostile areas (the Dead Sea, the Sahara desert) requiring well-organized security for transport, storage, and distribution. The "Gabelle", a notoriously high tax levied upon salt, played a role in the start of the French Revolution, when 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.

Examples of alleged and legal monopolies

• The salt commission, a legal monopoly in China formed in 758.
• British East India Company; created as a legal trading monopoly in 1600.
• Dutch East India Company; created as a legal trading monopoly in 1602.
• U.S. Steel; anti-trust prosecution failed in 1911.
• Standard Oil; broken up in 1911.
• National Football League; survived anti-trust lawsuit in the 1960s, convicted of being an illegal monopoly in the 1980s.
• Major League Baseball; survived U.S. anti-trust litigation in 1922, though its special status is still in dispute as of 2007.
• United Aircraft and Transport Corporation; aircraft manufacturer holding company forced to divest itself of airlines in 1934.
• American Telephone & Telegraph; telecommunications giant broken up in 1982.
• Microsoft; settled anti-trust litigation in the U.S. in 2001; fined by the European Commission in 2004, which was upheld for the most part by the Court of First Instance of the European Communities in 2007.
• De Beers; settled charges of price fixing in the diamond trade in the 2000s.
• Apple Inc., Accused of forming a Vertical Monopoly, with iPod, iTunes, iTunes Music Store, and the FairPlay DRM System.

Notes and references

Further reading

• Guy Ankerl, Beyond Monopoly Capitalism and Monopoly Socialism. Cambridge,Mass.: Schenkman Pbl., 1978. ISBN0870739387
• Impact of Antitrust Laws on American Professional Team Sports

See also

Market forms

• Monopolistic competition
• Duopoly
• Triopoly
• Monopsony
• Bilateral monopoly
• Oligopoly

Types

• Cartel
• Natural monopoly
• Monopolies of knowledge

Proposed benefits

• The Long Tail
• Economies of scale

Monopolistic practices

• Dumping
• Predatory pricing
• Price discrimination
• Zone pricing

General

• Creative destruction
• Free market
• List of economics topics
• Perfect competition
• Competition regulator

External links

• Monopoly: A Brief Introduction by The Linux Information Project
• Monopoly by Elmer G. Wiens: Online Interactive Models of Monopoly (Public or Private) and Oligopoly

Criticism

• Natural Monopoly and Its Regulation
• The Myth of the Natural Monopoly
• Natural Monopoly and Its Regulation