Monopoly

What Is Monopoly?

Monopoly is a market structure characterized by a single seller who has exclusive control and dominance over a particular good or service.

This market power allows the monopolistic seller to dictate prices and restrict competition, resulting in limited choices and potentially higher consumer prices.

Monopoly

Monopoly Explanation | Source: Investopedia

Types of Monopoly

There are different types of monopolies:

  1. Pure Monopoly: This occurs when there is only one seller in the market for a specific good or service. For instance, a water company that supplies water to all households in a city would be considered a pure monopoly.
  2. Natural Monopoly: This type of monopoly arises when economies of scale enable a single firm to supply the entire market at a lower average cost than multiple firms. An example of a natural monopoly is the electricity industry, where it is most efficient for one company to provide electricity to a region.
  3. Legal Monopoly: A legal monopoly is granted by the government. It includes situations where patent rights are awarded to inventors to encourage research and development. Additionally, broadcast, cable, and telecommunications companies may be issued licenses. Legal monopolies are established when the government determines that the benefits outweigh the costs.

Market Equilibrium in the Presence of a Monopoly

In a monopoly, equilibrium is reached when the marginal cost (MC) curve intersects the marginal revenue (MR) curve from below, indicating equality.

There are three possible outcomes for a firm’s equilibrium in a monopoly:

  1. Normal Profits: The firm makes expected profits when the average cost equals the average revenue.
  2. Super-normal Profits: The firm earns super-normal profits if the average cost is lower than the average revenue.
  3. Losses: The firm incurs losses when the average cost exceeds the average revenue.

Determinants of a Monopoly’s Demand Curve

In real-world scenarios, the demand curve of a monopoly may exhibit the following variations:

  • Inelastic Demand: In industries with few buyers and few substitute products, demand remains relatively constant at both high and low prices. Monopolies often have price-inelastic demand due to the presence of high barriers to entry.
  • Price Elasticity of Demand: In industries with many buyers and numerous substitute products, demand changes with price variations. When prices are raised, demand decreases, and vice versa.

Conditions for Monopoly

To be considered a monopoly, a firm must meet three essential characteristics:

  1. Barriers to Entry: A monopoly arises when one company possesses a significant advantage over potential competitors. In a monopoly, there is only one seller of a particular product or service.
  2. Barriers to Exit: A firm may exit the market by closing its business or selling it to another company.
  3. Differentiated Product: Monopolies often result from the low differentiation of products found in perfect competition markets. Differentiation can be achieved through various characteristics such as price, quality, or features. For example, Apple products differentiate themselves through their unique quality and features.

Monopoly vs. Oligopoly and Competition

There are key differences between monopoly, oligopoly, and perfect competition:

  • Monopoly: In a monopoly, there is only one seller, significant barriers to entry and exit, and the firm has control over pricing.
  • Oligopoly: An oligopoly consists of a few sellers, relatively high entry and exit barriers, and limited pricing control.
  • Perfect Competition: In perfect competition, there are many firms, no barriers to entry or exit, and firms have no control over prices.

What Is Monopolistic Competition?

The monopolistic competition combines features of both monopoly and competitive markets. It has the following characteristics:

  • Many Sellers: Like competitive markets, monopolistic competition involves numerous sellers.
  • Barriers to Entry: Some barriers may exist, making it difficult for certain firms to enter the market due to factors such as economies of scale or government regulations.
  • Control over Quantity, Not Price: Firms in monopolistic competition control the quantity of goods produced but not the prices, which are influenced by market forces.