Monopoly

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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. ^[1]

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).

1 Economic analysis
2 Historical examples of alleged de facto monopolies
3 Notes and references
4 Companies that are alleged monopolists
5 See also
6 External links

[edit] Economic analysis

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[edit] Primary characteristics of a monopoly

Single seller

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.

[edit] Price setting for unregulated monopolies

Surpluses and deadweight loss created by monopoly price setting

In economics a firm 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.

[edit] 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) $P (Q)$ 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 maximization:

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

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

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 maximization).

This procedure assumes that the monopolist knows exactly the demand function. ^[2]

[edit] 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.

[edit] Historical examples of alleged de facto monopolies

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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-organized security for transport, storage and highly monopolized 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 monopolized 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.

Other examples:

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.

[edit] Notes and references

^ Blinder, Alan S, William J Baumol and Colton L Gale (June 2001). “11: Monopoly”, Microeconomics: Principles and Policy (paperback) (in english), Thomson South-Western, 212. Retrieved on October 2006. “A pure monopoly is an industry in which there is only one supplier of a product for which there are no close substitutes and in which is very difficult or impossible for another firm to coexist”
^ For a discussion on a monopolist who does not know the demand function, see [1] where a free software is available as well.