A Monopoly is the exclusive and complete control (as by a business) of a product, service, or invention that makes it possible to control prices. (WordReference.com)
In economics, a monopoly is a market structure characterized by a single seller selling a unique product or service in the market. In a monopoly, the seller faces no competition, as he is the only seller of goods without substitutes.
In economics, we have a monopoly when a company or group of companies become so much big and powerful, that with its offerings is able to dominate an entire economic sector. This degree of exclusivity makes it almost impossible for any other company that tries to provide a similar product or service to enter the market.
Table of Contents
The main characteristics of the monopoly are the presence of a single seller, who is the one that produces all the output and therefore that serves the entire market, which makes the company the whole industry.
This concentration of the production in the hand of one company or group of companies creates high barriers to entry which will allow the monopolist to consolidate its central position.
Moreover, given that the monopolist is the only supplier, this makes it a price maker and profit maximizer, because it can set the price of the product or services it produces by determining the quantity to produce, and with price discrimination, monopolists are able to increase their profits by charging higher prices to those that are willing (or able) to pay more for the same goods or services.
How companies become monopolies
There is no single way to create monopolies, there are different processes that can lead a company or group to become so big that becomes the only supplier in a specific industry.
Most of these processes are linked to government activities, like when the government grants to a company the exclusive rights to provide certain goods or services.
Another way to create a monopoly may be through the nationalization of companies, it consists of the government taking control over a business or an entire industry.
Intellectual property can also lead to the creation of new monopolies, mainly because the law has to protect it and therefore the owner of that property have monopoly power over it.
Finally, monopolies can be created also through mergers and acquisitions, because bigger players are able to use economies of scale in order to lower their costs and therefore supply their products or services at lower prices than the competition, putting them out of business.
Monopoly vs Competitive markets
Monopoly and perfect competition are two different market structures that are positioned at the extremes, and they differentiate themselves mainly for the market share, price control, and the barriers to entry.
In fact, the monopoly gives birth to an economic environment where there is one big company that supplies the entire market and has almost complete control over it.
While, at the same time, in competitive markets, there are several players of different dimensions that “compete” with each other, and every company has a specific market share.
The high degree of control that the monopolist has over its market gives him also great control over the price of the good or service that it sells, while in competitive markets if a company set a price that is higher than the market, that company will probably go out of business soon, because consumers will buy more from other suppliers.
Therefore we usually say that when there is perfect competition the supplier has no price control.
Finally, the barriers to entry in a competitive market are usually pretty low, while for a new company, to enter into a market where there is already a powerful monopolist is barely impossible due to the high barriers to entry.
These barriers can be created by the fact that the monopolist has a structure that is too big and allows him to set lower prices, or because it has exclusive patents or because it is the only one to have received from the state the permissions for carrying out certain activities.
Duopoly and Oligopoly
Related to monopoly we also find the duopoly and the oligopoly. The oligopoly is a market characterized by the presence of a small number of firms, where none of them is capable of having a significant influence, while the duopoly is similar to the monopoly but it is characterized by the presence of two big firms in the entire market as opposed to only one in the monopoly.
Lastly, in the middle between monopoly and perfect competition, we find a third model, the monopolistic competition, which is characterized by a combination of certain elements of both systems.
In monopolistic competition, many firms offer products or services that are similar to one another, but that are not perfect substitutes, therefore brand differentiation is important as a business strategy.
In fact, in monopolistic competition firms tend to advertise heavily, mainly because product differentiation tends to be low and all the products serve the same or similar purpose.
Therefore, for the average consumer is hard to understand which are the precise differences between the various products and what is the right price to pay for them.
A peculiarity that is similar to the pure monopoly market is the fact that firms in monopolistic competition are not “price takers”, on the contrary, they make their own prices, they are price makers.
However, if their market is characterized by a very elastic demand (when price or other factors have a big effect on the quantity that consumers decide to buy), in order to increase prices they also need to differentiate their products from those of their competitors.
Laws against monopoly
Many countries have laws that try to protect their internal markets from the creation of monopolies.
In fact, in many cases they are seen as negative for the consumers because with a monopoly is easy to see higher prices and lower quality of products and services purchased.
For example, Article 102 of the Treaty on the Functioning of the European Union which regulates dominance in the EU and aims at enhancing the consumer’s welfare and also the efficiency of allocation of resources by protecting competition on the downstream market.
However, is important to note that competition laws are not intended to make illegal the mere fact of having a monopoly. In fact, the law wants to fight the abuse of power that having a monopoly confer, like through exclusionary practices.
In addition, it is usually considered illegal in many legal systems to obtain a monopoly by adopting certain illegal behaviors, like buying out the competition.