MONOPOLY
Pure monopoly: A market that has only one seller and many buyers. Pure monopoly is rare, but in most markets only a few firms compete with each other. So we better say pure monopoly as a market that has one seller and many buyers as idealized in most cases. This is not saying that it completely does not exit. Examples of monopoly: let us try to find some examples of near-monopolies if not pure monopolies.
Microsoft Corporation’s dominance in the PC operating system can be a good example here.
A local monopoly – where a firm is the only supplier in a given geographical area (however small the area is).
In monopoly, the firm does not necessarily have to be so big to have monopoly power – it has to be just large in relation to the relevant market. The only pay or cable TV, or dance club, or dance and drama theatre, or even a movie theatre in a small town is also a local monopoly.
Natural monopolies
Economies of scale may make it too costly for more than a few firms to supply the entire market. In some cases, economies of scale may be too large that it is. most efficient for single firm (natural monopoly) to supply the entire market. The minimum efficient scale of a producing firm or unit is large relative to the total market demand. We can say that a natural monopoly is a firm that can produce the entire output of the market at a cost that is lower than what it would be if there were many firms.
Some terms
- Monopsony: A market in which there is a single buyer. Because it is
a single buyer, the buyer has monopsony power that enables it to purchase a good for less than the price that would prevail in a competitive market. - Oligopsony: A market with only very few buyers.
- Market power: The ability by either the seller or buyer to affect price.
- Cartel: A group of firms coordinates decisions and acts as a monopolist (e.g. OPEC – Organization of
Oil Producing Countries)
Conditions of monopoly
- There is only one sellers – and many buyers
- The good being sold has no close substitutes (This means that buyers must buy from the monopolist or not at all)
- There are barriers (economic, legal, and deliberate) to entry that prevent others firms from entering the market and start to produce the good
Barriers to entry of firms
Economic barriers
Such barriers arise primarily from the nature of technology used in production.
- Production technology can be characterized by high fixed costs, size of the market and economies of scale, or network externalities and all this can discourage entry of new firms to compete with the monopolies.
- high fixed costs on entry prevent potential competitors from entering the sector on a small scale and expanding. It means therefore that competitors must invest large scale operation at the outset, which may be too risky – and therefore most firms do not enter this sector/ industry.
- is the size of the market relative to the minimum efficient scale if the firm. A market may too small for several firms to invest and operate in it efficiently. Therefore if several firms try to operate in this market, they will higher average costs. It is then left to only one firm – the monopolist – to serve and be able to efficient.
Legal barriers (also called natural barriers to entry):
- These barriers include copyrights (which protect creative works), patents (preventing other firms from using technological innovations – until the patent expires), trade marks (which protect brand names), and franchises and concessions (which directly prohibit entry).
- A firm may have a patent on the technology needed to produce a particular product. Until the patent expires, it is difficult, if not impossible, for other firms to enter the market. In US, patent protection allows a firm exclusive use of an invention for period usually covering 17 to 20 years – that is when the patent expires.
- Copyright. This, like the patent, is another legally created right that works in the same way as the, patent. A copy right can limit the sale to a single company of the copyrighted material – a book, music, or a computer software program.
- Government can give a license to a firm which can prevent new firms from entering the market – for some time – and it has mostly been done for telephone service, television broadcasting, etc.
Deliberate Barriers
Such barriers to entry by firms include physical, financial, and political intimidation of potential competitors. The monopolist may use both exclusionary practices and predatory pricing to discourage potential competitors.
- Exclusionary practices: where a monopolist gets its suppliers (example of essential raw materials) or distributors to agree not to sell goods or services to potential competitors.
- Predatory pricing: where a seller temporarily sets a price for its goods or services below cost in order to drive weaker competitors out of business.
Political
- In developing countries, a monopolist who is well-connected politically can secure political support not to allow competitors in its territory.
- It can obtain exclusive rights and other companies cannot be licensed in its industry.
Sources of monopoly power
Monopoly power is the ability to set prices above marginal cost and that amount by which price exceeds marginal cost depends on the elasticity of demand facing the firm i.e., the less elastic the firm’s demand curve, the more monopoly power that the firm has. The final determinant of the firm’s monopoly power is the firm’s elasticity of demand. Why do some firms face demand curves that are more elastic than those faced by other firms?
3 factors that determine a firm’s elasticity of demand:
- The elasticity of market demand: The market elastic of demand limits the potential for monopoly
power. This is because the firm’s own demand will be at least as elastic as market demand. - The number of firms in the market: in the market where there are many firms, it is unlikely that any
one firm will be able to affect price significantly. - The level interaction and competitive rivalry among the firms in the market: whether there only two
or three firms in the market, each will be unable to profitably raise price very much if the rivalry
among them is very aggressive – with each firm trying to capture as much of the market as it can.
Measures to control monopoly
- Taxation: The government can impose a tax discourage monopoly practices, and to take away part of the abnormal profits
- Anti-monopoly legislation (Anti-trust laws) – laws can be imposed to discourage monopoly creation (e.g. by some competitor companies merging to from one company that becomes a monopoly). The US has such laws.
- Government can deliberately subsidize companies wanting to compete with the monopolist
- Nationalization of monopolies: This is the extreme case where the government, in public interest, can nationalize such enterprises.
- Fixing prices of commodities that are being distributed by monopolies: This is again the extreme case where the government, in public interest, can fix prices for the commodities supplied by such enterprises.
- Government operating monopolies that provide basic services such as water, or hydro-electricity. In Kenya and Uganda, for a long time, these services were operated by a public entity.
