Monopoly

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This article is about the economic term. For the board game, see Monopoly (game). For other uses, see Monopoly (disambiguation).

In economics, a monopoly (from Greek monos , alone or single + polein , to sell) exists when a specific individual or enterprise has sufficient control over a particular product or service to determine significantly the terms on which other individuals shall have access to it.[1] Monopolies are thus characterized by a lack of economic competition for the good or service that they provide and a lack of viable substitute goods.[2] The verb "monopolize" refers to the process by which a firm gains persistently greater market share than what is expected under perfect competition.

A monopoly should be distinguished from monopsony, in which there is only one buyer of a product or service; a monopoly may also have monopsony control of a sector of a market. Likewise, a monopoly should be distinguished from a cartel (a form of oligopoly), in which several providers act together to coordinate services, prices or sale of goods. Monopolies can form naturally or through vertical or horizontal mergers. A monopoly is said to be coercive when the monopoly firm actively prohibits competitors from entering the field.

In many jurisdictions, competition laws place specific restrictions on monopolies. Holding a dominant position or a monopoly in the market is not illegal in itself, however certain categories of behaviour can, when a business is dominant, be considered abusive and therefore be met with legal sanctions. A government-granted monopoly or legal monopoly, by contrast, is sanctioned by the state, often to provide an incentive to invest in a risky venture or enrich a domestic constituency. The government may also reserve the venture for itself, thus forming a government monopoly.

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[edit] Economic analysis

The single price monopoly profit maximization problem

Let the price set as a market response be a function of the quantity produced (Q) P(Q). Let the cost function be as a function of quantity C(Q).

Monopoly revenue is the product of the price and quantity. Hence, assuming that the monopolist knows the exact demand function.[3], monopoly 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).

In economics, the study of market structures under imperfect competition begins with the anaylisis of Monopoly. If there is a single seller in a certain industry and there are no close substitutes for the good being produced by her, then the market structure is that of a Pure monopoly. Sometimes, there are many sellers in an industry and/or there exist many close substitutes for the good being produced, but nevertheless firm's retain some market power. This is called Monopolistic competition by economists, whereas Oligopoly refers to the case where the main theoretical framework revolves around firm's strategic interactions.

A company with a monopoly does not undergo price pressure from competitors, although it may face pricing pressure from potential competition. If a company raises prices too high, then others may enter the market if they are able to provide the same good, or a substitute, at a lower price.[4] The idea that monopolies in markets with easy entry need not be regulated against is known as the "revolution in monopoly theory".[5][verification needed]

A monopolist can extract only one premium[clarification needed], and getting into complementary markets does not pay. That is, the total profits a monopolist could earn if it sought to leverage its monopoly in one market by monopolizing a complementary market are equal to the extra profits it could earn anyway by charging more for the monopoly product itself. However, the one monopoly profit theorem does not hold true if customers in the monopoly good are stranded or poorly informed, or if the tied good has high fixed costs.

The pricing and production choices made by monopoly firms follow identical decision rules as any other. That is, regardless of the type of firm, the profit maximizing price and quantity choice will equate the marginal cost and marginal revenue of production (see diagram). The key difference is in the outcome of such a rule: typically a monopoly selects a higher price and lower quantity of output than a price-taking firm; less is available at a higher price.[6]

There are important points for one to remember when considering the monopoly model diagram (and its associated conclusions) displayed here. The result that monopoly prices are higher, and production output lower, than a competitive firm follow from a requirement that the monopoly not charge different prices for different customers. That is, the monopoly is restricted from engaging in price discrimination (this is called first degree price discrimination, where all customers are charged the same amount). If the monopoly were permitted to charge individualized prices (this is called third degree price discrimination), the quantity produced, and the price charged to the marginal customer, would be identical to a competitive firm, thus eliminating the deadweight loss; however, all gains from trade (social welfare) would accrue to the monopolist and none to the consumer. In essence, every consumer would be just indifferent between (1) going completely without the product or service and (2) being able to purchase it from the monopolist.

As long as the price elasticity of demand for most customers is less than one in absolute value, 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 case above it will be greater than one for most customers.

[edit] Monopoly and Efficiency

Surpluses and deadweight loss created by monopoly price setting

According to the standard model, in which a monopolist sets a single price for all consumers, the monopolist will sell a lower quantity of goods at a higher price than would firms under perfect competition. Because the monopolist ultimately forgoes transactions with consumers who value the product or service more than its cost, monopoly pricing creates a deadweight loss referring to potential gains that went neither to the monopolist or to consumers. Given the presence of this deadweight loss, the combined surplus (or wealth) for the monopolist and consumers is necessarily less than the total surplus obtained by consumers under perfect competition. Where efficiency is defined by the total gains from trade, the monopoly setting is less efficient than perfect competition.

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 psychological 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.

In the short run it can be good to allow a firm to attempt to monopolize a market, since practices such as Predatory pricing can benefit consumers. When monopolies are not broken through the open market, sometimes a government will step in, either to regulate the monopoly, turn it into a publicly owned monopoly environment, or forcibly break it up (see Antitrust law). Public utilities, often being naturally efficient with only one operator and therefor 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 server.

[edit] Law

Main article: Competition law

The existence of a very high market share does not always mean consumers are paying excessive prices since the threat of new entrants to the market can restrain a high-market-share firm's price increases. Competition law does not make merely having a monopoly illegal, but rather abusing the power a monopoly may confer, for instance through exclusionary practices.

First it is necessary to determine whether a firm is dominant, or whether it behaves "to an appreciable extent independently of its competitors, customers and ultimately of its consumer."[7] As with collusive conduct, market shares are determined with reference to the particular market in which the firm and product in question is sold.

Under EU law, very large market shares raise a presumption that a firm is dominant,[8] which may be rebuttable.[9] If a firm has a dominant position, then there is "a special responsibility not to allow its conduct to impair competition on the common market".[10] The lowest yet market share of a firm considered "dominant" in the EU was 39.7%.[11]

Certain categories of abusive conduct are usually prohibited under the country's legislation, though the lists are seldom closed.[12] The main recognized categories are:

Despite wide agreement that the above constitute abusive practices, there is some debate about whether there needs to be a causal connection between the dominant position of a company and its actual abusive conduct. Furthermore, there has been some consideration of what happens when a firm merely attempts to abuse its dominant position.

[edit] Historical monopolies

This section requires expansion.

The term "monopoly" first appears in Aristotle's Politics, wherein Aristotle describes Thales of Miletus' cornering of the market in olive presses as a monopoly[13] (μονοπωλίαν)[14].

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.

[edit] Examples of alleged and legal monopolies


[edit] See also

Look up monopoly in Wiktionary, the free dictionary.

[edit] Notes and references

  1. ^ Milton Friedman (2002). "VIII: Monopoly and the Social Responsibility of Business and Labor" (in English) (paperback). Capitalism and Freedom (40th anniversary edition ed.). The University of Chicago Press. pp. 208. ISBN 0-226-26421-1. 
  2. ^ Blinder, Alan S; William J Baumol and Colton L Gale (June 2001). "11: Monopoly" (in English) (paperback). Microeconomics: Principles and Policy. Thomson South-Western. pp. 212. ISBN 0-324-22115-0. "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" 
  3. ^ For a discussion on a monopolist who does not know the demand function, see [1] where a free software is available as well.
  4. ^ Depken, Craig (November 23, 2005). "10". Microeconomics Demystified. McGraw Hill. pp. 170. ISBN 0071459111. 
  5. ^ The revolution in monopoly theory, by Glyn Davies and John Davies. Lloyds Bank Review, July 1984, no. 153, p. 38-52.
  6. ^ Levine, David; Michele Boldrin (2008-09-07). Against intellectual monopoly. Cambridge University Press. pp. 312. ISBN 978-0521879286. http://www.dklevine.com/general/intellectual/againstfinal.htm. 
  7. ^ C-27/76 United Brands Continental BV v. Commission [1978] ECR 207
  8. ^ C-85/76 Hoffmann-La Roche & Co AG v. Commission [1979] ECR 461
  9. ^ AKZO [1991]
  10. ^ Michelin [1983]
  11. ^ BA/Virgin [2000] OJ L30/1
  12. ^ Continental Can [1973]
  13. ^ http://www.constitution.org/ari/polit_01.htm
  14. ^ http://www.perseus.tufts.edu/cgi-bin/ptext?doc=Perseus%3Atext%3A1999.01.0057&layout=&loc=1.1259a
  15. ^ Leo Cendrowicz. "Microsoft Gets Mother Of All EU Fines". Forbes. http://www.forbes.com/home/markets/2008/02/27/microsoft-eu-fines-markets-equity-cx_po_0227markets08.html. Retrieved on 2008-03-10 {{{accessyear}}}. 
  16. ^ "EU fines Microsoft record $1.3 billion". Time Warner. http://money.cnn.com/2008/02/27/technology/eu_microsoft.ap/. Retrieved on 2008-03-10 {{{accessyear}}}. 

[edit] Further reading

[edit] External links

[edit] Criticism

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