Monopoly

A market structure characterized by a single seller or producer who dominates the market by selling the same product and eliminating the competition.

Author: Josh Pupkin
Josh Pupkin
Josh Pupkin
Private Equity | Investment Banking

Josh has extensive experience private equity, business development, and investment banking. Josh started his career working as an investment banking analyst for Barclays before transitioning to a private equity role Neuberger Berman. Currently, Josh is an Associate in the Strategic Finance Group of Accordion Partners, a management consulting firm which advises on, executes, and implements value creation initiatives and 100 day plans for Private Equity-backed companies and their financial sponsors.

Josh graduated Magna Cum Laude from the University of Maryland, College Park with a Bachelor of Science in Finance and is currently an MBA candidate at Duke University Fuqua School of Business with a concentration in Corporate Strategy.

Reviewed By: Aditya Salunke
Aditya Salunke
Aditya Salunke
Last Updated:March 15, 2024

What Is a Monopoly?

A monopoly is an industry or sector in which one company dominates. It is a market structure characterized by a single seller or producer who dominates the market by selling the same product and eliminating the competition.

In law, a monopoly is a business entity with considerable market power that enables it to charge high prices and depletes societal earnings.

In free-market nations, monopolies are often discouraged. However, in the absence of alternative options for consumers, there is a perception of price-gouging and quality degradation. 

Furthermore, they can concentrate wealth, power, and influence in the hands of one or a few individuals. In contrast, the government may encourage and even enforce monopolies of some essential services, such as utilities.

Monopolies are often characterized by a lack of economic competition (for the production of adequate goods and services), a lack of proper substitutes, and high monopolistic prices that lead to high monopolistic profits.

In conclusion, monopolies arise when a single company dominates a field. They can be developed naturally or imposed by the government for particular reasons.

Key Takeaways

  • A monopoly is a market structure where one company dominates, acting as the sole producer or seller of a particular product or service.
  • The monopolistic dominance allows the monopolist to set prices and eliminate competition, leading to the potential exploitation of consumers and societal loss.
  • They differ significantly from competitive markets in terms of the number of firms, market power, entry barriers, product differentiation, price setting, profit maximization, innovation, economic efficiency, consumer welfare, and regulation.
  • Monopolies are subject to antitrust laws and regulations like the Sherman Antitrust Act, the Clayton Antitrust Act, and oversight by the Federal Trade Commission (FTC).

Types of Monopolies

It is common for monopolies to have an unfair advantage over their competition because they are the only product manufacturer or control most of the market for that product.

In discussion there are five types of monopolies:

  1. Pure
  2. Natural
  3. Geographic
  4. Technological
  5. Government

It is crucial to recognize that although monopolies differ from one industry to the next, they tend to share similar characteristics. These include:

  • The dominance of a single company prevents competitors from breaking into the market because entry barriers are high.
  • It is a single-seller market: There is only one seller present.
  • A monopoly company can set its price without worrying about competitors undercutting it. 

Therefore, monopolies can raise prices whenever they want.

Monopolistic firms can gain economies of scale by acquiring large quantities of raw materials at a discount. The company can then lower its prices so much that smaller competitors can no longer compete with it.

The Pure Monopoly

A pure monopoly exists when there is only a single seller in the market with significantly high barriers to entry whose products have no significant substitute.

For example, Microsoft Corporation once had a virtual monopoly on operating systems for personal computers. As of July 2021, the company's desktop Windows software still held a market share of about 73%, compared to 97% in 2006.

In contrast to an oligopoly, a pure monopolist company running a printing business, for instance, is more likely to experience high barriers to entry, such as high start-up expenses, that prevent other companies from entering that market.

The Natural Monopoly

A natural monopoly is defined as an industry with high barriers to entry and high infrastructural costs, relative to the size of the market, that has a considerable advantage over potential competitors.

This monopolistic business emerges given high capital costs and economies of scale. Examples include electricity boards, water services, telecommunications, etc.

Natural Monopolies are market structures that result from natural advantages, such as a strategic geographical location or abundant mineral resources. 

These industries have high fixed costs or start-up costs, and the raw materials or technology used are unique or highly specialized.

Often a company will be the only provider of a product or service in a region or industry because no other company can match its investment history, its technology, or the talent it employs.

Geographic Monopolies

These monopolies refer to a monopoly that exists in a specific geographic region as a result of scarce natural resources or a service that is exclusive to one geographic region.

This means that one company has exclusive rights and authority to provide the products and services, and also has the right to operate within a geographic area.

One suitable example of this would be a pharmacy on an island. Another would be a convenience store in a remote area with all the goods available in the city.

Technological Monopoly

A tech monopoly refers to a condition where a business holds exclusive rights and authority to technology or materials that are necessary for the production of a product or service.

This type of monopoly is created by the patents, granting the organization the authority to use the technology or the resources.

When a business uses copyrighted technology to create a new medication, it creates a technical monopoly because it gives them the only authority to produce that medication and prevents other businesses from utilizing the same technology to create a comparable product.

Government-Sanctioned Monopoly

Government-granted monopolies, also known as regulated or de jure monopolies, are forms of involuntary monopolies in which the government grants exclusive privileges to private individuals or firms to be the sole providers of products and services.

Governments may establish public monopolies to provide essential goods and services to the public. 

Initially, the U.S. Postal Service operated as a single entity; however, private carriers like FedEx and United Parcel Service have gained much of their market share. 

The trade-off is that these companies are heavily regulated and monitored by the government. Regulations can control the rate that utilities charge and the timing of rate increases.

Characteristics of a monopoly

A monopoly is a market arrangement in which only one producer or seller offers the same good, preventing other potential competitors from entering the market.

It is a company with substantial market strength, which enables it to set excessive prices and possibly reduce society's surplus.

The characteristics of a monopoly include the following:

  1. Profit Maximization: Maximizing profits is, if not, the most important objective of a monopoly. And, this becomes possible since there is little or no competition, providing the monopolist to set prices of its own.
  2. Price Maker: When a goods or service provider has a monopoly, she/he/they can decide the production quantity and set the price for the products and services.
  3. High Barriers To Entry: Other businesses can't enter the market given the existing firm's market presence and domination. Various factors, such as economies of scale, capital requirements, superior technology, control of key inputs, and legal barriers, also contribute to this.
  4. Single Seller: In a monopolistic market, the existing firm is the single provider of a particular product or service, effectively, supplying for the same market.
  5. Price Discrimination: Based on the elasticity of demand and changing situations, a monopolist firm can change the prices and quantities provided for different customers.
  6. Profit Rate: This rate measures the profitability of the monopolist firm. The higher the rate of profitability, the greater the chance of the firm being monopolist.
  7. Herfindahl-Hirschman Index (HHI): The index gauges a market's competition and concentration. The lower the index measures, the higher the competition is. And, the higher the index measures, the lower the competition, leading to a monopoly.

Sources of Monopoly

Monopolies are situations in which a specific source of revenue generates individual control over the market. These sources of power include:

  1. Economies Of Scale: Monopolies can emerge because of large economies of scale, network cost and benefit, control over resources, and technology for production that provides advantages.
  2. Government Grants: Governments can sanction and create monopolies through patents and franchises. This can be achieved when a government provides the authority to produce or sell particular products.
  3. Control Over Essential Resources: Monopolies can also be created by providing authority and license to one particular organization. This could include the license to mine natural resources, quarries, and technological innovation.
  4. Barriers To Entry: Barriers to entry can be defined as the cost a new entrant has to bear regardless of production and sales. When these costs are high, and the existing firm doesn't have any competition, it essentially forms a monopoly.
  5. Manipulation And Advertising: Advertising can extensively influence an individual's or group's perception of a product/service. Apart from this, intentional collusion, conspiring, lobbying, and anti-competitive practices (price fixing, group boycotts, and anti-consumer trade plans) can also contribute towards monopoly.
  6. Lack Of Consumer Information: Ill-informed or misleading consumer information that deviates a consumer from seeing alternative goods and services can also amount to the emergence of a monopoly.

Monopoly vs. Competitive Market

A market structure consists of two extremes - monopolistic markets and competitive markets

Some similarities exist between the two models, such as the cost functions, the minimization of costs and maximizing profit, the shutdown decisions, and the assumption of perfectly competitive markets.

The two market structures are very different regarding a number of factors. Some of the areas where they differ are as follows:

Monopoly Vs. Competitive Markets
Aspect Monopoly Competitive Markets
Number Of Firms A Single business dominating the market. A number of small businesses coexist in the market.
Market Power The firm is the only price-maker in the firm, exercising absolute power in the market. Prices are determined by supply and demand forces. Firms have limited power.
Entry Barriers There are always high barriers to entry, limiting the entry of new firms. The firms can enter and exit easily since there are low entry barriers.
Product Differentiation There are a few selected options for the consumer in the presence of a monopolist. Availability of multiple products due to more than one business in the market.
Price Setting Since there is only one firm in the market. The firm is the ultimate price setter. Prices here are set by the competitive market forces.
Profit Maximization If not, profit maximization is the main objective at the expense of consumers Cost efficiency and quality maintenance are the main objectives here.
Innovation The existence of little or no competition, there is less scope for innovation. The firms present in the market push each other to regularly innovate and experiment to grab a customer base.
Economic Efficiency The abundance of time and lack of competition push the firm to underutilization of resources. Commonly speaking, the firms here promote economic efficiency and appropriate allocation of resources.
Consumer Welfare Monopolist firms charge high prices and lower consumer surplus. Firms with competition lead to lower prices and higher consumer surplus.
Regulation Laws and regulations will be required to regulate a monopolist firm. Regulations here may be required to ensure fair competition among the firms.

The most critical difference between an ideal competitive market and a monopoly is that the latter has a downward-sloping demand curve rather than the "perceived" perfectly elastic curve of a perfect market.

Accordingly, these barriers imply that under a monopoly, there is no difference between a firm and an industry.

  • In the market for that product, there are no other close competitors.
  • The monopolist, as the price maker, has the power to set prices.
  • While monopolists can maintain supernormal profits on a long-term basis, they do not necessarily make profits on a short-term basis. In addition to maximizing revenue, a monopolist can lose money as well. 

Perfect competition does not allow this to happen. It is clear that, in the long run, if abnormal profits exist, other firms will have no choice but to enter the market, which will eliminate these profits.

Advantages And Disadvantages Of Monopolistic Market Structures

Here are some of the advantages and disadvantages that can be associated with monopolistic market structures:

The advantages are:

  1. Price Stability: Prices are stable in a monopolistic market structure. Although there are no competitors in the market, only one company determines the price. The prices of other types of market structures are not stable and tend to be elastic because of the nature of competition.
  2. Economies Of Scale: Because there are no multiple sellers on the market, one seller can realize economies of scale through large-scale production, thus lowering production costs. Therefore, the consumer can benefit from this by paying less for the product.
  3. Supernormal Profits: Since the monopolist is making abnormal or supernormal profits, the firm can invest that money into research and development. As a result, consumers may be able to get better-quality products at reduced prices, leading to increased consumer surplus and satisfaction.

The disadvantages are:

  1. Price Setting: A monopolist can set a very high price for the product causing consumers to lose out since they have no option but to buy from the seller due to a lack of competition in the market.
  2. Pricing Strategies: It is possible for monopolists occasionally to charge different prices for the same product depending on the consumer. Market conditions play a crucial role in this. 
  3. Quality Compromise: The monopolistic firm may produce inferior products and services because it knows that consumers will purchase its products regardless of their quality.

Monopoly Regulations

An organization holding a dominant position in a particular industry or sector can use that position to its advantage and to the detriment of its customers, suppliers, and even its employees.

There is no other option than accepting the status quo for all these constituencies.

Despite the Sherman Antitrust Act, monopolies are not forbidden by this law. A dominant position cannot be perpetuated or created by restricting interstate commerce or competition.

Breaking Up Monopolies

Over the years, the Sherman Antitrust Act has broken up large companies like Standard Oil and American Tobacco.

The Microsoft Case

A U.S. government report accused Microsoft in 1994 of monopolizing the personal computer operating systems business and preventing competition. As part of the complaint filed on July 15, 1994:

In this civil suit, the United States seeks to prevent Microsoft Corporation from marketing its operating system software in an exclusionary and anticompetitive manner.

In 1998, a federal judge ruled that Microsoft should be divided into two technology companies. However, a higher court later reversed the decision.

Despite a few changes, Microsoft was free to maintain its operating system, application development, and marketing methods.

The AT&T Breakup

AT&T's breakup was the most consequential in American history. After being allowed to control the nation's telephone service for decades, a lawsuit was filed against the giant telecommunications company under antitrust laws.

A court battle over eight years forced AT&T to divest 22 local exchange service providers. Afterward, it had to sell off additional assets or split units several times.

Antitrust Laws

Several antitrust laws and regulations prohibit or discourage monopolistic practices - protecting consumers, stopping activities that restrain trade, and ensuring an open market environment.

The Sherman Antitrust Act of 1890 was the first federal law to curb monopolies' power. Congress strongly supported it, passing it 51-1 in the Senate and 242 to 0 in the House of Representatives.

The second update of antitrust laws was adopted in 1914 to prevent monopolies and protect consumers. 

In the Clayton Antitrust Act, rules were established for mergers and corporate executives, along with examples of conduct that would violate the Sherman Antitrust Act. 

Under the Federal Trade Commission Act, the Federal Trade Commission (FTC) serves as the federal agency for regulating business practices and enforcing the two antitrust laws.

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