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Author: Kate Eskra

This lesson will explain Monopoly

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Video Transcription

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Hi, welcome to economics. This is Kate. This tutorial is on monopoly. As always, my key terms are in red, and my examples are in green.

So in this tutorial we'll be talking about monopoly as one of the market structures studied in economics. You'll be able to define this market structure, and you'll understand its main characteristics by end of the tutorial.

So we know that businesses, or firms, are the ones that take in or hire factors of production as inputs, and then with them, they're able to supply us with outputs-- or the goods and services. So we know that all firms don't behave the same way. And what economics does, is it studies how firms behave. And it's really going to vary depending on a number of different characteristics-- how big they are as a company, what kind of product they're selling, how much competition they face, how easy or difficult it was to get into that business, and there are other factors as well. You yourself may have some companies that you really like to shop at, maybe because of their customer service level that they offer, or the price that they charge, and there very well may be companies that you refuse to ever go back again and purchase from them. So probably based on some of these characteristics are the reasons why you either like or don't like certain companies.

But today what we're going to be looking at is an extreme end of the spectrum, and that is monopoly. So if you've ever played the game Monopoly, you know that the point is to monopolize the board. You get to be the one to control everything. And that's just what a monopoly as a market structure does, they control everything.

So if we're looking at the big picture here, and looking at the spectrum of competition, we go from one end of the spectrum-- an extreme of perfect competition, where there's so many competitors you can't even tell the difference between them at all-- to this tutorial's focus is on monopoly, where there's only going to one seller providing a unique product.

OK, so let's define it. Monopoly is an industry market structure characterized by one firm supplying a unique product to the entire market. And it's barriers to entry that are going to prevent competition. I'll be outlining some of those barriers to entry in a little bit.

So monopolies sell a differentiated product. What this means is that it is actually so unique that no other company provides anything like it. So if a consumer wants this product, they have to buy it from this company.

In a monopoly, obviously-- hence the name monopoly-- there's only one seller. They're the only firm selling this product. And what that means is they alone determine the price. So in economics, we sometimes like to call firms either price takers, or price makers. A price taker is someone who has no control all over price, and that would be like in perfect competition. But here, at the opposite end of the extreme, they are certainly price makers. They're the entire market, a and so they can choose alone what price they want to charge. They're going to choose the price that is going to maximize their profit. And because they have this great ability to charge pretty high prices and make significant profit, we'll be talking in a few slides how regulation from the government is definitely prevalent in this market structure.

So have you ever purchased something without perfect information about it? I know that I have. I know that I've gotten home several times and said, oh boy, I really wish I had known this about this product before I spend money on it. Unfortunately for us, there is not perfect information between the monopolist and the consumer. Information does not flow freely. We don't know everything about the company-- their cost structure, what all goes into their production process. And so because of this imperfect information, it's not really an ideal situation for the consumer. The monopolist wants to keep their market power, and they want to continue selling a unique good, and so because of that we're not always going to know everything about the monopolist.

Barriers to entry, like I said, are what are going to prevent other companies from coming in and competing with the monopoly. So a barrier is anything that prevents other companies from entering the market and competing. And there are a number of different kinds of barriers to entry that can exist. So they all represent different reasons why a monopoly may be in operation.

So let's talk about the first one. Any time there's an industry with really high start-up costs, or a significant amount of technology, that can present a very high barrier to entry. The example I'm using here-- if you think about public utility companies, does it really makes sense for more than one water company to service an area? Not only would that be difficult, with competing water lines, but it may actually not be profitable for more than one company to take on those really high initial costs and service one area. So for that reason, public utility companies are, generally speaking, allowed to operate as a monopoly.

Sports leagues. I can't imagine trying to compete with the NFL. Think about how expensive it is to start a sports league like that. Some of these are what we call natural monopolies, due to something called economies of scale. And economies of scale is an issue where it just makes sense for the company to get bigger, because they can spread out those really high start-up costs that they had to incur in the beginning.

The government actually creates some monopoly, if you think about it. I know I never thought about a patent or a copyright as a monopoly, but that's what they're creating. A patent or a copyright allows an inventor to monopolize their good or service for a period of time. Pharmaceutical companies, for example, can exclusively sell their new drug until the patent expires, for whatever period of time that is. And so it makes it really expensive to get that medication until the patent expires and a generic version can be developed. So why is it that we offer patents and copyrights? If you think about it, would anyone really dedicate their life to finding cures to things, or developing new drugs, if they couldn't reap the profit from that for at least a period of time? So patents and copyrights do encourage inventors, but they allow them to monopolize their product for a period of time.

Control over a key resource is also a barrier to entry. So if a company has control over a resource, it can be really difficult-- or almost impossible-- for any other companies to acquire it. A classic example is De Beers, their ability that they had to control all of the diamond mines. And then, if we think about oil-- no, there's not just one company controlling the resource of oil-- but it is really controlled by a select number of countries or companies.

And then we have predatory pricing. This is an interesting phenomenon we see. So let's use the example, let's say some huge superstore opens in a small town. Why might they actually at first, when they first open, sell their product below cost-- meaning not make a profit on it, actually sell it below what it costs them to produce it? Well, the idea here is to drive out their competitors, or to keep others from entering the market. If they can do that, they become a monopoly. And then they have complete control over price. And once all of the competition is driven out, they're what's left. That is what we call predatory price cutting.

So one note here, I told you I was going to talk about some of the government regulation. Because companies that have significant market power can have these negative effects on us as consumers, there is a history of regulation, at least it within our country. In the late 1800s and early 1900s all of these three-- the Sherman Anti-Trust Act, the Clayton Act of 1914-- they both were developed to try to prevent businesses from getting together and colluding or restricting competition and having a lot of monopoly power. In 1914, the Federal Trade Commission Act was passed to study these things, and to study more of these mergers and acquisitions. So mergers and acquisitions, for example, I know in my city, a large bank wanted to come in and merge with another one. And actually, that was not allowed to happen because they found that there would be too much market power by this one bank.

So again, keep in mind where we are here. This is our spectrum, and we were just talking about monopoly on this extreme end.

Again, I want you remember that this is a simplified view of a market. It is an extreme. And most companies are not monopolies. Most firms fall somewhere between the two, of perfect competition and monopoly. So we study it because it gives us a place to start, looking at how complex the real world really is, and it's going to help us to compare and contrast. So for example, the closer we are to a monopoly, the worse it's going to be for consumers.

So in this tutorial we talked about monopoly, and how they have a differentiated product. There's one seller who is a price maker. They have imperfect information, and there are barriers to entry. And we ended by talking about some of the anti-trust laws, and regulation meant to protect us. Thanks so much for listening. Have a great day.

Terms to Know

An industry market structure characterized by one firm supplying a unique product to the entire market. Barriers to entry prevent competition.