Beginning with some basics, businesses or firms demand the factors of production, known as inputs, and supply goods and services, or outputs.
The field of economics studies this behavior of firms and, given that not all firms are created equal, how it varies depending on certain characteristics:
All of these factors affect how firms behave.
Today we will look at an extreme end of the spectrum, which is monopoly.
If you've ever played the board game Monopoly, you know that the point of the game is to monopolize the board and control everything.
This is exactly what a monopoly as a market structure does: it controls everything.
Looking at the spectrum of competition, we go from one end of the spectrum, an extreme of perfect competition where there are so many competitors that you cannot tell the difference between them, to this tutorial's focus of monopoly, where there is only one seller providing a unique product.
Monopoly is an industry market structure characterized by one firm supplying a unique product to the entire market. Barriers to entry prevent competition, which we will cover later in this tutorial.
Let's explore the different characteristics of monopoly.
Monopolists sell a completely differentiated product, meaning it is so unique that no other company provides anything like it.
If a consumer wants this product, they must buy it from this company.
In a monopoly, as mentioned, there is only one seller. The monopolist is the only firm selling this product, which means that they alone determine the price.
In a monopoly, the "price-taker" will choose the price that is going to maximize their profit. Because they have this great ability to charge high prices and make significant profit, regulation from the government is quite prevalent in this market structure.
Well, unfortunately for us, information is not perfectly shared between the monopolist and consumer.
Information does not flow freely. We do not know everything about the company, such as their cost structure, what goes into their production process, etc.
Therefore, because of this imperfect information, it is not an ideal situation for the consumer.
The monopolist wants to keep their market power and continue selling a unique good; therefore, consumers are not always going to know everything about the monopolist.
There are a number of different barriers to entry that can exist, representing different reasons why a monopoly may be in operation.
Any time there is an industry with high start-up costs or a significant amount of technology, this can present a very high barrier to entry.
EXAMPLE
Consider public utility companies. Does it make sense for more than one water company to service an area?For that reason, public utility companies are, generally speaking, allowed to operate as a monopoly.
EXAMPLE
Another example is sports leagues, such as the NFL, NHL, NBA, and MLB. Consider how expensive it is to start a sports league!Some of these are what we call "natural monopolies," due to economies of scale, referring to a situation where it simply makes sense for a company to get bigger, because they can spread out those high start-up costs incurred in the beginning.
The government actually creates some monopoly. For instance, you may have never thought about a patent or a copyright as a monopoly, but that is what they are creating.
A patent or a copyright allows an inventor to monopolize their good or service for a period of time.
Pharmaceutical companies can exclusively sell new drugs until the patent expires, which makes it quite expensive to buy that medication until the patent expires and a generic version can be developed.
Control over a key resource is also a barrier to entry.
If a company has control over a resource, it can be difficult--or almost impossible--for any other companies to acquire it.
EXAMPLE
A classic example is De Beers and their ability to control all of the diamond mines. Similarly, while there is not just one company controlling the resource of oil, it is controlled by a select number of countries or companies.Next we have predatory pricing, which is an interesting phenomenon.
IN CONTEXT
Suppose a huge superstore opens in a small town. Why might they actually sell their product--at first, when they open--below cost?
Why would they not make a profit on it and sell it below what it costs them to produce it?
Well, the idea is to drive out their competitors or to keep others from entering the market.
If they can do that, they become a monopoly, and once they are a monopoly, they have complete control over price.
Once all of the competition is driven out, they are the ones left standing--and this is known as predatory price-cutting.
Earlier in the tutorial, we mentioned the prevalence of government regulation in monopolies.
Companies that have significant market power can have negative effects on consumers, which explains why there is a history of regulation, at least in the U.S.
In the late 1800s and early 1900s, these three acts were passed to prevent businesses from colluding or restricting competition:
The Federal Trade Commission Act was passed to regulate mergers and acquisitions.
EXAMPLE
For example, under the Federal Trade Commission Act, a large bank may not be allowed to merge with another one, because it may be determined that there would be too much market power held by this one bank.As a reminder, keep in mind that our spectrum of market structures represents a simplified view of a market, and monopolies are one extreme.
Most companies are not monopolies. Most firms fall somewhere between the two extremes of perfect competition and monopoly.
We study it because it gives us a place to start when looking at the complexities of the real world. It's going to help us compare and contrast.
For instance, the closer we are to a monopoly, the worse it will be for consumers.
Source: Adapted from Sophia instructor Kate Eskra.
