A Monopoly is said to exist when there is a sole supplier in the market or the market is dominated by a single supplier of manufacturer. The supplier has almost full control over the market and can influence the market through its decisions. An imperfect market exists in a monopoly i.e. a market where a sole supplier has enough power to influence the market through his/her decisions. A monopoly is just the opposite of a Perfectly Competitive Market Structure.
The following characteristics in regard to a monopoly market structure are there in a market:
- There is a single supplier in the market, there may be many buyers.
- The firm is the price-maker; the firm can control the price and affect it through its decisions.
There are strong barriers to entry and exit in the industry, it is very difficult for firms to enter the market, even if a firm manages to enter the market through excessive investments etc. the huge cost of entering the market and sustaining in it prevents the firm to exit the industry i.e. there is the presence of barriers to exit as well.
The product is highly differentiated i.e. every product usually can have its own distinct packaging, scent, taste, fragrance, shape etc. Advertising and other forms of marketing also differentiates the products from other products in the market.
The monopolist can control only one factor at a time i.e. it can either decide on the price it wishes to sell its output or the quantity which he will offer to the buyers; the monopolist cannot control demand. Therefore if it wishes to sell at a particular price, the market demand curve will determine the quantity that can be sold in the market. Similarly, if it decides to sell a particular quantity in the market, the market demand curve will determine the price at which the desired output will be sold.
There are also no substitutes available in the market. As in other market structures the profit maximization output is at the point where MR=MC. However, in this case Price or Average Revenue (AR) is not equal to Marginal Revenue (MR); instead Price (or AR) > MR. Firms can earn supernormal profits in the long-run because of the existence of the barriers to entry. When firms earn supernormal profits, other suppliers may be attracted but the existence of the barriers to entry prevents them to enter the industry and provide competition to the monopolist, therefore the inability of new suppliers to enter the market prevents them to drive-away the profits earned by the monopolist.
Firms can also exercise ‘price discrimination’ i.e. charge different prices form different groups of customers for the same level of service or product offered in the market. A ‘Natural monopoly’ may also exist. It is one where the market has only enough capacity to sustain a single producer/manufacturer. These may be industries which require high investment or where only a single firm can produce the output required by the market. Examples may be the national electric or water supply companies or the telephone (landline) company in some cases. Due to the large scale on which the monopolistic firm operates it might achieve economies of scale.
There is a common perception that monopoly inflicts more social costs than social benefits and was deemed to be against the interest of the consumer/general public. The charges against was that it charges prices well above costs, hampers the technological progress of the industry and consequently the economy, exercises price discrimination and other such factors. There are some laws made in regard to the existence and operations of monopoly which might determine the code of conduct of a monopoly and its practices to minimize any damage which a monopoly might inflict on the society or economy.
The Government can also grant monopoly right or certain patents to a company to provide it with monopoly rights and protect it from competition. This may be when the Government wishes to protect a local infant industry which is unable to compete with the global giants or may be a company which may not be willing to invest the huge capital investment required without such protection or the grant of monopoly rights by the Government. Example of such case is Crixivan (produced by Merck) designed to prove as therapy to HIV (AIDS), which required a huge sum of more than a billion dollars worth of investment to develop, is protected from competition by Government regulations.
The existence of a monopoly and whether it is beneficial or harmful to the environment or the society is a much debatable topic and has remained a controversial topic between economists. Some economists believe that the existence of a monopoly hampers the progress of the industry and since it has no incentive to invest in Research & Development or to enhance the efficiency of the manufacturing, the monopolist will not work towards that as it is guaranteed a profit in either case; whether it innovates or not. They also argue that by restricting new entrants they are negatively affecting the growth of the industry and the restricting the influx of new or innovative ideas. They believe that consumer sovereignty is also lower and the consumer may though have a wide range of products to choose from it will have little or no choice in choosing a producer.
On the other hand, the other group of economists believes that innovation and technological progress is most likely to occur in a monopoly than in any other market structure. They feel that the desire to earn higher profits will lead the firm to invest more in Research & Development and discover newer, faster and more efficient ways of production which will lower costs and consequently increase the profits. They also believe that small firms will not be willing or cannot make investments in R & D which might require huge sums of capital, whereas a firm with a monopoly has enough incentive and capital to fund the technological advancement and research.
Some current and past examples of monopolies are mentioned as follows:
- AT & T
- U.S. Postal Service.
A Monopsony or a Monoponistic market approach is similar to a Monopoly except that in a monopsony the buyer has full control over the market. As in a monopoly, this is also an imperfect market as a single buyer can alone affect the output or the price in an industry. The buyer can influence the market from his/her own decisions.
In a monopsony, the buyer can decide on the price at which he/she will buy the output or quantity of the products; it is not a price-taker as in a monopoly. Because of the power of the buyer to restrict the price and affect the market, the monopsony usually experiences a lower quantity of goods traded and a lower price than in other forms of market structures.
The argument against monopsony is similar to those against monopoly, some economists believe that in a monopsony the power of the consumer hampers the economic or technological progress of the industry as well as the economy. The firms are not rewarded for their effort on their own grounds or at the price at which they wish to sell their product, this leaves them with little or no incentive to increase the quality of the product or involve in other types of Research & Development. On the other hand, some economists believe that a monopsony is more likely to experience innovation because sellers compete to attract the buyers and the seller which has the highest quality or the lowest cost is more likely to win the bid or sell the product to the buyer. The power of the buyer can be restricted or limited through laws which restrict a price floor which mentions the lowest price at which they product can sell.
However, great care should be taken in deciding on the level at which the floor should be placed, if the floor is too high the buyer may not be willing to purchase the product and this will further reduce the already lower amount of goods traded in the market. On the other hand if the ceiling is placed too low, it will not fulfill the purpose of its imposition and will have little impact on buyer’s power. The floor should be imposed at a modest level, and be used as a whip to control buyer’s domination and efficiency of the producers.
The buyer may also restrict the entry of new buyers into the market by simply purchasing the whole output from the producers or simply by coming into contracts with suppliers or manufacturers. This type of market structure may also contain a lower number of producers/manufacturers. Since the structure does not promise high profits, especially in the long-run many sellers/manufacturers will not be attracted to invest into the industry or become part of a industry where the company has to deal on they buyer’s terms.
Some examples of a monopsonistic market model are as follows:
- The market for Registered Nurses.
- Trade unions and labor markets.
- AT&T was the sole buyer of phone equipment before its break up.
- BP and ARCO are the biggest bidders for state oil in the town of Alaska.
- Another example can be in sports; where the reserve clause restricts the salaries of the players to be put up for bidding.
An Oligopoly is a market structure is one in which there are a small number of large, powerful and dominant firms which account for almost all of the industry’s output.
The following characteristics are there in an oligopoly:
- There are a limited number of sellers in the market.
- Usually firms are price makers as they account for a major proportion of the market.
Barriers to entry and exit do exist in this market structure. The firms in the market are very large compared to new firms entering the market; the older firms generally enjoy economies of scale and benefit extensive cost-cuts from bulk buying and other such practices. They provide extensive competition to the new firm through discounts, reduced prices, special offers etc., and the newer firm is generally not capable of competing with the bigger firms and eventually has no other option but to shut down. However, the existence of the barriers to exit such as sunk costs make it difficult for the firm to exit and the producers are often left with little or no options, eventually they shut down or merge with a larger firm (increasing the power of the larger firm).
In a ‘perfect oligopoly’, the products are homogeneous, for example, salt and sugar. However, in an ‘imperfect oligopoly’ the products are differentiated and marketed under different brand names, packaging etc. Producers can decide on which price to sell their product or the quantity they wish to sell in a particular market, they cannot obviously decide both and has to decide whether they will fix the price and let the market (mechanisms of demand and supply) determine the quantity that is sold in the market; or vice versa. Firms can earn supernormal profits in the long-run (due to the existence of the barriers to entry for the new firms).
The firms can also form ‘cartels’ or ‘collusions’ and decide on the output they will sell in the market or price at which they will sell their products, the existence of cartels or collusions can result in the exploitation of the customers. There are certain laws made and rules mentioned which restrict the practices of ‘cartels’ and collusions and prevent the exploitation of the customers.
Oligopoly is a more realistic market structure than a perfectly competitive market. There are various reasons for an oligopoly to be a more common market structure in the real world. The market for many products is dominated by a few large firms which enjoy economies of scale (with very low costs as compared to the costs of the new firm) through their large scale production. A huge amount of capital is required to start off production; firms usually do that by merging with other firms or through acquisition; a small firm alone cannot compete with the giant firms in the industry. Consumers have become brand loyal and are ready to pay even more for a product from a renowned company (a company that has build and maintained goodwill and brand loyalty) rather than purchasing a product from a new or unknown producer even though the product is being offered at a lower price. The producers have also realized that they can earn maximized profits and higher returns on their investment if they collude rather than compete with each other.
Some examples with an oligopoly are:
- BP, Shell and a few other firms (petrol market in UK).
- Soft-drinks market (Coca Cola, Pepsi)
- OPEC (oil industry)
- Airline industry
- Dell, IBM.
This type of market structure has the characteristics of both, a monopoly as well as a perfectly competitive market. However, in a monopolistic market structure no single buyer or seller has full control over the market; the market will not be affected by a single buyer’s or seller’s decision. In this structure, there are a large number of buyers and sellers in the market and the products are not homogeneous.
The monopolistic market structure has the following characteristics:
- There are many buyers and sellers in the market.
- Each buyer and seller comprises only a small portion of the market.
- Usually there are no ‘collusions’ or ‘cartels’ in a monopolistic competition market model.
- The firms are price-makers.
- Firms operate on the profit maximizing point i.e. where Marginal Revenue is equal to Marginal Cost (MR=MC).
- There are little or no barriers to entry and exit.
- The products are similar but they are not homogeneous. The products are differentiated from each other through different techniques; the buyers can distinguish the products from each seller.
- Firms can earn supernormal profit in the short-run.
- Large-scale capital investment or other such investment is not required for a firm which wishes to enter the market.
Since there are little or no barriers to entry, the firms cannot earn supernormal profits in the long-run. When supernormal profits are experienced, new firms will get attracted and enter the market, the entry of new firms will increase the output of the industry and lower the price, the process will carry on until the profits are driven away and the firms return to the break-even point i.e. no profit, no loss point. Firms in a monopolistic competition model are faced with an elastic demand curve. In monopolistic competition, firms do not operate at the bottom of their Average Cost curve, instead they operate where Average Costs are falling and there is capacity left for the firms to further reduce their costs.
Some examples of monopolistic competition are listed below:
- Sporting goods.
- Soft drinks
- Fast food: McDonalds, Burger King etc.
- Dishwashing powder
- Hirschey, Mark (2006). Managerial Economics. Belmont, CA: Thompson South-Western College Pub.
- Lipsey, Richard G, & Chrystal, K. Alec (1999). Introductory Economics. New York: Oxford University Press.
- Stanlake, GF & Grant, SJ (2000), Introductory Economics, Harlow, Longman.