Monopoly (Economics) - Explained

What is a Economic Monopoly?

Updated at March 27th, 2023

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What is a Monopoly?

A monopoly is a term used to refer to a market structure, where one entity, like a company, dominates the market with its products or services. Monopoly comes into existence when there is extreme free-market capitalism. In free-market capitalism, there are usually no restrictions. A single company can enlarge, hence dominating the entire market with a given product or service.

Generally, the motive of monopolists is to maintain high profits in the long run. However, under perfect competition, this becomes a rare case. In case of abnormal profits in such markets, many new firms will find their entry into the market, hence bringing stiff competition. Once the competition is in the market, it gets rid of the abnormal profits that monopolists have been enjoying.

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How Monopolies Arise

In a monopoly market, competition does not exist as one seller dominates the market. That single seller becomes the sole seller of a particular product, and in most cases, there are usually no close substitutes for his product or service. Also, there are so many restrictions related to market entry, ranging from government license, copyright/patent, ownership of resources, as well as high costs of starting a business. All these factors restrict new entry into the market hence encouraging monopoly. In addition, monopoly firms possess specific information, that other firms dont have, a situation that gives them a competitive advantage over other firms. Generally, in a monopoly market, a single entity controls the market, and this includes determining the prices of goods and services. The entity also enjoys the liberty of setting a price to its goods and services. It means that it can single-handedly influence the prices of products and services in the market. Generally, monopolies are known to be big businesses. However, it is worth noting that size is not one of the characteristics that define a monopoly. Remember, a small business can still monopolize the market where it has the power to raise prices of goods and services in a small market or industry. A monopoly is the ability of an entity to take full control of the market regardless of its size.

Characteristics of a Monopoly Market

The following are typical characteristics that define a monopoly market:

Lack of substitutes: In a monopoly market, a single firm produces a product or offers a service that has no close substitutes. The products are usually exceptional (unique).
Price Maker: Monopolists are the ones who decide how much a product or service should cost in a given market. In other words, they are price setters, and consumers are usually at their mercy.
High barriers to entry: A monopoly is also characterized by barriers to market entry. There are regulations that restrict the entry of new firms into a monopoly market. The restrictions ensure that monopolists do not face any competition and that they continue to enjoy control over the market.
Price discrimination: In a monopoly market, sellers are at liberty to change prices and quantity their products and services at any given time. For instance, if the demand for a given product increases, the monopolists are likely to revise the price of that particular product upwards. Generally, price changes are always as a result of market conditions.
Single seller: A monopoly market is always served by one seller. It means that a single business entity is the same as the market it serves. In this type of market, one business entity is the sole producer of all the output for a good or service.
Profit maximizer: The motive that guides monopolists is revenue maximization. They do this either by increasing the prices of their products and services in the market or expanding their production scales.

Sources of Monopoly Power

In a market an individual's power to control the market is generated by specific sources. Some of these sources include:

Capital requirement
Network externalities
Control of natural resources
Economies of scale
The existing legal barriers
Lack of substitute goods or services
Technological superiority
Deliberate actions

Reasons why Monopolies are Illegal

Monopolies are illegal because of the following reasons:

Due to the lack of competition in the market, monopolists produce inferior products and services to consumers, a behavior that can be termed as corrupt
A monopoly leads to exaggerated costs on products and services, a move that exploits consumers. It also denies consumers the right to use a competitor.
Also, in a monopoly market, sellers create artificial scarcities to enable them to fix prices and circumvent the existing laws of supply and demand

Antitrust Laws and Consumer Protection

To limit monopolies in the market, the Sherman Antitrust Act was passed in 1980 by the U.S. Congress. It was the first legislation law to pass that put a limit to monopolies. The act got strong support from the Congress members through votes where there were 51votes against 1. The same law also passed in the House of Representatives unanimously with 242 votes against 0. There were two additional antitrust laws introduced in 1914, which got the support of the Congress. The enactment of the two laws was for the purpose of protecting consumers and preventing monopolies. There was an establishment of new rules under the Clayton Antitrust Act that applied to mergers and corporate. The rules gave specific example practices that would be considered a violation of Shermans Act. There is also another act known as the Federal Trade Commission established by the Federal Trade Commission. The act sets business-standard practices and also enforces the other antitrust acts. All this is done in conjunction with the Antitrust Division of the United States Department of Justice. The laws are intentionally established so as to help preserve competition and also give small companies opportunities to enter the market.

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