Monopoly

:This article is about the state of a player in economics. For the Parker Brothers board game, see Monopoly (game).

Economic analysis

Primary characteristics of a monopoly

• Single Seller

:A pure monopoly is an industry in which a single firm is the sole producer of a good or the sole provider of a service. This is usually caused by a blocked entry.

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

• No Close Substitutes

:The product or service is unique in ways which go beyond brand identity, and cannot be easily replaced (a monopoly on water from a certain spring, sold under a certain brand name, is not a true monopoly; neither is Coca-Cola, even though it is differentiated from its competition in flavor).

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

• Price Maker

:In a pure monopoly a single firm controls the total supply of the whole industry and is able to exhert a significant degree of control over the price, by changing the quantity supplied. In subtotal monopolies (for example diamonds or petroleum at present) a single organization controls enough of the supply that even if it limits the quantity, or raises prices, the other suppliers will be unable to make up the difference and take significant amounts of market share.

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

• Blocked Entry

:The reason a pure monopolist has no competitors is that certain barriers keep would be competitors from entering the market. Depending upon the form of the monopoly these barriers can be economic, technological, legal (basic patents on certain drugs), or of some other type of barrier that completely prevents other firms from entering the market.

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

Monopolistic pricing

In economics a company is said to have monopoly power if it faces a downward sloping demand curve (see supply and demand). This is in contrast to a price taker that faces a horizontal demand curve. A price taker cannot choose the price that they sell at, since if they set it above the equilibrium price, they will sell none, and if they set it below the equilibrium price, they will have an infinite number of buyers (and be making less money than they could if they sold at the equilibrium price). In contrast, a business with monopoly power can choose the price they want to sell at. If they set it higher, they sell less. If they set it lower, they sell more.

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

If a monopoly can only set one price it will set it where marginal cost (MC) equals marginal revenue (MR) as seen on the diagram on the right. This can be seen on a supply and demand diagram for the firm. This will be at the quantity Qm and at the price Pm. This is above the competitive price of Pc and with a smaller quantity that the competitive quantity of Qc. The profit the monopoly gains is the shaded in area labeled profit.

Related Topics:
Marginal cost - Marginal revenue - Supply and demand

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

As long as the price elasticity of demand (in absolute value) for most customers is less than one, it is very advantageous to increase the price: the seller gets more money for less goods. With an increase of the price the price elasticity tends to rise, and in the optimum mentioned above it will for most customers be above one. A formula gives the relation between price, marginal cost of production and demand elasticity which maximizes a monopoly profit: rac{P}{MC} = rac{1}{1 + 1 / e} (known as Lerner Index).

Related Topics:
Price elasticity of demand - Absolute value

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

The economy as a whole loses out when monopoly power is used in this way, since the extra profit earned by the firm will be smaller than the loss in consumer surplus. This difference is known as a deadweight loss.

Related Topics:
Consumer surplus - Deadweight loss

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

Calculating monopoly output

The single price monopoly profit maximisation problem is as follows:

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

The monopoly's profit is its total revenue less its total cost. Let the price it sets as a market response be a function of the quantity it produces (Q) P(Q) and let its cost function be as a function of quantity C(Q). The monopoly's revenue is the product of the price and the quantity it produces. Hence its profit is:

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

Pi = P(Q).Q - C(Q)

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

Taking the first order derivative with respect to quantity yields:

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

rac{d Pi }{dQ} = P'(Q).Q + P(Q) - C'(Q)

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

Setting this equal to zero for maximisation:

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

rac{d Pi }{dQ} = P'(Q).Q + P(Q) - C'(Q)=0

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

rac{d Pi }{dQ} = P'(Q).Q + P(Q)= C'(Q)

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

i.e. marginal revenue = marginal cost, provided

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

rac{d^2 Pi }{dQ^2} = P(Q).Q + (Q+1).P'(Q) +P(Q) - C(Q) < 0 (the rate of marginal revenue is less than the rate of marginal cost, for maximisation).

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

This procedure assumes that the monopolist knows exactly which is the demand function. For a discussion on a monopolist who does not know it, see http://www.economicswebinstitute.org/essays/monopolist.htm where a free software is available as well.

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

Monopoly and efficiency

In standard economic theory (see analysis above), a monopoly will sell a lower quantity of goods at a higher price than firms would in a purely competitive market. In this way the monopoly will secure monopoly profits by appropriating some or all of the consumer surplus, as although the higher price deters some consumers from purchasing, most are willing to pay the higher price. Assuming that costs stay the same, this does not lead to an outcome which is inefficient in the sense of Pareto efficiency; no-one could be made better off by shifting resources without making someone else worse off. However, total social welfare declines compared with perfect competition, because some consumers must choose second-best products.

Related Topics:
Purely competitive - Monopoly profit - Consumer surplus - Pareto efficiency

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

It is also often argued that monopolies tend to become less efficient and innovative over time, becoming "complacent giants", because they don't have to be efficient or innovative to compete in the marketplace. Sometimes this very loss of efficiency can raise the potential value of a competitor enough to overcome market entry barriers, or provide incentive for research and investment into new alternatives. The theory of contestable markets argues that in some circumstances (private) monopolies are forced to behave as if there were competition, because of the risk of losing that monopoly to new entrants, or because of the availability in the longer-term of substitutes in other markets. For example, a canal monopoly in the late eighteenth century United Kingdom was worth a lot more than in the late nineteenth century, because of the introduction of railways as a substitute.

Related Topics:
Contestable markets - Canal - United Kingdom - Railways

~ ~ ~ ~ ~ ~ ~ ~ ~ ~

Some argue that it can be good to allow a firm to attempt to monopolize a market, since practices such as dumping can benefit consumers in the short term; and once the firm grows too big, it can then be dealt with via regulation. (This is a rather optimistic view of how effectively regulation can substitute for competition.) When monopolies are not broken through the open market, often a government will step in to either regulate the monopoly, turn it into a publicly-owned monopoly, or forcibly break it up (see Antitrust law). Public utilities, often being natural monopolies and less susceptible to efficient breakup, are often strongly regulated or publicly-owned. AT&T and Standard Oil are debatable examples of the breakup of a private monopoly. When AT&T was broken up into the "Baby Bell" components, MCI, Sprint, and other companies were able to compete effectively in the long-distance phone market and started to take phone traffic from the less efficient AT&T.

Related Topics:
Regulation - Antitrust law - Public utilities - AT&T - Standard Oil - MCI - Sprint

~ ~ ~ ~ ~ ~ ~ ~ ~ ~