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In economics, a monopoly (from Greek monos / μονος (alone or single) + polein / πωλειν (to sell)) exists when a specific individual or an enterprise has sufficient control over a particular product or service to determine significantly the terms on which other individuals shall have access to it. Monopolies are thus characterized by a lack of economic competition for the good or service that they provide and a lack of viable substitute goods. The verb "monopolize" refers to the process by which a firm gains persistently greater market share than what is expected under perfect competition.

A monopoly must be distinguished from monopsony, in which there is only one buyer of a product or service ; a monopoly may also have monopsony control of a sector of a market. Likewise, a monopoly should be distinguished from a cartel (a form of oligopoly), in which several providers act together to coordinate services, prices or sale of goods. Monopolies can form naturally or through vertical or horizontal mergers. A monopoly is said to be coercive when the monopoly firm actively prohibits competitors from entering the field.

In many jurisdictions, competition laws place specific restrictions on monopolies. Holding a dominant position or a monopoly in the market is not illegal in itself, however certain categories of behaviour can, when a business is dominant, be considered abusive and therefore be met with legal sanctions. A government-granted monopoly or legal monopoly, by contrast, is sanctioned by the state, often to provide an incentive to invest in a risky venture or enrich a domestic constituency. The government may also reserve the venture for itself, thus forming a government monopoly.

Economic analysis

In economics, the study of market structures under imperfect competition begins with the analysis of Monopoly. If there is a single seller in a certain industry and there are no close substitutes for the goods being produced, then the market structure is that of a "pure monopoly". Sometimes, there are many sellers in an industry and/or there exist many close substitutes for the goods being produced, but nevertheless firms retain some market power. This is called monopolistic competition, whereas oligopoly refers to the case where the main theoretical framework revolves around firm's strategic interactions.

Basic market structures

There are four basic types of market structures under traditional economic analysis, perfect competition, monopolistic competition, oligopoly and monopoly. A Monopoly is a market structure is which a single supplier produces and sells the product.

Characteristics of a monopoly

  • Single Seller: In a monopoly there is one seller of the monopolized good who produces all the output. The firm and industry are identical. In a PC market there are an infinite number of sellers each producing an infinitesimally small quantity of output.
  • Market Power: Market Power is the ability to affect the terms and conditions of exchange. It is the ability to set your own price. Although a monopoly's market power is high it is not absolute. A monopoly faces a negatively sloped demand curve not a perfectly inelastic curve. Consequently, any price increase will result in the loss of some customers. The monopoly's objective is to maximize profits.
  • High Barriers to Entry and Competition: Monopolies derive their market power from barriers to entry - circumstances that prevent or greatly impede a potential competitor's entry into the market or ability to compete in the market. There are three major types of barriers to entry; economic, legal and deliberate.
Economic Barriers:Economic barriers include economies of scale, capital requirements, cost advantages and technological superiority.
:Economies of scale: Monopolies are characterized by declining costs over a relatively large range of production. Declining costs coupled with large start up costs give monopolies an advantage over would be competitors. Monopolies are often in a position to cut prices below a new entrant's operating costs and drive them out of the industry. Further the size of the industry relative to the minimum efficient scale may limit the number of firms that can effectively compete within the industry. If for example the industry is large enough to support one firm of minimum efficient scale then other firms entering the industry will operate at a size that is less than MES meaning that these firms cannot produce at an average cost that is competitive with the dominant industry.
:Capital requirements: Production processes that require large investments of capital, or large research and development costs or substantial sunk costs limit the number of firms in an industry. Large fixed costs also make it difficult for a small firm to enter an industry and expand.
:Technological Superiority: A monopoly may be better able to acquire, integrate and use the best possible technology in producing its goods while entrants do not have the size or fiscal muscle to use the best available technology. In plain English one large firm can sometimes produce goods cheaper than several small firms.
:No Substitute Goods:A monopoly sells a good for which there is no close substitutes. The absence of substitutes makes the demand for the good relatively inelastic enabling monopolies to extract positive profits.
:Control of Natural Resources: A prime source of monopoly power is the control of resources that are critical to the production of a final good.
Legal Barriers: Legal rights can provide opportunity to monopolize the market in a good. Intellectual property rights, including patents and copyrights, give a monopolist exclusive control over the production and selling of certain goods. Property rights may give a firm the exclusive control over the materials necessary to produce a good.
Deliberate Actions: A firm wanting to monopolize a market may engage in various types of deliberate action to exclude competitors or eliminate competition. Such actions include collusion, lobbying governmental authorities, and force.


In addition to barriers to entry and competition, barriers to exit may be a source of market power. Barriers to exit are market conditions that make it difficult or expensive for a firm to leave the market. High liquidation costs are a primary barrier to exit. Market exit and shutdown are separate events. The decision whether to shut down or operate is not affected by exit barriers. A firm will shut down if price falls below minimum average variable costs.

Monopoly versus competitive markets

While monopoly and perfect competition mark the extremes of market structures there are many point of similarity. The cost functions are the same. Both monopolies and perfectly competitive firms minimize cost and maximize profit. The shutdown decisions are the same. Both are assumed to face perfectly competitive factors markets. There are distinctions, some of the more important of which are as follows:

Market Power - market power is the ability to control the terms and condition of exchange. Specifically market power is the ability to raise prices without losing all one's customers to competitors. Perfectly competitive (PC) firms have zero market power when it comes to setting prices. All firms in a PC market are price takers. The price is set by the interaction of demand and supply at the market or aggregate level. Individual firms simply take the price determined by the market and produce that quantity of output that maximize the firm's profits. If a PC firm attempted to raise prices above the market level all its "customers" would abandon the firm and purchase at the market price from other firms. A monopoly has considerable although not unlimited market power. A monopoly has the power to set prices or quantities although not both. A monopoly is a price maker. The monopoly is the market and prices are set by the monopolist based on his circumstances and not the interaction of demand and supply. The two primary factors determining monopoly market power are the firm's demand curve and its cost structure.

Product differentiation: There is zero product differentiation in a perfectly competitive market. Every product is perfectly homogeneous and a perfect substitute. With a monopoly there is high to absolute product differentiation in the sense that there is no available substitute for a monopolized good. The monopolist is the sole supplier of the good in question. A customer either buys from the monopolist on her terms or does without.

Number of competitors: PC markets are populated by an infinite number of buyers and sellers. Monopoly involves a single seller.

Barriers to Entry - Barriers to entry are factors and circumstances that prevent entry into market by would be competitors and impediments to competition that limit new firm’s from operating and expanding within the market. PC markets have free entry and exit. There are no barriers to entry, exit or competition. Monopolies have relatively high barriers to entry. The barriers must be strong enough to prevent or discourage any potential competitor from entering the market.

PED; the price elasticity of demand is the percentage change in demand caused by a one percent change in relative price. A successful monopoly would face a relatively inelastic demand curve. A high coefficient of elasticity is indicative of effective barriers to entry. A PC firm faces what it perceives to be perfectly elastic demand curve. The coefficient of elasticity for a perfectly competitive demand curve is infinite.

Excess Profits- Excess or positive profits are profit above the normal expected return on investment. A PC firm can make excess profits in the short run but excess profits attract competitors who can freely enter the market and drive down prices eventually reducing excess profits to zero. A monopoly can preserve excess profits because barriers to entry prevent competitors from entering the market.

Profit Maximization - A PC firm maximizes profits by producing where price equals marginal costs. A monopoly maximizes profits by producing where marginal revenue equals marginal costs. The rules are equivalent. The demand curve for a PC firm is perfectly elastic - flat. The demand curve is identical to the average revenue curve and the price line. Since the average revenue curve is constant the marginal revenue curve is also constant and equals the demand curve, Average revenue is the same as price (AR = TR/Q = P x Q/Q = P). Thus the price line is also identical to the demand curve. In sum, D = AR = MR = P.

P-Max quantity, price and profit: if a monopolist took over a perfectly competitive industry he would raise prices cut production and realize positive economic profits.

The most significant distinction between a PC firm and a monopoly is that the monopoly faces a downward sloping demand curve rather than the "perceived" perfectly elastic curve of the PC firm. Practically all the variations above mentioned relate to this fact. If there is a downward sloping demand curve then by necessity there is a distinct marginal revenue curve. The implications of this fact are best made manifest with a linear demand curve, Assume that the inverse demand curve is of the form x = a - by. Then the total revenue curve is TR = ay - by2 and the marginal revenue curve is thus MR = a - 2by. From this several things are evident. First the marginal revenue curve has the same y intercept as the inverse demand curve. Second the slope of the marginal revenue curve is twice that of the inverse demand curve. Third the x intercept of the marginal revenue curve is half that of the inverse demand curve. What is not quite so evident is that the marginal revenue curve lies below the inverse demand curve at all points. Since all firms maximize profits by equating MR and MC it must be the case that at the profit maximizing quantity MR and MC are less than price which further implies that a monopoly produces less quantity at a higher price than if the market were perfectly competitive.

A company with a monopoly does not undergo price pressure from competitors, although it may face pricing pressure from potential competition. If a company raises prices too high, then others may enter the market if they are able to provide the same good, or a substitute, at a lower price. The idea that monopolies in markets with easy entry need not be regulated against is known as the "revolution in monopoly theory".

A monopolist can extract only one premium, and getting into complementary markets does not pay. That is, the total profits a monopolist could earn if it sought to leverage its monopoly in one market by monopolizing a complementary market are equal to the extra profits it could earn anyway by charging more for the monopoly product itself. However, the one monopoly profit theorem does not hold true if customers in the monopoly good are stranded or poorly informed, or if the tied good has high fixed costs.

A pure monopoly follows the same economic rationality of firms under perfect competition, i.e. to optimize a profit function given some constraints. Under the assumptions of increasing marginal costs, exogenous inputs' prices, and control concentrated on a single agent or entrepreneur, the optimal decision is to equate the marginal cost and marginal revenue of production (see diagram). Nonetheless, a pure monopoly can -unlike a competitive firm- alter the market price for her own convenience: a decrease in the level of production results in a higher price. In the economics' jargon, it is said that pure monopolies "face a downward-sloping demand". An important consequence of such behavior is worth noticing: typically a monopoly selects a higher price and lower quantity of output than a price-taking firm; again, less is available at a higher price.

There are important points for one to remember when considering the monopoly model diagram (and its associated conclusions) displayed here. The result that monopoly prices are higher, and production output lower, than a competitive firm follow from a requirement that the monopoly not charge different prices for different customers. That is, the monopoly is restricted from engaging in price discrimination (this is called first degree price discrimination, where all customers are charged the same amount). If the monopoly were permitted to charge individualized prices (this is called third degree price discrimination), the quantity produced, and the price charged to the marginal customer, would be identical to a competitive firm, thus eliminating the deadweight loss; however, all gains from trade (social welfare) would accrue to the monopolist and none to the consumer. In essence, every consumer would be just indifferent between (1) going completely without the product or service and (2) being able to purchase it from the monopolist.

As long as the price elasticity of demand for most customers is less than one in absolute value, it is advantageous for a firm to increase its prices: it then receives more money for fewer goods. With a price increase, price elasticity tends to rise, and in the optimum case above it will be greater than one for most customers.

Monopoly and efficiency

According to the standard model, in which a monopolist sets a single price for all consumers, the monopolist will sell a lower quantity of goods at a higher price than would firms under perfect competition. Because the monopolist ultimately forgoes transactions with consumers who value the product or service more than its cost, monopoly pricing creates a deadweight loss referring to potential gains that went neither to the monopolist or to consumers. Given the presence of this deadweight loss, the combined surplus (or wealth) for the monopolist and consumers is necessarily less than the total surplus obtained by consumers under perfect competition. Where efficiency is defined by the total gains from trade, the monopoly setting is less efficient than perfect competition.

It is often argued that monopolies tend to become less efficient and innovative over time, becoming "complacent giants", because they do not have to be efficient or innovative to compete in the marketplace. Sometimes this very loss of psychological efficiency can raise a potential competitor's value 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 their monopoly to new entrants. This is likely to happen where a market's barriers to entry are low. It might also be because of the availability in the longer term of substitutes in other markets. For example, a canal monopoly, while worth a great deal in the late eighteenth century United Kingdommarker, was worth much less in the late nineteenth century because of the introduction of railways as a substitute.

Natural monopoly

A natural monopoly is a firm which experiences increasing returns to scale over the relevant range of output. A natural monopoly occurs where the average cost of production “declines throughout the relevant range of product demand.” The relevant range of product demand is where the average cost curve is below the demand curve. When this situation occurs it is always cheaper for one large firm to supply the market than multiple smaller firms, In fact, absent government intervention such markets will naturally evolve into a monopoly. An early market entrant who takes advantage of the cost structure and can expand rapidly can exclude smaller firms from entering and can drive or buy out other firms. A natural monopoly suffers from the same inefficiencies as any other monopoly. Left to its own devices a profit seeking natural monopoly will produce where marginal revenue equals marginal costs. Regulation of natural monopolies is problematic. Breaking up such monopolies is counter productive. The most frequently used methods dealing with natural monopolies is government regulations and public ownership. Government regulation generally consists of regulatory commissions charged with the principal duty of setting prices. To reduce prices and increase output regulators often use average cost pricing. Under average cost pricing the price and quantity are determined by the intersection of the average cost curve and the demand curve. This pricing scheme eliminates any positive economic profits since price equals average cost. Average cost pricing in not perfect. Regulators must estimate average costs. Firms have a reduced incentive to lower costs. And regulation of this type has not been limited to natural monopolies.

Government-granted monopoly

A government-granted monopoly (also called a "de jure monopoly") is a form of coercive monopoly by which a government grants exclusive privilege to a private individual or firm to be the sole provider of a good or service; potential competitors are excluded from the market by law, regulation, or other mechanisms of government enforcement. Copyright, patents and trademarks are examples of government-granted monopolies.

Breaking up monopolies

When monopolies are not broken through the open market, sometimes a government will step in, either to regulate the monopoly, turn it into a publicly owned monopoly environment, or forcibly break it up (see Antitrust law). Public utilities, often being naturally efficient with only one operator and therefore 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.

Law

The existence of a very high market share does not always mean consumers are paying excessive prices since the threat of new entrants to the market can restrain a high-market-share firm's price increases. Competition law does not make merely having a monopoly illegal, but rather abusing the power a monopoly may confer, for instance through exclusionary practices.

First it is necessary to determine whether a firm is dominant, or whether it behaves "to an appreciable extent independently of its competitors, customers and ultimately of its consumer." As with collusive conduct, market shares are determined with reference to the particular market in which the firm and product in question is sold.

Under EU law, very large market shares raises a presumption that a firm is dominant, which may be rebuttable. If a firm has a dominant position, then there is "a special responsibility not to allow its conduct to impair competition on the common market". The lowest yet market share of a firm considered "dominant" in the EU was 39.7%.

Certain categories of abusive conduct are usually prohibited under the country's legislation, though the lists are seldom closed. The main recognized categories are:



Despite wide agreement that the above constitute abusive practices, there is some debate about whether there needs to be a causal connection between the dominant position of a company and its actual abusive conduct. Furthermore, there has been some consideration of what happens when a firm merely attempts to abuse its dominant position.

Historical monopolies

The term "monopoly" first appears in Aristotle's Politics, wherein Aristotle describes Thales of Miletus' cornering of the market in olive presses as a monopoly (μονοπωλίαν).

Common salt (sodium chloride) historically gave rise to natural monopolies. Until recently, a combination of strong sunshine and low humidity or an extension of peat marshes was necessary for winning salt from the sea, the most plentiful source. Changing sea levels periodically caused salt "famines" and communities were forced to depend upon those who controlled the scarce inland mines and salt springs, which were often in hostile areas (the Sahara desert) requiring well-organized security for transport, storage, and distribution. The "Gabelle", a notoriously high tax levied upon salt, played a role in the start of the French Revolution, when strict legal controls were in place over who was allowed to sell and distribute salt.

Robin Gollan argues in The Coalminers of New South Wales that anti-competitive practices developed in the Newcastlemarker coal industry as a result of the business cycle. The monopoly was generated by formal meetings of the local management of coal companies agreeing to fix a minimum price for sale at dock. This collusion was known as "The Vend." The Vend collapsed and was reformed repeatedly throughout the late nineteenth century, cracking under recession in the business cycle. "The Vend" was able to maintain its monopoly due to trade union support, and material advantages (primarily coal geography). In the early twentieth century as a result of comparable monopolistic practices in the Australian coastal shipping business, the vend took on a new form as an informal and illegal collusion between the steamship owners and the coal industry, eventually going to the High Court as Adelaide Steamship Co. Ltd v. R. & AG.

Examples of legal (and or) illegal monopolies



How to counter monopolies?

According to professor Milton Friedman, laws against monopolies cause more harm than good, but unnecessary monopolies should be countered by removing tariffs and other regulation that upholds monopolies.

A monopoly can seldom be established within a country without overt and covert government assistance in the form of a tariff or some other device. It is close to impossible to do so on a world scale. The De Beers diamond monopoly is the only one we know of that appears to have succeeded. - - In a world of free trade, international cartels would disappear even more quickly.

On the other hand, professor Steve H. Hanke believes that although private monopolies are more efficient than public ones, often by factor two, sometimes private natural monopolies, such as local water distribution, should be regulated (not prohibited) through, e.g., price auctions.

See also



Notes and references

Further reading

External links



Criticism




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