There is power in uniqueness, meaning that if you have something that no one else has, you automatically wield a lot of authority. Something similar happens in a monopoly, where a certain product is sold by only one seller in the market. This exclusiveness gives the firm absolute control over the market and puts it in a major position of power.
With power, however, comes the ability to abuse it. This leads to the question—are all monopolies bad? Are monopolies illegal? Before diving in to answer these questions, let’s first look at other market structures that exist apart from a monopoly.
Types Of Market Structures
The characteristics of a monopoly are at one extreme end of the market structure spectrum. Let’s start with perfect competition, which that stands at the opposite edge of monopoly.
A perfectly competitive market structure is one in which a large number of small firms compete against each other without any single firm having significant marketing power. They sell identical products at a price set by the firms in the market. However, a perfectly competitive market is highly unrealistic; it is mostly theoretical and rarely exists in the real world.
The agriculture markets in the beginning of the 20th century were viewed as being close to a real-world version of a perfectly competitive market. There were many farmers, and no single farmer constituted a sizable portion of the market activity. However, in recent decades, even farming operations have changed in ways that deviate from the assumptions of perfect competition (Source).
Like perfect competition, monopolistic competition is characterized by a large number of small firms competing against each other. However, the difference is that the firms in this market structure sell similar, but highly differentiated products. Despite the remarkable similarities in these products, the small differences become the basis for a firm’s marketing and advertising. Firms might choose to differentiate their products on the basis of quality, style, packaging, brand name, advertising, pricing strategies and so on.
Coke and Pepsi are quite similar, but if Pepsi launched a huge promotional sale at a supermarket chain, some Coke drinkers might switch, at least temporarily. Monopolistic competition can also be found in the fast food restaurant industry, clothing stores, breakfast cereal companies, beauty salons and spas, etc.
An oligopoly is dominated by a few firms that collaborate with or compete against each other. These firms have control over raw materials, patents and other resources that make it difficult for any potential businesses planning an entry into the market. The concentration of power in the hands of a few players also leads to high prices. However, prices cannot go too high, as buyers always have the option to head to product substitutes in the market.
Some prime examples of oligopolies are airlines, cable television services, mass media, pharmaceuticals, etc.
Monopoly, and what gives rise to it
A monopoly is a market structure where a single firm is the sole producer of a product with no close substitutes. Therefore, under a monopoly, the firm and industry are synonymous. A monopoly arises when one firm has a crucial advantage over the others. This advantage may simply be due to a key resource owned by a firm (e.g., De Beers owns most of the diamond mines in the world), or due to an exclusive right given by the government in the form of patents and copyrights to produce a certain good.
Sometimes, an industry starts with many competitors, but only one survives the competition. All other firms are driven out of the industry due to their products being inferior or for other reasons, such as their inability to reduce costs.
A firm may also become a monopoly by dominating the industry and using that dominance to its advantage to eliminate competition and discourage potential competition.
Sometimes, one large business can supply the entire market at a lower price than two or more smaller ones. Suppose your firm is building a toll bridge across a river. This would entail huge initial setup costs, but the marginal cost of allowing one more car is close to zero. Simply put, building a bridge involves huge costs, but once the bridge is constructed, you incur hardly any cost to allow a car to pass. Therefore, with every car driving over the bridge, the average cost reduces.
If a second bridge is produced, the average costs would nearly double, as the two bridges would split the market. A natural monopoly is created in such situations, since having one bridge instead of two is more efficient.
Public utilities enjoy extreme economies of scale, which means that they are at a huge advantage due to their size. Other firms looking to enter this industry would be discouraged to compete, simply because it would be incredibly expensive to reach a comparable size in a short amount of time.
What is the problem with a monopoly?
The concentration of power in the hands of a single firm is dangerous. It puts the firm in a position to exploit this power in the following ways:
High prices – Demand is elastic in a competitive market. This means that, in a competitive market, if you charge a price for your product that is higher than the market price, you won’t sell anything. Conversely, if you charge a price that is lower than the market price, people will prefer to buy it from you. However, in a single-seller market, consumers—devoid of any other options to buy from—will have to pay the price set by the monopoly, despite it being high.
Low quality – A competitive market demands customer satisfaction by constantly testing the ability of firms to innovate, find new production methods, and produce high-quality products. If a firm does not live up to the expectations of consumers, it will not survive. However, a monopoly is largely immune to such pressures. Consumers are likely to be left with no choice but to buy products of a lower quality and at a higher price than they would find in a more competitive setting.
Price Discrimination – Price discrimination occurs when a company sells identical products at different prices to different people, depending on factors like the financial status of the customer, the quantity ordered, and so on. In order to make the most revenue out of each customer, monopolies may charge a customer the maximum amount he is willing to pay. Some monopolies may also vary the price according to the quantity demanded by offering bulk discounts.
Tying Contracts – Tying occurs when a firm sells you a product only if you also agree to purchase a different product. In technological products, for example, a firm may design its products in such a way that makes them impossible to use with another firm’s product (Source).
For example, when Apple initially released the iPhone in 2007 in the United States, it was sold exclusively with AT&T contracts. A software lock was employed on the iPhone ensuring that it would not work on any other network!
Unfair barriers to entry – A monopoly may try to aggressively protect or even expand its position by unfairly discouraging new entrants. They may be willing to spend their economic profits in an attempt to influence public authorities and political leaders who can help them maintain their superior position.
Antitrust law: Are monopolies illegal?
After understanding the effect that such a concentration of power has on an economy, one might suggest that monopolies must be prohibited. However, not all monopolies are bad, and not all of them are illegal. For example, businesses might become monopolies if they produce a superior and expertly managed product. One cannot penalize successful companies just for being successful!
Even so, monopolies are illegal if they’re established or maintained through improper conduct.
Antitrust laws are in place in many countries to protect consumers by regulating how companies operate their businesses. They help provide an equal playing field for firms in the same industry and prevent firms from playing dirty to acquire too much power over their competitors. Three core federal antitrust laws in effect today are the Sherman Act, the Federal Trade Commission Act, and the Clayton Act.
These laws forbid unlawful business practices in general terms, leaving the courts to decide which ones are illegal based on the facts of each case. For example, the FTC Act bans unfair methods of competition, the Clayton Act prohibits mergers and acquisitions where the effect may be to substantially reduce competition or create monopoly, and so on (Source).
Under these federal and some state laws, businesses and consumers who are harmed by anticompetitive conduct can seek (or in some cases win) damages and injunctive relief.
Monopoly is not an unbeatable system anymore. In addition to these stated laws, technological changes and the pursuit of profits chip away at the established powers of large firms. Potential rivals are constantly trying to make the next breakthrough with their new products, which might eliminate an old firm’s power. Thus, just like our lives, constantly improving and trying to be the best is the only option!