A business or a firm is said to be a monopoly in an industry when it is the only producer of a certain good or service (Dixon & Rankin, 1995). A monopolist has a sufficient control over the price and quantity which the consumer shall access the product. Monopolies exist in the industry because there is no competition for the good and service they produce and there are no viable substitute goods for them that exist. Specifically, they exist because of three possible reasons: (1) exclusive control over the inputs needed to make the product; (2) economies of scale, the industry is better off with only one supplier; and (3) patents and licenses given to inventions so that others cannot produce the same thing and limit the use of a particular resource or area, respectively (Djolov, 2006).
Monopolies are less efficient structure compared to perfect competition (Wolfstetter, 2008). Monopolist can set a single price for all consumers, sell a lower quantity of goods at a higher price. This pricing scheme creates a deadweight loss to society, a potential gain that neither goes to monopolist nor to consumers. Unlike a competitive firm who charges consumers the price which equals its marginal cost of production, monopolist can supply the goods at any level where its marginal cost is equal to its marginal revenue. Therefore, monopolies are less efficient than firms under perfect competition because the combined surplus (or wealth) for the monopolist and consumers is necessarily less than the total surplus obtained by consumers. Efficiency is lost because the consumer loses the surplus that would occur under perfect competition. Though the monopolist captures part of that surplus, still some becomes a deadweight loss.
Monopolies are said to be damaging for the entire industry as they tend to become “complacent giants” because they do not have the incentive to be efficient and innovative without the pressure of other competing firms (Schotter, 2009). However, monopolies can also benefit consumers. In the short run, consumers can take advantage of predatory pricing, where monopolist sells the product or service at the lowest possible price to drive competitors out of the market or create barriers to entry for potential new competitors (Shy, 1996). Sometimes, the government intervenes to regulate the monopoly and turn it into a publicly owned monopoly environment, or forcibly seize its operation. Examples of these are public utilities. Public utilities are efficiently working under one operator, less likely to break up and often heavily regulated.
Examples of important monopolies in history are Standard Oil which broke up in 1911 but two of its surviving companies are ExxonMobil and the Chevron Corporation. Standard Oil was an oil producing, refining, transporting and marketing company (Olien, 2000). Established in 1870, it was once the largest oil company in the world. Another example is the Joint Commission which is largely responsible over whether or not US hospitals are able to participate in the Medicare and Medicaid programs (Sherman, 1989). It is a US-based non-profit organization, enjoying exclusive legal protection in the USA and collecting $113 million yearly revenue, mainly from the fees it charges US hospitals for evaluating their compliance with federal regulations.
Though monopolies have the advantage to charge higher price for their product, there are still advantages of their existence (Djolov, 2006). Their huge profit can allow high cost of research and development which can improve their products and lower its cost over time. Consumers can also benefit in the form of lower prices from economies of scale which lowers the average cost of production of the monopolies. Finally, monopolies can create international competitiveness and therefore their existence is a sign of a market success and not a failure.
Dixon, Huw David & Neil Rankin. The New Macroeconomics: Imperfect Markets and Policy Effectiveness. UK: University Cambridge Press, 1995.
Djolov, George. The Economics of Competition: The Race to Monopoly. NY: Haworth Press, Inc., 2006.
Olien, Roger. Oil and Ideology: The Cultural Creation of the American Petroleum Industry. US: University of North Carolina Press.
Schotter, Andrew. Microeconomics: A Modern Approach. OH: South-Western Cengage Learning, 2009.
Sherman, Roger. The Regulation of Monopoly. UK: University Cambridge Press, 1989.
Shy, Oz. Industrial Organization: Theory and Practice. NY: Maple-Vail Book Manufacturing Group.
Wolfstetter, Elmar. Topics in Microeconomics: Industrial Organization, Auctions, and Incentives. UK: University Cambridge Press, 2008.