A pure monopoly is defined as a single supplier. While there only a few cases of pure monopoly, monopoly ‘power’ is much more widespread, and can exist even when there is more than one supplier – such in markets with only two firms, called a duopoly, and a few firms, an oligopoly.
According to the 1998 Competition Act, abuse of dominant power means that a firm can 'behave independently of competitive pressures'. See Competition Act.
For the purpose of controlling mergers, the UK regulators consider that if two firms combine to create a market share of 25% or more of a specific market, the merger may be ‘referred’ to the Competition Commission, and may be prohibited.
Formation of monopolies
Monopolies are formed under certain conditions, including:
- When a firm has exclusive ownership or use of a scarce resource, such as British Telecom who owns the telephone cabling running into the majority of UK homes and businesses.
- When governments grant a firm monopoly status, such as the Post Office.
- When firms have patents or copyright giving them exclusive rights to sell a product or protect their intellectual property, such as Microsoft’s ‘Windows’ brand name and software contents are protected from unauthorised use.
- When firms merge to given them a dominant position in a market.
Maintaining monopoly power - barriers to entry
Monopoly power can be maintained by barriers to entry, including:
Economies of large scale production
If the costs of production fall as the scale of the business increases and output is produced in greater volume, existing firms will be larger and have a cost advantage over potential entrants – this deters new entrants.
Predatory pricing
This involves dropping price very low in a ‘demonstration’ of power and to put pressure on existing or potential rivals.
Limit pricing
Limit pricing is a specific type of predatory pricing which involves a firm setting a price just below the average cost of new entrants – if new entrants match this price they will make a loss!
Perpetual ownership of a scarce resource
Firms which are early entrants into a market may ‘tie-up’ the existing scarce resources making it difficult for new entrants to exploit these resources. This is often the case with ‘natural’ monopolies, which own the infrastructure. For example,British Telecom owns the network of cables, which makes it difficult for new firms to enter the market.
High set-up costs
If the set-up costs are very high then it is harder for new entrants.
High ‘sunk’ costs
Sunk costs are those which cannot be recovered if the firm goes out of business, such as advertising costs – the greater the sunk costs the greater the barrier.
Advertising
Heavy expenditure on advertising by existing firms can deter entry as in order to compete effectively firms will have to try to match the spending of the incumbent firm.
Loyalty schemes and brand loyalty
If consumers are loyal to a brand, such as Sony, new entrantswill find it difficult to win market share.
Evaluation of monopoly
Since Adam Smith the general view of monopolies is that they tend to act against the public’s interest, and generate more costs than benefits.
The costs of monopoly
Less choice
Clearly, consumers have less choice if supply is controlled by a monopolist – for example, the Post Office used to bemonopoly supplier of letter collection and delivery servicesacross the UK and consumers had no alternative letter collection and delivery service.
High prices
Monopolies can exploit their position and charge high prices, because consumers have no alternative. This is especially problematic if the product is a basic necessity, like water.
Restricted output
Monopolists can also restrict output onto the market to exploit its dominant position over a period of time, or to drive up price.
Allocative inefficiency
Monopolies may also be allocatively inefficient – it is not necessary for the monopolist to set price equal to the marginal cost of supply. In competitive markets firms are forced to ‘take’ their price from the industry itself, but a monopolist can set (make) their own price. Consumers cannot compare prices for a monopolist as there are no other close suppliers. This means that price can be set well above marginal cost.
Net welfare loss
Even accounting for the extra profits derived by a monopolist, which can be put back into the economy when profits are distributed to shareholders, there is a net loss of welfare to the community. Welfare loss is the loss of community benefit, in terms of consumer and producer surplus, that occurs when a market is supplied by a monopolist rather than a large number of competitive firms.
A ‘net welfare loss’ refers any welfare gains less any welfare loses as a result of an economic transaction or a government intervention. Using ‘welfare analysis’ allows the economist to evaluate the impact of a monopoly.
Less employment
Monopolists may employ fewer people than in more competitive markets. Employment is largely determined by output – the more output a firm produces the more labour it will require. As output is lower for a monopolist it can also be assumed that employment will also be lower.