A monopoly can be defined as an entity that has an exclusive right to sell a certain service or a product (Baumol & Blinder, 2015; Pearson, n.d.a). In order for a business to gain a monopolistic power over its market, it has to satisfy two key criteria. First, the company’s offerings should be relatively unique and do not have close substitutes.
Second, the market in which the company operates must be characterized by barriers to entry, which prevents other firms from disrupting the unrestrained monopoly power. These impediments can be divided into the following categories: legal restrictions, patents, control of scarce resources, deliberately created barriers, exorbitant sunk costs, technical advantage, and economies of scale (Baumol & Blinder, 2015). The aim of this paper is to discuss the role of monopoly in the market by analyzing the market structure spectrum and focusing on its polar ends.
The market structure is a spectrum of markets that are “characterized by the numbers of firms in them, the ease or difficulty that firms have in entering them, and the quantity and closeness of substitute goods” (Gottheil, 2012, p. 230). Giving that perfectly competitive firms and monopolistic firms are located at the opposite ends of the market spectrum, their demand curves are different. Monopolistic firms are often referred to as price makers because they have control over the market supply and are less constrained in their pricing decisions. Unlike monopolies, perfectly competitive firms or price takers are constrained to a higher degree by the demands of the market (Pearson, n.d.b). Figure 1 shows demand curves for a company operating in a monopolistic market and a company operating in a perfectly competitive market.
The demand curve facing a perfectly competitive firm is horizontal. It has to do with the fact that price takers cannot exercise control over the market, thereby charging higher prices for their products; therefore, demand exists only at the level determined by the conditions of the market. Under perfect competition, a company represents only a small fraction of the market, which means that it can only sell at the prevailing market price. For example, a farmer selling corn has no influence over other sellers of the commodity the price of which is determined by “the intersection of the industry’s supply and demand curves” (Baumol & Blinder, 2015, p. 200). A perfectly competitive firm can increase its sales by 200 percent or even 300 percent without reducing the price of its services or products (Baumol & Blinder, 2015).
The demand curve facing a monopolistic firm is downward sloping. A company operating in the monopolistic market has the power to dictate its prices. It means that by raising the price of its product, the company will not necessarily experience a loss of all customers; however, some consumers might opt for substitute products. Therefore, it can be said that a monopolistic firm can choose either the price or the quantity in order to maximize its profits. A monopolistic market is not a guarantee that a company will turn a positive profit if the demand for its products is low. As a result, a profit-maximizing monopolist is driven by the demand curve when making an output decision.
Tap water is most likely to be produced under the natural monopoly, which can be defined as “an industry in which advantages of large-scale production make it possible for a single firm to produce the entire output of the market at lower average cost than a number of firms each producing a smaller quantity” (Baumol & Blinder, 2015, p. 220). The cost advantage associated with a natural monopoly allows a single entity to profit from a public resource, which is essential for human existence.
The cost function of the industry and the management of water pipe networks create natural entry barriers preventing competition between several distributors of the public good. Given the technical aspects of the water provision, it is hard to imagine the competitive infrastructures of pipes. It must, however, be borne in mind that natural monopolies require government intervention for controlling their operations and prohibiting them from abusing their market power. Relevant regulatory policies at municipal, state, and federal levels prevent natural monopolies such as tap water and gas suppliers from charging exorbitant prices and taking environmental risks.
Due to the rarity of the deposits of natural resources, oil is most likely to be produced in the market that is characterized by oligopolistic competition. Books, movies, and wheat, on the other hand, are produced in competitive markets, which helps to ensure that excessively high profits are not extracted at the expense of consumers.
Zero Economic Profit
Zero economic profit is a revenue level that allows a company to meet its operating costs. In the long run, a monopolistic competitor and a perfect competitor can be expected to earn zero economic profits. Similar to companies operating under the condition of perfect competition, monopolistic competitors can only earn profits in the short run; however, in the long run, the excess of economic profits will be divided among the new entrants into the industry that have similar propositions. Therefore, it can be argued that a monopolistic competitor has no more power over the market than do economic actors in the perfectly competitive industry (Pearson, n.d.a).
Entries and exits play an important role in eliminating economic profits and losses under the perfect competition because they regulate both the price and the supply curve. Therefore, consumers can be considered the ultimate beneficiaries of the perfectly competitive markets.
Patent licensing is essential for the market economy because it facilitates the dissemination of new technologies. Even though the government creates monopolies by granting patents, patent licensing provides strong incentives for companies to conduct research and development (R&D) activities. It has to do with the fact that patents prevent rival companies from immediately mimicking new inventions. However, patent licenses should expire after a company has returned its investment in R&D because anticompetitive patent licensing practices harm consumers. Patent holders prevent new entrants from challenging their position in the market, thereby creating a patent-protected monopoly. While it is necessary to encourage new product development, the legal protection granted by a patent system must have limits in order to introduce competition into the market (Mateer et al., 2016).
The paper has discussed the role of monopoly in the market by analyzing the market structure spectrum and focusing on its polar ends. It has been shown that even though monopolistic markets are detrimental for consumers, sometimes it is necessary to protect them with a patent system in order to encourage innovation.
Baumol, W., & Blinder, A. (2015). Economics: Principles and policy. New York, NY: Cengage Learning.
Gottheil, F. (2012). Principles of microeconomics. New York, NY: Cengage Learning.
Mateer, D., Coppock, L., & Roark, B. (2016). Essentials of economics. London, England: W. W. Norton & Company.
Pearson. (n.d.a). Monopoly.
Pearson. (n.d.b). Monopoly: Lesson introduction.