MARKETS AND MONOPOLIES

A monopoly is a situation where there is a single seller in the market. In conventional economic analysis, a monopoly is taken as the polar opposite of perfect competition. By definition, the demand curve facing the monopolist is the industry demand curve, which is downward sloping. Thus, the monopolist has significant power over the price it charges, i.e. is a price setter rather than a price taker.

Comparison of a monopoly and perfect competition* reveals that the monopolist will set a higher price, produce a lower output and earn above normal profits (sometimes referred to as monopoly rents). This suggests that consumers will face a higher price, leading to a loss. In addition, income will be transferred from consumers to the monopoly firm.

The preceding arguments are purely static and constitute only part of the possible harm resulting from monopoly. It is sometimes argued that monopolists, being largely immune from competitive pressures, will not have the appropriate incentives to minimize costs or undertake technological change. Moreover, resources may be wasted in attempts to achieve a monopoly position. However, a counter argument advanced is that a degree of monopoly power is necessary to earn higher profits in order to create incentives for innovation.

Monopolies can only continue to exist if there are barriers to entry. Barriers which sustain monopolies are often associated with legal protection created through patents and monopoly franchises. However, some monopolies are created and sustained through strategic behavior or economies of scale. The latter are natural monopolies which are often characterized by steeply declining long-run average and marginal costs and the size of the market is such that there is room for only one firm to exploit available economies of scale or duplication of facilities would be wasteful.

Monopsony. A monopsony consists of a market with a single buyer. When there are only a few buyers, the market is defined as an oligopsony. In general, when buyers have some influence over the price of their inputs they are said to have monopsony power.

Natural monopoly. A natural monopoly exists in a particular market if a single firm can serve that market at lower cost than any combination of two or more firms. Natural monopoly arises out of the properties of productive technology, often in association with market demand, and not from the activities of governments or rivals. Generally speaking, natural monopolies are characterized by steeply declining long run average and marginal-cost curves such that there is room for only one firm to fully exploit available economies of scale and supply the market.

Oligopoly. An oligopoly is a market characterized by a small number of sellers who realize they are independent in their pricing and output polices. The number of sellers is small enough to give each seller some market power.

An oligopoly is distinguished from perfect competition because each seller in an oligopoly has to take into account their independence; from monopolistic competition because firms have some control over price; and from monopoly because a monopolist has no rivals, in general, the analysis of oligopoly is concerned with the effects of mutual interdependence among firms in pricing and output decisions.

There are several types of oligopoly. When all sellers are of (roughly) equal size, the oligopoly is said to be symmetric. When this is not the case, the oligopoly is asymmetric. One typical asymmetric oligopoly is the dominant firm. An oligopoly industry may produce goods which are homogeneous (undifferentiated) or may produce goods which are heterogeneous (differentiated).

The analysis of oligopoly behavior normally assumes a symmetric oligopoly, often a duopoly. Whether the oligopoly is differentiated or undifferentiated, the critical problem is to determine the way in which the firms act in the face of their realized independence.