The term Monopoly is a combination of two words: “mono” means “single,” and “poly” implies “seller.” Thus, a monopoly is a market controlled by a single seller. The seller could be a specific person or enterprise developing and distributing a particular product.
Besides hampering the ability to deliver products at lower costs per unit, monopolies can also slow down research and innovation.
To make sure wealth and power do not concentrate with a single seller, several countries discourage monopolies. In the United States, for example, the three major Federal antitrust laws ensure that one company cannot control a market and use that control to exploit its customers. These three laws are
- The Sherman Antitrust Act
- The Clayton Act
- The Federal Trade Commission Act
Most of us have never heard of them, but enforcement of these laws saves consumers billions of dollars every year.
While monopolies can be categorized into different groups, they all share some common characteristics.
- High entry barriers: Competitors cannot easily enter the market due to high startup costs, patents, or government policies.
- No close alternatives: There is no similar product available in the market. Monopolies have total control over the production and distribution of a specific offering.
- Price setter: Since there is no close substitute for their products or services, monopolies can set and raise prices at will.
To further explain this market structure, we have described four major types of monopolies with examples. They all arise due to various proprietary technologies and superior products that help them gain a competitive advantage.
4. Public Monopoly
Nuclear power plants of Électricité de France, owned by the French State
In a public monopoly, the government is the sole provider of specific goods or services, and competition is prohibited by law. In other words, the monopoly is formed by the government (it could be local, regional, or national government).
Since these monopolies are created by the government itself and there are hardly any competitors, they have the power to increase the production or prices of goods and services. They can change operational strategies and impose restrictive terms and conditions without the fear of losing market share.
In most cases, public monopolies are created by the national or regional government for two main reasons:
- The cost of producing and delivering goods is too high
- A sole business operator could be more reliable and beneficial for the general public
Governments often allow monopolies to exist by granting them patents, tenders, and funding. This limits competitors’ entry into the market.
The most common example of a public monopoly is the postal system. It is run by several national governments with competitions prohibited in almost all related services. In Canada, healthcare systems are government monopolies. Other examples include railroads, local telephone services, and public utilities.
Utility corporations range from niche companies focusing on wind energy to large businesses providing a spectrum of services. Électricité de France, for instance, is one of the largest multinational electric utility companies owned by the French State.
In the recent decade, however, we have witnessed a strong privatization trend across the world.
3. Natural Monopoly
In any industry, a natural monopoly arises due to a high fixed cost or barrier to starting a business and a need to achieve powerful economies of scale. In simple terms, it is only economically viable for one organization to serve the market.
A business obtains this position through its geographical advantages, technological expertise, and various barriers to entry. And it is referred to as ‘natural’ because the government usually doesn’t interfere with policies to change the ‘natural’ state of the market.
Since organizations need to serve the entire market to remain financially viable, some of them use tactics (like a merger, collusion, acquisition, or hostile takeover) to gain unfair advantages. For example, the two biggest players in the market might conspire together to fix the prices of particular goods and services.
All crucial characteristics of a natural monopoly are attributable to economies of scale:
- Naturally Occurring: other businesses are unable or unwilling to complete
- Large Fixed Costs: competitors need huge investments just to set up infrastructure. Adding customers and maintenance would require more money.
- Low Marginal Costs: it costs very little to serve extra customers
- Long Economies of Scale: a business can generate profits only if it captures the majority of the market share
In the 19th century, natural monopolies were recognized as potential causes of market failure. In such situations, governments intervene to prevent high costs and corruption.
Today, we have dozens of regulatory agencies in each sector that set and enforce standards for government-enabled natural monopolies.
For example, the United States Department of Energy has broad responsibilities for the safety of the oil and natural gas industries, while the US Department of Transportation is responsible for the efficient and equitable movement of people and goods. So far, there is no similar agency empowered to regulate information and technology monopolies. There might be in the future, though.
Water and electricity are the two most common examples of natural monopolies that exist on a regional basis. When you buy a house, you usually don’t have many choices to get water supply and electricity connection. The railroad industry is another great example.
Can you imagine the land, facilities, machinery, and technology you have to purchase to start a business in this sector? Difficult regulation and licensing further limit the number of competitors. It is too risky and costly to get into this business.
2. Imperfect Monopoly
In an imperfect monopoly (also referred to as monopolistic competition), several companies compete against each other to gain more market share. But since their products or services could be slightly different from one another, they are not perfect substitutes.
In other words, an imperfect monopoly is a type of market structure where multiple firms [that develop similar but differentiated products] compete with each other. None of the firms have a monopoly in the market, and each firm can take action without impacting the other firms’ operations.
The competing businesses differentiate themselves based on marketing tactics and pricing. They market products by brand or quality.
The five main characteristics of monopolistic competition are:
- Product differentiation: Companies differentiate their products by assigning brand names and multiple quality levels.
- Independent decision-making: Businesses can make data-driven decisions without fear of raising competition.
- Low entry barrier: Since no firm monopolizes the market, there are only a few barriers to entry and exit.
- Some degree of market power: Sellers have a degree of control over products’ prices.
- Highly elastic demand: Consumers can easily switch to other brands based solely on availability or price increases.
Typically, two types of equilibrium define monopolistic competition: short-run equilibrium and long-run equilibrium. The former keeps profit margins high, while the latter decreases the profit margin to sell more units and keep the business viable in the longer run.
As for the downside, monopolistic competition gives too many choices to consumers. Sometimes, businesses mislead consumers with catchy advertisement slogans and not-so-accurate information.
Manufacturers of digital devices, heating/cooling machines, clothing, restaurants, and common products like soap and toothpaste are all examples of imperfect monopoly. They differentiate their products by changing the physical composition, or by simply advertising products with different brand names and images.
1. Pure Monopoly
Pure monopoly is a type of economic market where a single company controls the entire supply of goods and services. In other words, only one corporation dominates a sector or industry, and it determines all rules, pricing, and terms and condition.
Unlike a monopoly that may exist in a sector with several suppliers, a pure monopoly has only one producer or supplier of goods. Although controlling the entire sector seems almost impossible, pure monopolies do exist in the real world. They have specific characteristics:
- Sole supplier: Only one company determines the market price and availability of certain products or services
- No substitute products: There is no alternative or closely-related products in the market
- No rivals: Pure monopolies are themselves an industry
- High barrier to entry: It’s extremely difficult for competitors to enter the market, even if the monopoly is making exceptionally high profits. The barriers include control of resources, economies of scale, and legal barriers like patents and copyrights.
The United States Postal Service, operated by the federal government, has a legal monopoly over other kinds of mail services. It controls the market, sets prices, and is protected by the government. Other companies are prohibited from entering the postal industry to minimize costs and enhance quality for the benefit of customers.
In the mid-1990s, Microsoft Corporation held a pure monopoly position on personal computer operating systems. Microsoft Windows accounted for more than 90% of the OS market, and Microsoft customers (both PC users and computer manufacturers) had no commercially viable alternative to the Windows OS.
Although Microsoft is not a pure monopoly anymore, it still holds over 74% market share of the desktop operating system.
More To Know
Are monopolies illegal?
No, not all monopolies are illegal. Governments don’t punish businesses for creating superior products and services. However, antitrust law prohibits illegitimate monopoly behavior, such as price discrimination, exclusive dealing, predatory pricing, product tying, and refusing to supply an essential facility.
Monopoly businesses in the 21st century do not dominate the whole industry on a global scale. Instead, they manage substantial assets in one region or country.
What are the pros and cons of monopolies?
Monopolies are typically considered to be a bad thing in modern economics. However, they have both advantages and disadvantages:
- Can produce products in mass quantities at lower costs per unit
- Can invest more in research and development without fear of competition
- Can build up cash reserves for difficult times
- Higher prices than in competitive markets
- With less competition, firms often lack the incentive to control costs
- Less choice for consumers
Furthermore, the evaluation of the advantages and disadvantages of a monopoly depends on several factors, such as ownership structure, management, and government regulations.
The most famous monopolies of all time
Salt Commission: Formed during the decline of Tang dynasty China, the organization used to increase tax revenue from the state monopoly of the salt trade.
Dutch East India Company: It enjoyed huge profits from carrying out trade activities in Asia through most of the 17th century.
American Tobacco Company: It acquired more than 200 rival firms to dominate the tobacco industry. In 1911, the Antitrust law broke the company into multiple major firms.
Standard Oil Company: At its peak, Standard Oil was the biggest petroleum company in the world. Its success made its cofounder, John D. Rockefeller, one of the richest people in modern history. In 1911, it was dissolved into 34 smaller corporations.