Monopoly (economics)

I

Introduction

Monopoly (economics), economic situation in which only a single seller or producer supplies a commodity or a service. For a monopoly to be effective, there must be no practical substitutes for the product or service sold, and no serious threat of the entry of a competitor into the market. This enables the seller to control the price.

One or more of the following elements are of great importance in establishing a monopoly in a particular industry: (1) control of a major resource necessary to produce a product; (2) technological capabilities that allow a single firm to produce at reasonable prices all the output of a particular commodity or service, a situation sometimes described as a “natural” monopoly; (3) exclusive control over a patent on a product or on the processes used to produce the product; and (4) a government franchise that awards a company the sole right to produce a commodity or service in a given area.

II

Historical Background

Economic monopolies have existed throughout much of human history. In ancient and medieval times dire scarcity of resources was common and affected the lives of most human beings. When resources are extremely scarce, little room exists for a multiplicity of producers for many products and services. Chinese emperors from the Han dynasty onwards used official monopolies to create key industries. The medieval guilds, for example, were associations of merchants or artisans that controlled output, set terms for entering a trade, and regulated prices and wages.

As nation-states began to emerge in the late Renaissance era, monopoly proved to be a useful device for sovereigns, ever strapped for the cash necessary to sustain their armies, courts, and extravagant lifestyles. Monopoly rights were awarded to court favourites for manufacture and trade in basic essentials such as salt and tobacco. In all such charters, the sovereign received an ample share of the profits. Most major European nations also granted monopoly powers to private trading companies, such as the East India Companies, to stimulate exploration and the discovery of new lands. The awarding of monopoly power by the sovereign to private companies and court favourites, however, led to many abuses. In England, Parliament finally passed a Statute of Monopolies (1624) that sharply curtailed the monarch's right to create private monopolies in domestic trade. This act did not apply to the monopoly powers granted to companies formed for exploration and colonization.

Two developments, both English in origin, brought about a reversal of these conditions, leading to a competitive-based economic order in the early 19th century. First was the emergence through English common law of a hostile attitude towards private combinations that were in restraint of trade. Under the common law, private agreements of a monopolistic nature that restrained free trade were not enforceable. This common-law hostility towards monopoly was important in Great Britain and America. The second development was the expansion of production that followed the Industrial Revolution, combined with the ideas of the Scottish philosopher and economist Adam Smith on private property, markets, and the free play of competition, which became the dominant influences shaping economic life in the first half of the 19th century. This period most resembled Smith's textbook “model” of a competitive economic order—one in which business firms in nearly all industries were many in number and small in size.

In the late 19th century the tendencies inherent in a free market economy order brought about new changes. In Great Britain, the United States, and other industrial nations, giant business firms began to emerge and dominate the economy. In part, this stemmed from the empire-building tactics of the “captains of industry”, such as the American entrepreneur John D. Rockefeller, who drove most competitors from the field. It also came about because of technological advances that enabled a handful of large firms to satisfy the demand in many markets. The result was not complete monopoly but, rather, an economic order known as oligopoly, in which production is dominated by a few firms.

In more recent years, most governments have sought, through competition laws, to prevent the outright emergence of private monopolies in major industries by using law, the courts, and regulators to impose competitive conditions on firms in these industries. If competitive conditions are not possible—in the case of natural monopolies—governments have either nationalized the industry, or regulated its profits so as to protect consumers.

III

Theory of Monopoly

Economists have developed a complicated body of theory to explain why the behaviour of a monopoly firm differs significantly from that of a competitive firm. A monopoly company, like any other business, confronts two forces: (1) a set of demand conditions for the commodity or service it produces; (2) a set of cost conditions that governs how much it has to pay to those who supply the resources and labour required to produce its product. Every business firm must adjust its production to the point at which it is able to maximize its profit—that is, the difference between the revenue it receives from its sales and the costs it incurs in producing the amount sold. The level of production at which it achieves its maximum profit is not necessarily the one at which the firm is getting the highest possible price for its product. The major difference between a monopoly firm and one in a competitive industry is that the monopoly will have greater control over the price it charges for its product, although this control is never absolute. The monopoly firm thus has more freedom than the competitive firm to adjust price as well as production as it strives to achieve a maximum profit.

From the viewpoint of society, monopoly leads to effects that are less desirable than those resulting from economic competition. In general, monopoly results in a smaller output of goods or services as compared with competition, and also in prices that are often higher than those in competitive industries. Another practice associated with monopoly is price discrimination, which involves charging a different price for the same goods or services to different segments of the same market.

IV

Kinds of Monopolies

Among the various kinds of economic monopolies are natural monopolies, trust companies, cartels, and industrial mergers.