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monopolya MARKET STRUCTURE characterized by a single supplier and high barriers to entry. In practice, the term ‘monopoly’ is usually given a wider interpretation, particularly within the context of COMPETITION POLICY, to cover DOMINANT FIRM situations and COLLUSION between rival suppliers. Monopoly is often depicted as an inefficient form of market organization since the lack of effective competition tends to remove the monopolist's incentive to reduce industry supply costs. Worse still, monopolists may abuse their market power both with respect to consumers (for example, by charging excessive prices), and actual and potential competitors (for example, by depriving them of market access through EXCLUSIVE DEALING practices). On the other hand, MARKET CONCENTRATION may lower industry supply costs by enabling firms to take advantage of ECONOMIES OF SCALE, and it is to be noted that governments go out of their way to encourage patent monopolies (see PATENT) as a means of encouraging innovation. See CONCENTRATION RATIO, MONOPOLY OF SCALE.
monopolyA type of MARKET STRUCTURE characterized by:
- one firm and many buyers: a market comprising a single supplier selling to a multitude of small, independently acting buyers;
- a lack of substitute products: there are no close substitutes for the monopolist's product (CROSS-ELASTICITY OF DEMAND is zero);
- blockaded entry: BARRIERS TO ENTRY are so severe that is impossible for new firms to enter the market.
In static monopoly, the monopolist is in a position to set the market price. Unlike a perfectly competitive producer (see PERFECT COMPETITION), however, the monopolist's marginal and average revenue curves are not identical. The monopolist faces a downward-sloping demand curve (D in Fig. 131 (a)), and the sale of additional units of his product forces down the price at which all units must be sold. The objective of the monopolist, like that of the competitive firm, is assumed to be PROFIT MAXIMIZATION, and he operates with complete knowledge of relevant cost and demand data. Accordingly, the monopolist will aim to produce at the price-output combination that equates MARGINAL COST and MARGINAL REVENUE. Fig. 131 (a) indicates the short-run equilibrium position for the monopolist. The monopolist will supply Qe output at a price of Pe. At the equilibrium price, the monopolist secures ABOVE-NORMAL PROFITS. Unlike the competitive firm situation, where entry is unfettered, entry barriers in monopoly are assumed to be so great as to preclude new suppliers. There is thus no possibility of additional productive resources entering the industry, and, in consequence, the monopolist will continue to earn above-normal profits over the long term (until such time that supply and demand conditions radically change). Market theory predicts that, given identical cost and demand conditions, monopoly leads to a higher price and lower output than does perfect competition and thus may be considered to be a form of MARKET FAILURE.
Equilibrium under perfect competition occurs where supply equates to demand. This is illustrated in Fig. 131 in which the competitive supply curve is MC (the sum of all the individual suppliers’ marginal cost curves). The competitive output is Qc and the competitive price is Pc. Since the supply curve is the sum of the marginal cost curves, it follows that, in equilibrium, marginal cost equals price. Assume now that this industry is monopolized as a result, say, of one firm taking over all the other suppliers but that each plant's cost curve is unaffected by this change, that is, there are no ECONOMIES OF SCALE or DISECONOMIES OF SCALE arising from the coordinated planning of production by the monopolist - thus marginal costs will be the same for the monopolist as for the competitive industry, and, hence, their supply curves will be identical. As noted above, the monopolist who seeks to maximize profits will equate cost not to price but to marginal revenue. In consequence, in equilibrium, the output of the industry falls from Qc to Qm and market price rises from Pc to Pm.
Moreover, the monopolist, lacking any competitive pressure to minimize cost, may produce any given level of output at unit costs that are higher than those attainable without any penalty (see X-INEFFICIENCY).
The conclusion of competitive optimality, however, rests on a number of assumptions, some of which are highly questionable, in particular the assumption that cost structures are identical for small perfectly competitive firms and large oligopolistic and monopoly suppliers, while, given its static framework, it ignores important dynamic influences, such as TECHNOLOGICAL PROGRESS.
In a static monopoly, a fundamental assumption is that costs of production increase at relatively low output levels. The implication of this is that the firm reaches an equilibrium position at a size of operation that is small relative to the market. Suppose, however, that production in a particular industry is characterized by significant economies of scale, that is, individual firms can continue to lower unit costs by producing much larger quantities. We shall illustrate this by assuming that a perfectly competitive industry is taken over by a monopolist. It is very unlikely in this instance that costs would be unaffected by the change in the scale of operations. Fig. 131 illustrates the case where the reduction in unit costs as a result of the economies of single ownership gives rise to greater output and lower price than the original perfect competition situation.
The fall in unit costs as a result of monopolization moves the marginal cost curve of the monopolist (MCm) to the right of the original supply curve (Spc) so that more is produced (Qm) at the lower price (Pm). We still make the assumption that marginal costs are rising over the relevant range of output. In the long run, this expectation follows from the proposition that, at some size, economies of large scale are exhausted and diseconomies of scale set in. The diseconomies are usually associated with the administrative and managerial difficulties that arise in very large complex organizations. There is growing evidence, however, to the effect that the long-run average cost curve (and hence MC curve) for many capital-intensive industries is L-shaped. In these industries, total demand and individual market shares, not cost considerations, are the factors limiting the size of the firm. The firm may thus grow and find a level of output such that further expansion would be unprofitable, but in doing so, it may become so large relative to the market that it attains a degree of power over price. This is not to deny that the monopolist could further increase output and lower price were he not trying to maximize his profit. Such a position would not, however, be the result of a return to perfect competition. What has happened is that the firm, seeking its best profit position, has abandoned the status of an insignificant small competitor. It has not necessarily done so through a systematic attempt to dominate the market. On the contrary, it is the underlying cost conditions of the market that have impelled this growth. In such an industry, it is possible that small ‘competitive-sized’ firms cannot survive. Moreover, to the extent that the unit costs are lower at higher production levels, the large firm is a technically more efficient entity.
The case of significant economies of scale, then, may be characterized as one in which atomistic competition becomes technically impossible and, under an efficiency criterion, undesirable. The demonstration of competitive optimality implicitly assumes away this kind of complication.
The analysis developed above also neglects dynamic aspects of the market system. According to an influential group of writers, major improvements in consumer welfare occur largely as a result of technological INNOVATIONS, that is, the growth of resources and the development of new techniques and products over time, rather than adjustments to provide maximum output from a given (static) input, and monopolistic elements function as a precondition and protection of innovating effort. Perfectly competitive firms certainly have the motivation to employ the most efficient known production techniques, since these are necessary to their survival. But their inability to sustain above-normal profits limits both their resources and incentive to develop new technology. By contrast, the pure monopolist, earning above-normal profits, will have greater financial resources to promote technical advance, but his incentive to innovate may be weak given the lack of effective competition. However, technological advance is a means of lowering unit costs and thereby expanding profits; and these profits will not be of a transitory nature, given barriers to entry. Moreover, technical superiority may itself be one of the monopolist's barriers to entry; hence, the monopolist must persist and succeed in the area of technological advance to maintain his dominant position.
One of the most important advocates of the possibility that an industry exhibiting strong monopolistic elements may employ productive techniques superior to those of its competitive counterpart was SCHUMPETER. To the extent that invention and introduction of new processes and products is centred in the large oligopolistic firm, a comparison of oligopoly/monopoly with perfect competition at a fixed technological position systematically understates the social contribution of the former.
Diagrammatically, the Schumpeterian contention may be illustrated by using Fig. 131. The competitive market produces Qpc where short-run marginal cost equals price. If this industry were monopolized, the ordinary expectation would be a price rise to Pm1 and output decrease to Qm1. However, if the monopolist in such an industry introduces cost-saving innovations, the entire marginal cost curve may fall so that the monopolist may actually produce more (Qm) at a lower price (Pm) than the original competitive industry, even if the monopolist fully exploits his market power.
It is, of course, possible that society will remain worse off under monopoly, even if the monopoly innovates; the benefits of innovation may not outweigh the costs of monopolistic exploitation. See alsoOLIGOPOLY, MONOPOLISTIC COMPETITION, DISCRIMINATING MONOPOLY, COMPETITION POLICY, CONSUMER SURPLUS, CONCENTRATION MEASURES, REVISED SEQUENCE.