Monopoly Meaning Types Characteristics How To Measure

Monopoly Meaning

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Monopolies are discouraged in several countries as power and wealth tend to concentrate with a single seller. Moreover, such sellers may offer low-quality products at high prices, thus exploiting the consumer. A monopoly can be broken by imposing government regulations or opening the market to competition.

Key Takeaways

A monopoly consists of a single seller selling unique products or services. The monopolist has full control over the market, making it a price setter rather than a price taker.A monopolist can seek to maximize profits due to the absence of close substitutes, lack of competition, and barriers for new entrants.Monopoly power can be measured by the Lerner index, concentration ratio, price discrimination policy, profit rate, and Herfindahl-Hirschman index.Monopolies can be of several kinds like simple, pure, natural, legal, and public.

Monopoly in Economics Explained

Monopoly is derived from the words “monos” (single) and “polein” (to sell) of Greek. Monopoly was first depicted in The Landlord’s Game, which was invented by Elizabeth Magie Phillips (or Lizzie Magie) in 1904. This game inspired the monopoly board game that is played by most students today.

In economics, a monopoly exists when the following conditions are satisfied:

A single seller dominates either the entire industry (or market) or a substantial percentage of the industry. This domination makes the monopolist firm a price setter (or price maker) rather than a price taker.There is a lack of competition in the market. Additionally, there are barriers to the entry of new firms. This implies that it is difficult to enter the market as the consumers prefer the products of the established firm over those of the new entrants. Moreover, the established firm can produce the products at low prices while the new entrants cannot do this initially.There is an absence of the availability of close substitutes. This implies that the consumer has no choice but to purchase from the monopolist firm.

Monopolies can often lead to unfair trade practices like charging different prices from different consumers (price discrimination), setting prices far above the costs of manufacturing, selling inferior products and services, etc. Due to these practices, a monopoly may be dissolved sooner or later.

Types of Monopoly

The different types of monopolies are discussed as follows:

#1 – Simple monopoly

A simple monopoly charges uniform prices for its product (or service) from all the buyers. In this, the monopolist firm usually operates in one market and its consumers are price takers.

#2 – Pure monopoly

A pure monopoly is the rarest form wherein the product (or service) being sold has no close substitutes. Moreover, competitors are discouraged from entering the market often due to high initial costs.

#3 – Natural monopoly

A natural monopoly depends on unique raw materials or sophisticated technology to manufacture its products. In this, the monopolist firm utilizes its copyright and patents to prevent competition. In addition, such firms usually provide public utilities (like electricity, gas, etc.), adhere to government regulations, and incur high costs on research and innovation.

#4 – Legal monopoly

A legal monopoly is one wherein the monopolist firm reserves the right to manufacture a product by way of a patent, trademark or copyright. Since the monopolist is the inventor of such a product (or process), it is the exclusive supplier in the market. Patents allow time to firms to recover the high costs of development and research.

#5 – Public or industrial monopoly

A public monopoly is set up by the government to supply important products and services. The government creates such monopolies for the following reasons:

The costs associated with production and deliveries are too high.The presence of a sole supplier is considered to be more reliable and beneficial for the general public.

Public monopolies are created when the government nationalizes certain industries to serve the interest of the people.

Characteristics

The features of a monopoly are listed as follows:

#1 – Maximizes profits

The monopolist firm aims to maximize its profits owing to no rivalry and lack of consumer choices. This is the major reason a monopolist firm wants to continue enjoying its monopoly. The monopolist firms strive to earn abnormal (or supernormal) profits.

#2 – Sets prices

The single manufacturer has the power to set the prices of its products or services. The monopolist firm (price maker) may or may not charge the same price from all its consumers. The consumers (price takers) have to accept the prices set by the firm unless the government intervenes to impose a maximum price.

#3 – Poses high entry barriers

The new entrants have to face several challenges while trying to enter a monopolist market. Such challenges include high startup costs, specialized technologies, high government restrictions, complex business contracts, restricted purchase of raw materials, etc.

#4 – Lacks close substitutes

There are no products (or services) that match the offerings of the monopolist firm. The absence of close substitutes makes the demand for monopolist products relatively inelastic. The demand is inelastic when it does not change much with a change in the price of the product. Inelastic demand makes it easier to make profits in the market.

#5 – Becomes the industry

The single firm, being the sole supplier, becomes synonymous with the industry. This implies that the difference between a firm and an industry ceases to exist in the case of a monopoly.

Example

In May 2022, the Competition and Markets Authority (CMA), a competition regulator of the United Kingdom (UK), claimed that Google might be favoring its own services through its advertisements. However, Google charges fees from both buyers and sellers for selling a range of advertising services (like supplying online advertising space). Therefore, such favoring is against the interest of the general public and the rivals and customers of Google. The outcomes of this move are stated as follows:

The advertisement revenues of sellers may be reduced, which will force them to lower the costs or compromise the quality of their content. As a solution, such sellers may make their content available for a subscription fee (paywalls) from the consumers.Businesses relying on apps to fund their content may no longer be able to reach their consumers. This would weaken competition in the long-run and may also be detrimental for the other businesses of UK.

A Google spokesperson claimed that the company’s tools account for £55 billion from over 700,000 businesses across the globe. Further, Google will continue to share the working of its systems with the CMA. This will sort matters for the company (Google) and address the concerns of the regulator (CMA).

Measuring Monopoly Power

The various methods of measuring monopoly power are listed as follows:

#1 – Lerner index

The economist Abba P. Lerner proposed the Lerner index. According to this measure, the higher the monopolist firm charges above the marginal cost, the higher its monopoly power is said to be.

Lerner Index (L)=(Price-Marginal Cost)/Price

The value of L ranges from 0 to 1. Zero implies no monopoly power and one implies maximum power. L depends on factors like elasticity of demand, presence of competitors, extent of regulations, etc.

#2 – Concentration ratio

The concentration ratio indicates the extent of competition prevalent in an industry. The ratio can range from 0 to 100%. Zero implies the existence of a large number of firms (high competition) and one implies the absence of competitors (no competition or a monopoly).

#3 – Price discrimination policy

Price discrimination exists if a firm charges different prices from different consumers. High price discrimination implies more control of the monopolist over the prices. Further, the elasticity of demand is also an indicator of monopoly power.

#4 – Profit rate

The profit rate measure indicates that the higher the profit a firm makes, the greater its monopoly power. Earning low profits indicates a competitive market, while earning supernormal profits indicates a monopoly.

#5 – Herfindahl-Hirschman index (HHI)

The Herfindahl-Hirschman index indicates the competition or the market concentration of an industry. It is obtained by squaring the size of the different firms in the industry and summing the resulting numbers. HHI can range from 0 to 1 or from 0 to 10000 points. Lower HHI indicates more competition, while a higher one indicates less or no competition (i.e., monopoly).