1. Monopoly resources

The simplest way for a monopoly to arise is for a single firm to own a key resource.

THE DEBEERS DIAMOND MONOPOLY

A classic example of a monopoly that arises from the ownership of a key resource is DeBeers, the South African diamond company. DeBeers controls about 80 percent of the world’s production of diamonds. It is large enough to exert substantial influence over the market price of diamonds. The market power that DeBeers has depends on existence of close substitutes for its product. If people view emeralds, rubies, and sapphires as good substitutes for diamonds, then DeBeers has relatively little market power. In this case, any attempt by DeBeers to raise the price of diamonds would cause people to switch to other gemstones. But if people view these other stones as very different from diamonds, then DeBeers can exert substantial influence over the price of its product. DeBeers pays for large amounts of advertising. One goal of the DeBeers ads is to differentiate diamonds from other gems in the minds of consumers. When their slogan tells you that “a diamond is forever,” you are meant to think that the same is not true of emeralds, rubies, and sapphires. If the ads are successful, consumers will view diamonds as unique, rather than as one among many gemstones, and this perception will give DeBeers greater market power.

GOVERNMENT-CREATED MONOPOLIES

In many cases, monopolies arise because the government has given one person or firm the exclusive right to sell some good or service. The government grants a monopoly in order to satisfy public needs. For instance, the U.S. government has given a monopoly to a company called Network Solutions, Inc., which maintains the database of all .com, .net, and .org Internet addresses, on the grounds that such data need to be centralized and comprehensive.

Also government can give patents and copyrights. For instance, if the government deems the drug to be truly original, it approves the patent, which gives the company the exclusive right to manufacture and sell the drug for 20 years. Similarly, a novelist can copyright his book. The copyright is a government guarantee that no one can print and sell the work without the author’s permission. The copyright makes the novelist a monopolist in the sale of her novel.

Because these laws give one producer a monopoly, they lead to higher prices than would occur under competition. But by allowing these monopoly producers to charge higher prices and earn higher profits, the laws also encourage some desirable behavior. Drug companies are encouraged to new pharmaceutical research. Authors are encouraged to write more and better books.

NATURAL MONOPOLIES

An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms. A natural monopoly arises when there are economies of scale over the relevant range of output. In this case, a single firm can produce any amount of output at least cost. That is, for any given amount of output, a larger number of firms leads to less output per firm and higher average total cost.

An example of a natural monopoly is the distribution of water. To provide water to residents of a town, a firm must build a network of pipes throughout the town. If two or more firms were to compete in the provision of this service, each firm would have to pay the fixed cost of building a network. Thus, the average total cost of water is lowest if a single firm serves the entire market.

When a firm is a natural monopoly, it is less concerned about new entrants eroding its monopoly power. Normally, a firm has trouble maintaining a monopoly position without ownership of a key resource or protection from the government.