Lecture 9: monopoly, oligopoly and competition

1. Monopoly

2. Perfect Competition

3. Imperfect Competition

4. Oligopoly

As soon as economists start talking about real-world competition, market structure becomes a focus of the discussion.

Market structure is the physical characteristics of the market within which firms interact. It involves the number of firms in the market, barriers to entry, and communication among firms.

Monopoly and competition are two polar cases of market structure that economists generally focus on. Real-world markets generally fall in between, and it is useful to introduce briefly two market structures between perfect competition and monopoly: monopolistic competition and oligopoly.

1. Monopoly

Monopoly is a market structure in which one firm makes up the entire market. It is the polar opposite to competition. It is a market structure in which the firm faces no competitive pressure from other firms.

There's nobody else selling anything like what the monopolist is producing. In other words, there are no close substitutes.

Monopolies exist because of barriers to entry into a market that prevent competition. These can be legal barriers (as in the case where a firm has a patent that prevents other firms from entering), sociological barriers where entry is prevented by the invisible handshake, or natural barriers where the firm has a unique ability to produce what other firms can't duplicate.

Pure monopoly occurs when there is a single seller of a product that has no close substitutes. Buyers have only one source of supply for that particular good. Perfect competition is characterized by the inability of individual sellers to control price. No individual firm produces a large enough share of the total market supply to affect price. Monopoly, on the contrary, is characterized by concentration of supply in the hands of the owners of a single firm.

Examples of monopoly include DeBeers diamonds, the local gas and electric companies, and, until recently, AT&T. During the years after World War II, IBM, Xerox, and Alcoa (Aluminum Company of America) also had monopolies.

One might ask how close substitutes would need to be to disqualify firms from being monopolies. Surely a Cadillac Seville is a reasonably close substitute for a Lincoln Continental Further, there are many close substitutes for a Xerox photocopying machine, but there are no close substitutes for diamonds, gas, electricity, and telephone calls.

We should also distinguish between local and national monopolies. Someone may be the only doctor in the vicinity and have a local monopoly, but there are over 500,000 doctors in the United States. A hardware store, grocery, drugstore, or cleaners may have a monopoly in its neighborhood, but each may have several competitors within a few miles.

In actuality, it’s rare for a national or world market to have only one seller. The De Beers Company of South Africa, through its syndicate called the Central Selling Organization, accounts for about 80 percent of the annual sales of diamonds. Although by definition just given De Beers can't be regarded as a pure monopoly firm, it’s pretty close to one. Although De Beers isn't a pure monopoly firm, it sells a very large share of the uncut diamonds purchased each year. It can influence diamond prices controlling the amount it offers for sale (see The Global Economy).

A firm has a monopoly power if it can influence on the market price of its product by making more or less of it available to buyers. Although pure monopoly is very rare, monopoly power is quite common.

Local monopolies are more common than national monopolies, and local markets often are served by single sellers.

However, there are few if any products that have no substitutes. A local electric power company may be the sole seller of electricity in an area, but electricity does have substitutes. Natural gas and oil furnaces are goods substitutes for electric heat.

In most regions where local monopolies provide public utility services, the seller can’t set the price it charges for service. Most local monopolies that provide electricity, natural gas, and telephone and transportation services to regions are regulated by state and local government agencies. In evaluating rates charged by utility monopolies, these regulatory agencies are influenced by political as well as profit considerations. In fact, in many cases these monopolies are actually owned and operated by government agencies. The undesirable outcomes we expect when a pure monopoly firm has freedom to set its prices lead to political intervention to control the monopolist's pricing policies.