Lecture 9. Monopoly, oligopoly and competition

1. Monopoly.

2. Perfect competition.

3. Monopolistic 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.

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.

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.

How monopoly is maintained: barriers to entry

Our discussion of long-run competitive equilibrium showed how profits serve as a signal to attract new suppliers in competitive markets. If free entry were possible in monopolistic markets, economic profits earned by monopoly firms would attract new sellers. Supply would increase, as would the number of sellers. The monopolist’s control over price would eventually disappear as the market became competitive. A barrier to entry is a constraint that prevents additional sellers from entering a monopoly firm's market.

There are three barriers to entry: (1) control over an essential resource, (2) economies of scale, and (3) legal barriers to entry.

1. Control over an essential resource. We tend to think of resources as natural resources – oil, coal, iron ore, arable land – but in economics, the basic resources are land, labor, and capital.

A monopoly can also be maintained as a result of owning the entire source of supply of a particular input.

Unique ability or knowledge can also create a monopoly. Talented singers, artists, athletes, and the "cream of the crop" of any profession have monopolies on the use of their services. Firms with secret processes or technologies have monopolies if other firms can't duplicate the techniques.

2. Economies of scale. Typically, heavy industry – iron and steel, copper, aluminum, and automobiles – has high setup costs. But once your plant and equipment are set up, by increasing your output you can take advantage of economies of scale.

Economies of scale are cost savings that result from large-scale production. These cost savings favor the establishment of monopolies because bigger firms in industries for which economies of scale prevail can produce at lower average cost than smaller competitors.

The term natural monopoly is sometimes used to describe a situation in which a firm emerges as a single seller in a market because of cost or technological advantages contributing to lower average costs of production. Competition among firms in such industry results in one large firm supplying the entire market demand at lower cost than two or more smaller firms. A natural monopoly can produce the entire quantity demanded by buyers at any price at lower average cost than would be possible for each firm in the industry if more than one firm existed.

Natural monopoly is a monopoly that occurs because of a particular relation between industry demand and the firm's average total costs that makes it possible for only one firm to survive in the industry.

3. Legal barriers to entry. Legal barriers: legal franchise, license, patent or copyrights granted by government that prohibits other firms or individuals from producing particular products or entering particular occupations or industries.

The whole idea is for the government to allow just one firm or a group of individuals to do business.

First, it may be necessary to obtain a public franchise to operate in an industry. As we noted in the Focus essay, the monarch granted a franchise determining who could sell Asian goods in England in the seventeenth and eighteenth centuries. In modern times, franchises are granted by government for a variety of undertakings.

Public franchise is a right granted to a firm or industry allowing it to provide a good or service and excluding competitor from providing that good or service.

Second, in many industries and occupations a government license is required to operate.

Government license is a right granted by state or federal government to enter certain occupations or industries.

The patent prohibits others from producing the patented product and thereby confers a limited-term monopoly on the inventor. The purpose of a patent is to encourage innovation by allowing inventors to reap the exclusive fruits of their inventions for a period of time. Yet a patent also establishes a legal monopoly right. In effect, the social benefit of innovation is traded off against the possible social costs of monopoly.

Some barriers to entry are the result of government policies that grant single-seller status to firms.

Patents and copyrights are another government-supported barrier to entry.

A patent is a legal protection of a technical innovation that gives the person holding the patent a monopoly on using that innovation.