Monopoly (economics)

I INTRODUCTION

Monopoly (Economics), the economic situation in which only a single seller or producer supplies a commodity or a service. For a monopoly to be effective, there must be no practical substitutes for the product or service sold, and no serious threat of the entry of a competitor into the market. This enables the seller to control the price.

One or more of the following elements are of great importance in establishing a monopoly in a particular industry: (1) control of a major resource necessary to produce a product; (2) technological capabilities that allow a single firm to produce at reasonable prices all the output of a particular commodity or service, a situation sometimes described as a “natural” monopoly; (3) exclusive control over a patent on a product or on the processes used to produce the product; and (4) a government franchise that awards a company the sole right to produce a commodity or service in a given area.

II HISTORICAL BACKGROUND

Economic monopolies have existed throughout much of human history. In ancient and medieval times dire scarcity of resources was common and affected the lives of most human beings. When resources are extremely scarce, little room exists for a multiplicity of producers for many products and services. Chinese emperors from the Han dynasty onwards used official monopolies to create key industries. The medieval guilds, for example, were associations of merchants or artisans that controlled output, set terms for entering a trade, and regulated prices and wages.

As nation-states began to emerge in the late Renaissance era, monopoly proved to be a useful device for sovereigns, ever strapped for the cash necessary to sustain their armies, courts, and extravagant lifestyles. Monopoly rights were awarded to court favourites for manufacture and trade in basic essentials such as salt and tobacco. In all such charters, the sovereign received an ample share of the profits. Most major European nations also granted monopoly powers to private trading companies, such as the East India Companies, to stimulate exploration and the discovery of new lands. The awarding of monopoly power by the sovereign to private companies and court favourites, however, led to many abuses. In England, Parliament finally passed a Statute of Monopolies (1624) that sharply curtailed the monarch’s right to create private monopolies in domestic trade. This act did not apply to the monopoly powers granted to companies formed for exploration and colonization.

Two developments, both English in origin, brought about a reversal of these conditions, leading to a competitive-based economic order in the early 19th century. First was the emergence through English common law of a hostile attitude towards private combinations that were in restraint of trade. Under the common law, private agreements of a monopolistic nature that restrained free trade were not enforceable. This common-law hostility towards monopoly was important in Great Britain and America. The second development was the expansion of production that followed the Industrial Revolution, combined with the ideas of the Scottish philosopher and economist Adam Smith on private property, markets, and the free play of competition, which became the dominant influences shaping economic life in the first half of the 19th century. This period most resembled Smith’s textbook “model” of a competitive economic order—one in which business firms in nearly all industries were many in number and small in size.

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In the late 19th century the tendencies inherent in a free market economy order brought about new changes. In Great Britain, the United States, and other industrial nations, giant business firms began to emerge and dominate the economy. In part, this stemmed from the empire-building tactics of the “captains of industry”, such as the American entrepreneur John D. Rockefeller, who drove most competitors from the field. It also came about because of technological advances that enabled a handful of large firms to satisfy the demand in many markets. The result was not complete monopoly but, rather, an economic order known as oligopoly, in which production is dominated by a few firms.

In more recent years, most governments have sought, through competition laws, to prevent the outright emergence of private monopolies in major industries by using law, the courts, and regulators to impose competitive conditions on firms in these industries. If competitive conditions are not possible—in the case of natural monopolies—governments have either nationalized the industry, or regulated its profits so as to protect consumers.

III THEORY OF MONOPOLY

Economists have developed a complicated body of theory to explain why the behaviour of a monopoly firm differs significantly from that of a competitive firm. A monopoly company, like any other business, confronts two forces: (1) a set of demand conditions for the commodity or service it produces; (2) a set of cost conditions that governs how much it has to pay to those who supply the resources and labour required to produce its product. Every business firm must adjust its production to the point at which it is able to maximize its profit—that is, the difference between the revenue it receives from its sales and the costs it incurs in producing the amount sold. The level of production at which it achieves its maximum profit is not necessarily the one at which the firm is getting the highest possible price for its product. The major difference between a monopoly firm and one in a competitive industry is that the monopoly will have greater control over the price it charges for its product, although this control is never absolute. The monopoly firm thus has more freedom than the competitive firm to adjust price as well as production as it strives to achieve a maximum profit.

From the viewpoint of society, monopoly leads to effects that are less desirable than those resulting from economic competition. In general, monopoly results in a smaller output of goods or services as compared with the competition, and also in prices that are often higher than those in competitive industries. Another practice associated with the monopoly is price discrimination, which involves charging a different price for the same goods or services to different segments of the same market.

IV KINDS OF MONOPOLIES

Among the various kinds of economic monopolies are natural monopolies, trust companies, cartels, and industrial mergers.

A Natural Monopoly

Pure monopolies—only a single firm in an industry—are rare in most economies, except among the public utilities. These industries produce goods and provide services vital to the public well-being, including such essentials as water, power, transport, and communications. Although such monopolies often seem to be the most effective way to supply vital public services, they must be regulated when privately owned or else be owned and operated by a public body. In Great Britain, statutory regulators have been established for all the major utility industries, for example, the Office of Water Services (OFWAT), the Office of Electricity Regulation (OFFER), and the Office of Telecommunications (OFTEL). In addition, in cases of dispute between utility and regulator, the Monopolies and Mergers Commission can intervene to dictate prices, profits, etc.

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B Trusts

History is replete with attempts by producers either to organize or to engage in practices that give them, in effect, monopoly power, although competition may still appear to exist. One of the earliest means used by producers to create an effective monopoly while retaining some semblance of competition was the trust. This is a device by which the real control of a company is transferred to an individual or small group by an exchange of shares of stock for trust certificates, which are issued by the individuals seeking control. The widespread abuse of this technique in the United States after the American Civil War eventually led to passage of the Sherman Antitrust Act (1890), a law designed to make illegal all trusts and other combinations that aimed to create monopolies in restraint of interstate commerce. A similar device is the holding company, which issues its own stock shares for sale to the public and “holds” or controls other companies by owning their shares. Such an arrangement is not necessarily illegal, unless created specifically to monopolize commerce in trade.

C Cartels

Today perhaps the best-known form of combination is the cartel, because of the widespread attention is given to the activities of the Organization of the Petroleum Exporting Countries, or OPEC. A cartel is an organization formed by producers whose purpose is to allocate market shares, control production, and regulate prices. OPEC does all these things, but its most highly publicized acts have been to set the world price for petroleum.

D Mergers

Efforts to organize an industry in order to achieve practical monopoly control take different forms. Any combination of firms that reduces competition may be of a vertical, horizontal, or conglomerate character. A vertical combination involves merging firms at different stages of the production process into a single unit. Some of the oil companies, for example, own oil fields, refineries, transport systems, and retail outlets. A horizontal combination involves bringing together firms in the same industry and at the same level in the production chain. A conglomerate merger combines firms from several unrelated industries into a single organization. All mergers and combinations have the potential for eliminating competition and creating monopoly. Mergers are scrutinized by the competition authorities in individual countries and also, within the European Union, the European Commission. Any merger which creates monopoly power and acts against the public interest is unlikely to be permitted.