What is a monopoly

What Is a Monopoly?

Kimberly Amadeo is an expert on U.S. and world economies and investing, with over 20 years of experience in economic analysis and business strategy. She is the President of the economic website World Money Watch. As a writer for The Balance, Kimberly provides insight on the state of the present-day economy, as well as past events that have had a lasting impact.

The Balance / Bailey Mariner

A monopoly is a business that is effectively the only provider of a good or service, giving it a tremendous competitive advantage over any other company that tries to provide a similar product or service.

Definition and Examples of a Monopoly

A monopoly is a company that has «monopoly power» in the market for a particular good or service. This means that it has so much power in the market that it’s effectively impossible for any competing businesses to enter the market.

The existence of a monopoly relies on the nature of its business. It is often one that displays one or several of the following qualities:

Examples in the U.S.

The most famous monopoly was Standard Oil Company. John D. Rockefeller owned nearly all the oil refineries, which were in Ohio, in the 1890s. His monopoly allowed him to control the price of oil. He bullied the railroad companies to charge him a lower price for transportation. When Ohio threatened legal action to put him out of business, he moved to New Jersey.

In 1998, the U.S. District Court ruled that Microsoft was an illegal monopoly. It had a controlling position as the operating system for personal computers and used this to intimidate a supplier, chipmaker Intel. It also forced computer makers to withhold superior technology. The government ordered Microsoft to share information about its operating system, allowing competitors to develop innovative products using the Windows platform.

But disruptive technologies have done more to erode Microsoft’s monopoly than government action. People are switching to mobile devices, such as tablets and smartphones, and Microsoft’s operating system for those devices has not been popular in the market.

Some would argue that Google has a monopoly on the internet search engine market; people use it for more than 90% of all searches.

How Monopolies Work

Some companies become monopolies through vertical integration; they control the entire supply chain, from production to retail. Others use horizontal integration; they buy up competitors until they are the only ones left.

Once competitors are neutralized and a monopoly has been established, the monopoly can raise prices as much as it wants. If a new competitor tries to enter the market, the monopoly can reduce prices as much as it needs to squeeze out the competitors. Any losses can be recouped with higher prices once competitors have been squeezed out.

U.S. Laws on Monopolies

The Sherman Anti-Trust Act was the first U.S. law designed to prevent monopolies from using their power to gain unfair advantages. Congress enacted it in 1890 when monopolies were known as «trusts,» or groups of companies that would work together to fix prices. The Supreme Court later ruled that companies could work together to restrict trade without violating the Sherman Act, but they couldn’t do so to an «unreasonable» extent.

Some 24 years after the Sherman Act, the U.S. passed two more laws concerning monopolies, the Federal Trade Commission Act, and the Clayton Act. The Federal Trade Commission (FTC) was established by the former, while the latter specifically outlawed some practices that weren’t addressed by the Sherman Act.

When Monopolies Are Needed

Sometimes a monopoly is necessary. Some, like utilities, enjoy government regulations that award them a market. Governments do this to protect the consumer. A monopoly ensures consistent electricity production and delivery because there aren’t the usual disruptions from free-market forces like competitors.

There may also be high up-front costs that make it difficult for new businesses to compete. It’s very expensive to build new electric plants or dams, so it makes economic sense to allow monopolies to control prices to pay for these costs.

Federal and local governments regulate these industries to protect the consumer. Companies are allowed to set prices to recoup their costs and a reasonable profit.

PayPal co-founder Peter Thiel advocates the benefits of a creative monopoly. That’s a company that is «so good at what it does that no other firm can offer a close substitute.» He argues that they give customers more choices «by adding entirely new categories of abundance to the world.»

Criticism of Monopolies

Monopolies restrict free trade and prevent the free market from setting prices. That creates the following four adverse effects.

Price Fixing

Since monopolies are lone providers, they can set any price they choose. That’s called price-fixing. They can do this regardless of demand because they know consumers have no choice. It’s especially true when there is inelastic demand for goods and services. That’s when people don’t have a lot of flexibility about the price at which they will purchase the product. Gasoline is an example—if you need to drive a car, you probably can’t wait until you like the price of gas to fill up your tank.

Declining Product Quality

Not only can monopolies raise prices, but they also can supply inferior products. If a grocery store knows that poor residents in the neighborhood have few alternatives, the store may be less concerned with quality.

Loss of Innovation

Monopolies lose any incentive to innovate or provide «new and improved» products. A 2017 study by the National Bureau of Economic Research found that U.S. businesses have invested less than expected since 2000 in part due to a decline in competition. That was true of cable companies until satellite dishes and online streaming services disrupted their hold on the market.

Inflation

Monopolies create inflation. Since they can set any prices they want, they will raise costs for consumers to increase profit. This is called cost-push inflation. A good example of how this works is the Organization of Petroleum Exporting Countries (OPEC). The 13 oil-exporting countries in OPEC are home to nearly 80% of the world’s proven oil reserves, and they have considerable power to raise or reduce oil prices.

Monopoly

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

What Is a Monopoly?

A monopoly is a market structure where a single seller or producer assumes a dominant position in an industry or a sector. Monopolies are discouraged in free-market economies as they stifle competition and limit substitutes for consumers.

In the United States, antitrust legislation is in place to restrict monopolies, ensuring that one business cannot control a market and use that control to exploit its customers.

Key Takeaways

What’s a Monopoly?

Understanding a Monopoly

A monopoly is a business that is characterized by a lack of competition within a market and unavailable substitutes for its product. Monopolies can dictate price changes and create barriers for competitors to enter the marketplace.

Companies become monopolies by controlling the entire supply chain, from production to sales through vertical integration, or buying competing companies in the market through horizontal integration, becoming the sole producer.

Monopolies typically reap the benefit of economies of scale, the ability to produce mass quantities at lower costs per unit.

Types of Monopolies

The Pure Monopoly

A pure monopoly is a single seller in a market or sector with high barriers to entry such as significant startup costs whose product has no substitutes.

Microsoft Corporation was the first company to hold a pure monopoly position on personal computer operating systems. As of 2022, its desktop Windows software still held a market share of 75%.

Monopolistic Competition

Multiple sellers in an industry sector with similar substitutes are defined as having monopolistic competition. Barriers to entry are low, and the competing companies differentiate themselves through pricing and marketing efforts.

Their offerings are not perfect substitutes, such as Visa and MasterCard. Other examples of monopolistic competition include retail stores, restaurants, and hair salons.

The Natural Monopoly

A natural monopoly develops in reliance on unique raw materials, technology, or specialization. Companies that have patents or extensive research and development costs such as pharmaceutical companies are considered natural monopolies.

Public Monopolies

Public monopolies provide essential services and goods, such as the utility industry as only one company commonly supplies energy or water to a region. The monopoly is allowed and heavily regulated by government municipalities and rates and rate increases are controlled.

Pros and Cons of a Monopoly

Without competition, monopolies can set prices and keep pricing consistent and reliable for consumers. Monopolies enjoy economies of scale, often able to produce mass quantities at lower costs per unit. Standing alone as a monopoly allows a company to securely invest in innovation without fear of competition.

Conversely, a company that dominates a sector or industry can use its advantage to create artificial scarcities, fix prices, and provide low-quality products. Consumers must trust that a monopoly operates ethically due to limited or unavailable substitutes in the market.

Regulation of a Monopoly

Antitrust laws and regulations are in place to discourage monopolistic operations, protect consumers, and ensure an open market.

In 1890, the Sherman Antitrust Act was passed by the U.S. Congress to limit «trusts,» a precursor to the monopoly, or groups of companies that colluded to fix prices. This act dismantled monopolies including Standard Oil Company and the American Tobacco Company.

The Clayton Antitrust Act of 1914 created rules for mergers, corporate directors, and listed practices that would violate the Sherman Antitrust Act, and the Federal Trade Commission Act created the Federal Trade Commission (FTC), which, along with the Antitrust Division of the U.S. Department of Justice, sets standards for business practices and enforces the two antitrust acts.

The most consequential monopoly breakup in U.S. history was that of AT&T. After controlling the nation’s telephone service for decades as a government-supported monopoly, AT&T fell to antitrust laws. In 1982, AT&T, which had telephone lines that reached nearly every home and business in the U.S., was forced to divest itself of 22 local exchange service companies, the main barrier to competition.

What Companies Have Faced Antitrust Violations as a Monopoly?

In 1994, Microsoft was accused of using its significant market share in the personal computer operating systems business to prevent competition and maintain a monopoly. Using Antitrust legislation, Microsoft was accused of «using exclusionary and anticompetitive contracts to market its personal computer operating system software. By these contracts, Microsoft has unlawfully maintained its monopoly of personal computer operating systems and has an unreasonably restrained trade.»

A federal district judge ruled in 1998 that Microsoft was to be broken into two technology companies, but the decision was later reversed on appeal by a higher court. Microsoft was free to maintain its operating system, application development, and marketing methods.

What Is Price Fixing?

Price fixing is an agreement among competitors to raise, lower, maintain, or stabilize prices or price levels. Antitrust laws require that each company establish prices and other competitive terms on its own, without agreeing with a competitor. Consumers make choices about what products and services to buy and expect that the price has been determined based on supply and demand, not by an agreement among competitors.

How Do Antitrust Laws Protect Consumers?

Antitrust cases can be prosecuted by state or federal governments. Consumers who suspect a company is violating antitrust laws can contact the Antitrust Division or Federal Trade Commission at the federal level. A local company operating within one state can be investigated by the Attorney General of the state.

The Bottom Line

A monopoly is defined as a single seller or producer that excludes competition from providing the same product. A monopoly can dictate price changes and creates barriers for competitors to enter the marketplace. Antitrust legislation is in place to restrict monopolies, ensuring that one business cannot control a market and use that control to exploit its customers.

Monopoly: Definition, Types, Characteristics, & Examples

Economies around the world witness a combination of different market structures. While there’s a lot of competition in most industries, some industries witness just one seller. There exists no competition in such industries as there are virtually no other players. Such market structures are termed as monopolies.

But what exactly is a monopoly and how does it work?

What is a monopoly?

A monopoly is a market structure that consists of a single seller who has exclusive control over a commodity or service.

The word mono means single or one and the prefix polein finds its roots in Greek, meaning “to sell”. Hence, the word monopoly literally translates to single seller.

To understand the concept better, let’s break the definition into three key-phrases –

Characteristics of a monopoly

A monopoly displays characteristics that are different from other market structures. These characteristics are as follows:

Types of monopoly

There exist several different types of monopolies in an economy. These different types of monopolies are listed below:

Monopoly Examples

Some examples of monopolies which have great historical significance are listed below:

Barriers to Entry: How a Monopoly Maintains its Power

Several factors and strategies allow a monopoly to maintain the power that it holds in an industry. These essentially pose as barriers to entry to potential entrants. Some of these are:

Economies Of Scale

When it is said that the production of a certain commodity has become efficient, it means that the firm does not have to spend large amounts on the cost of production. After existing in the market for a considerable period of time, output can be generated at a larger scale with fewer input cost. This is known as economies of scale.

Due to this phenomenon, the output generated by a monopolist is large, with lesser input cost. In case a new firm tries to enter, the cost of production would be higher than that of the monopolist and the output generated would be lower than the monopolist. It is, hence, evident that the new entrant would be at a disadvantage in terms of production costs. Hence, the monopolist gains a cost advantage.
This inevitable disadvantage deters potential entrants and so, economies of scale poses as a barrier to entry.

Strategic Pricing

Strategic Pricing allows a monopolist to charge any price for their offerings. The price may be set to be extremely low – predatory pricing – in order to prevent any firm from entering the market. This is often done by a monopolist to demonstrate power and pressurise potential and existing rivals.

Sometimes, a monopolist often sets the price of its product or service just above the average cost of production of the product/service. This move ensures no competition. This is because if a competitor too decides to charge the same price for the commodity, the competitor will face losses as the cost of production for the monopolist is far lower than the competitor’s cost of production.

Ownership Of Essential And Scarce Resources

Monopolies that first enter a market have access to resources that it may choose to keep for itself. Due to this, these scarce but essential resources are made unavailable to the potential entrants.

This is often the case with natural monopolies.

High Sunk costs

Sunk costs are those which cannot be retrieved in the case a firm shuts down. These are costs that are essential for the firm, like advertising costs, but cannot be recovered.

With the existence of a large monopoly, the risk of a potential entrant going out of businesses always looms. Hence, these potential entrants hesitate when it comes to taking a risk that could cost them too much. This consequently poses as a barrier to entry.

Contracts

Monopolies maintain their power by creating contracts with suppliers and retailers.

Consumer Brand Loyalty

Consumers often develop trust and loyalty with firms that offer them quality products and services. A sense of familiarity that generates consequently deters them from going elsewhere to satisfy their demand. This does not allow other entrants a chance. Hence, they find it difficult to capture market share for the product and service that they offer.

A great example of a company using this technique to develop a monopoly is Google.

Advantages Of Monopoly

Monopolies are advantageous to economies in some ways. Some of these reasons are listed below:

Disadvantages Of Monopoly

The disadvantages of a monopoly in an economy often outweigh its advantages. Below listed are the disadvantages of a monopoly:

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3 Types and 7 Causes of Monopoly’s

WRITTEN BY PAUL BOYCE | Updated 11 March 2021

What is a Monopoly

When looking at the causes of monopoly, it is important to first define what it is. The term monopoly originates from the Ancient Greek language. Monos, meaning “sole”. And Poleo, meaning “sell”. Roughly translated, it means “Sole Seller”. Any person or business who is the only seller in the market could be classified as having a monopoly.

Monopolies are known as big companies that tend to take advantage of the consumer. They tend to use their position to set prices that are in excess of what the consumer would normally pay in a competitive market. As a result, they are usually heavily regulated in order to prevent unreasonable practices that take advantage of the consumer.

3 Types of Monopoly

There are three types of monopoly: Natural, Un-natural, and State. All three have unique characteristics and causes. So let us look at the 3 types of monopoly below:

1. Natural Monopolies

One type of monopoly is the natural monopoly, which is called ‘natural’ because there is no direct government involvement. This derives from the fact that its creation originates from variables that are not man-made.

For instance, railways are a prime example of a natural monopoly. This is because the cost to build another track would be over and above what a competitor would make back in profit.

Utilities are another example. To build new sewers or power lines would be costly, inefficient, and impractical. If two companies were to build and offer separate lines, the costs would be higher than what they would be under a monopoly. Therefore, other firms do not want to enter the market because there is no profit to be made.

In short, natural monopolies exist because it is able to provide a product or service at a lower cost than a competitive market would offer. In part, this is due to the efficiencies that economies of scale offers. For instance, utilities, railways, and other such industries can offer a service or product at a price that is lower than what would be achieved if there was competition.

With more competitors, there is competition over customers and resources, which pushes up prices beyond what the customer would be willing to pay. Therefore, there would be no point in conduction business with multiple competitors.

2. State Monopolies

Another type of monopoly is the state monopoly. This covers industries where the state has full ownership. Notable examples include postal services, utilities, television, and the supply of money. These are usually controlled by the state as they are deemed as ‘natural’ monopolies. In other words, the goods could only be efficiently provided under a monopoly structure. Therefore, rather than trust a private firm to run them, they are taken under government ownership instead.

The aim of state ownership is to prevent price gouging that private monopolies would participate in. As monopolies have greater power to dictate prices, they may increase the cost to the consumer over and above the market rate.

Some governments regulate these monopolies instead, but in many countries, there is a strong political will to have these controlled by the state. In the UK for example, the re-nationalization of the railways has become increasingly popular in order to reduce ticket prices.

3. Un-natural Monopolies

The third type of monopoly is un-natural monopolies which are a combination of natural and state monopolies. They are natural monopolies in the traditional sense but are re-enforced by the state. Patents are a clear example of an unnatural monopoly.

A private firm creates a new product. This may be completely different from whatever is on the market. For example, a new medical drug, that can reverse the effects of Alzheimer’s. Nothing else is available to the consumer. So this drug has a monopoly within the market.

It is naturally occurring as it is the first and only product on the market. However, this product is given an artificial monopoly through the patent system. For a certain period of time, this will be the only product customers can buy.

7 Causes of Monopolies

Monopolies can occur due to a number of factors. Some may apply, some may not. With that said, monopolies tend to erode over time; perhaps with the exception of natural monopolies. Causes such as patents, high entry costs, or low potential profits may prevent competition today. However, they tend not to last over the long-term.

1. High Costs Scare Competition

One cause of natural monopolies are barriers to entry. This is usually as a result of high costs – with railroads being a well-known example.

There are many industries that have high entry costs. For example, oil and gas are notoriously expensive to enter, with high fixed costs and a number of regulatory requirements. New companies face a tough time in an industry that is dominated by big firms in the market such as ExxonMobil and BP. High costs dis-incentivize potential competitors from entering the market. As costs are high, the financial impact of failure is that much greater.

High costs dis-incentivise potential competitors from entering the market. As costs are high, the financial impact of the failure is that much greater.

In an industry such as that described, it is economically effective for one company to be in the market as it benefits from economies of scale. This means the more customers it is able to serve, the lower prices it can offer as the cost per customer also falls. The most efficient company may end up driving all other competitors out due to its economies of scale and lower prices; taking advantage of lower production costs and out-pricing the competition.

2. Low Potential Profits Are Unattractive to Competitors

Potential profits are a key indicator to potential businesses. If monopolies are making small profits, it is not worth a competitor’s time and money to try and take a small share of the market.

Both Apple and Google invested billions in developing their operating systems in order to compete with Microsoft. The cost barriers were high, but the potential profits were also high. Therefore, while costs are a barrier to entry ; so too are the potential profits.

By contrast, when there are low profits, the monopolist’s position is maintained as competitors are dis-interested. If we look to nature as an example; a lion would not waste its effort pursuing beetles or shrew. They are too small and not worth the energy in catching.

3. Ownership of a key resource

Monopolies can arise when one business owns a key resource. These are generally physical resources, such as diamonds. For example, if there is only one diamond mine in the country, the business that owns it will be able to achieve a monopoly. This is how De Beers controlled the diamond industry throughout the 20th Century.

It controlled diamond mines in South Africa and brought up those in other nations. It managed to keep control of the diamond supply for most of the 20th Century, only collapsing once international competition became increasingly fierce.

“Monopolies can arise when one business owns a key resource. “

The National Grid in the UK is also a monopoly that has sole ownership of a key resource. It has power over the whole of the UK’s energy supply. While it is a publicly-traded company, it is held down by government regulation to prevent consumers from being in-directly overcharged.

When companies have sole ownership of a key resource, they are usually heavily regulated by government. This is so that they do not take advantage of their monopolistic position in the market.

4. Patents

Another cause of monopoly is when the government grants a patent to businesses. This is a form of intellectual property that gives the owner the legal right to be the sole producer of a product.

The owner of the patent must provide details of the product and make them public. In exchange, the government guarantees the protection of such rights in court for a period of time. Any business infringing on this right will be in violation of the patent and can be sued.

While this grants the inventor a monopoly, it is designed to incentivize innovation. If the inventor of a product knew there was no legal production, they may not invest the time, energy, and funds into developing it. There is little incentive for the inventor if they know the product will be copied by Mr. Bloggs the very next day. Nevertheless, it creates a monopoly on that product for a set period of time.

5. Restrictions on Imports

Import quotas, tariffs, and other trade restrictions can limit competition and be a cause of monopoly. If cheaper foreign competition is unable to enter the market, there are fewer pressures on domestic companies.

For example, when the patent of a small niche drug runs out; there may be few pharma companies that would want to compete. This may be because the drug only serves a few hundred people, so there is little profit to be made. Therefore, there is a domestic monopoly.

However, foreign drugs would be able to compete as they can access multiple national markets, which creates a larger consumer base and a greater potential for profit. By being able to access more markets, what was a niche product, becomes a large and quite a lucrative market. Yet many countries prevent this. In the US for example, only drugs approved by the FDA can enter. This stops perfectly safe drugs from Europe from coming in and serving as a competition to the domestic monopoly.

6. Baby Markets

Another cause of monopoly occurs in new ‘baby markets’. During the infancy of a market, the first entrant will be able to establish an initial monopoly position. This is because they are the first company in the market, without competition.

For example, if a business was to create a hypothetical teleportation device, it would be the first to do so. In the early stages at least, it may have a monopoly until competitors are able to enter and create a similar product.

During these initial stages of a new market, it is easy for the first entrant to establish a monopoly. However, this usually does not last long as competitors see an opportunity.

7. Geographic Markets

Geographic monopolies can be characterised by the sole presence within a local market. For example, there may only be one restaurant in the local town. If you want a meal out, you may have to travel half an hour to the nearest restaurant. When considering the local market; it can be considered as a monopoly.

Other examples of local monopolies may include a gas station that is the only supplier on the motorway. Whilst it does not have a monopoly over gas, it does within the bounds of its location.

Difference Between Monopoly and Monopolistic Competition

The difference is that monopolistic power means a company has monopoly like powers, but is not the sole provider. In monopolistic competition, there are many firms in the market, but they compete on factors other than price. Examples include: Taxi’s, Restaurants, or Hairdressing.

Monopolistic markets are also characterized by low barriers to entry; something that is usually non-existent in monopoly markets. This allows new firms to easily come in and compete; in stark contrast to monopolies.

Monopolies and Monopoly Power

Meaning and Characteristics

The Economics Glossary defines monopoly as: «If a certain firm is the only one that can produce a certain good, it has a monopoly in the market for that good.»

To understand what a monopoly is and how a monopoly operates, we’ll have to delve deeper than this. What features do monopolies have, and how do they differ from those in oligopolies, markets with monopolistic competition and perfectly competitive markets?

Features of a Monopoly

When we discuss a monopoly, or oligopoly, etc. we’re discussing the market for a particular type of product, such as toasters or DVD players. In the textbook case of a monopoly, there is only one firm producing the good. In a real-world monopoly, such as the operating system monopoly, there is one firm that provides the overwhelming majority of sales (Microsoft), and a handful of small companies that have little or no impact on the dominant firm.

Because there is only one firm (or essentially only one firm) in a monopoly, the monopoly’s firm demand curve is identical to the market demand curve, and the monopoly firm need not consider what it’s competitors are pricing at. Thus a monopolist will keep selling units so long as the extra amount he receives by selling an extra unit (the marginal revenue) is greater than the additional costs he faces in producing and selling an additional unit (the marginal cost). Thus the monopoly firm will always set their quantity at the level where marginal cost is equal to marginal revenue.

Because of this lack of competition, monopoly firms will make an economic profit. This would normally cause other firms to enter the market. For this market to remain a monopolistic one, there must be some barrier to entry. A few common ones are:

There’s the need-to-know information on monopolies. Monopolies are unique relative to other market structures, as it only contains one firm, and thus a monopoly firm has far more power to set prices than firms in other market structures.