Monopolies, Duopolies, and Oligopolies

Monopolies, duopolies, and oligopolies all represent market structures that deviate from perfect competition and in which production decisions by any single firm directly affect the sales or selling price of other firms. In these types of markets, the limited number of sellers that exist maintain some control over the price of the goods or services sold, and these goods or services are either unique or significantly differentiated from other potential competitors in the market. As with all market structures that deviate from perfectly competitive markets, firms in these markets will tend to restrict output in their efforts to increase prices above marginal cost and thereby reduce the efficiency of the marketplace. The loss in efficiency in the markets is associated with a misallocation of society's resources and a deadweight economic loss.

Under monopoly, a single firm produces the entire market supply of a good or service. The effective market for a monopoly can either be localized or considerably broader. A number of factors can result in the barriers to entry that allow a single producer of a good or service to exist over time. Exclusive patents or licenses, the existence of large economies of scale, large start-up costs, and ownership of essential resources can all result in the establishment and maintenance of monopoly power in a market. Often these barriers to entry are classified as natural or artificial. Natural barriers to entry occur when technology or other cost structures make the minimum efficient size of the firm large relative to the market. Artificial barriers to entry exist by virtue of restraints that are imposed either by other firms already in the market, by government policies, or by a combination of these factors and are typified by circumstances such as exclusive patents or ownership of existing resources. Several monopolies or near-monopolies have existed or currently exist: U.S. Steel during the 1920s, Alcoa in the 1940s, United Shoe Machinery Company in the 1950s, AT&T through the 1980s, and Inco during most of the 20th century. More recent cases where firms have been argued to be monopolists or nearmonopolists include Microsoft, De Beers, and the National Collegiate Athletic Association. Similarly, many local markets still exhibit local monopolies for cable television and many utilities.

Under conditions associated with natural monopoly, the average total cost of production is declining over the relevant range of production. Under such circumstances, a producer can always lower the average cost of a good by producing a larger quantity. As a result, the costs of production will not support the existence of more than one producer—whichever producer is capable of producing the greatest amount can afford to sell at a lower price than its competitors. For many years, conventional thinking regarded industries such as many utilities (e.g., telephone service, electricity, natural gas) and the U.S. Postal Service (with respect to delivery of first-class mail) as natural monopolies.

Regardless of whether a monopoly maintains its status through natural or artificial means, the effects of monopoly on key economic variables are essentially the same. Similar to competitive markets, a monopolist will produce output at the point where the marginal revenue from an additional sale will equal the marginal cost of producing an additional unit of output. However, unlike competitive markets where the market price of a good equates to the marginal revenue that the seller receives from an additional sale, in a monopoly market the marginal revenue is less than the price. (Graphically, the marginal revenue curve will be below the demand curve; see Figure 1.) Price exceeds marginal revenue in a monopoly market because when the seller lowers price to increase the quantity demanded, the seller must lower the price not only on the additional unit sold but also on all units sold by the firm.

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