Monopoly

The standard definition of monopoly is a single seller of a product or service. In the economic sphere, monopoly generally has a negative connotation. Under competitive conditions with many buyers and sellers, prices are bid down to the cost of production and, in the absence of externalities, such as pollution, this yields an efficient allocation of resources. In the [Page 575]absence of competition, producers have incentives to restrict supply and raise prices above competitive levels. Beyond the perceived unfairness of high monopoly prices, the gap between price and marginal cost misallocates resources because of the restricted supply.

The harm done by a monopoly can vary widely, depending on the extent of its market power, which could derive from either demand or supply conditions. On the demand side, where there are many close substitutes for the monopolist's product, the demand facing the monopolist will be highly elastic, and hence, the scope for profitable price increases will be small. However, where substitutes are few, as with a necessity, demand will be inelastic and the scope for price increases will be large. Pricing power may be limited by geographical considerations: A single general store in a small town will find little scope for raising prices if it is cheap to go to the next town for supplies. Likewise, a country with only a single producer of automobiles will find that free trade limits the possibilities for monopolistic pricing. Consequently, economists generally focus on the scope for profitably increasing price above marginal cost as the most appropriate measure of market or monopoly power.

A common misconception is that bigness, or firm size, is a good measure of the extent of its monopoly power. Thus, a Marxist view of monopoly capital will often label any large firm as a monopoly capitalist. It is quite possible, however, for a government of a small country with valuable natural resources to have more effective market power than the small groups of large multinational corporations that are competing for access to the resource. Where corruption is present, one or more of the multinationals may collude with government officials to stifle competition and exploit consumers. In the same vein, a company's country of origin is not the relevant basis for assessment of its monopoly power. Thus, it is a mistake to identify a large firm as a monopolist just because it is based in one of the leading economies, say, in the United States or Japan.

In some instances, monopoly may be useful as a method of calling forth innovation. Thus, patents offer a monopoly for limited periods. Likewise, so-called natural monopolies are traditionally regulated by government on both price and quality issues. The creation of artificial monopolies has often been a source of government revenue and was a major instrument in the heyday of mercantilism. Such blatant monopoly creation has gone out of fashion, but restrictions on entry are still a frequent goal of lobbyists.