Monopoly Power

A monopoly is a market where there is only one seller. In standard neoclassical economic theory, fully competitive markets are efficient in the sense that they produce the products that buyers want at the lowest feasible cost. Buyers signal their wants with their purchasing habits, and firms' production costs are pushed down as they compete for market share. Companies will make profits, but profit margins are kept in check by competition. In competitive markets, firms will produce the quantity of goods at the price where marginal cost equals marginal revenue (i.e., at the point where it costs as much to produce the last good as is obtained from selling it).

Monopolists, however, can make excess or monopoly profits. They can restrict output, pushing up price. Monopolists also do not need to respond or react to consumer demands in the same manner. Where customers have no other equivalent products to choose, they will have to buy the products the monopolist produces. The idea of monopoly power derives from this analysis of monopoly. Although, strictly speaking, monopoly means “one seller,” firms can have some degree of monopoly power where competition is weak and producers can collude. If there is only one seller, then the degree of monopoly power is sometimes expressed as the ratio of price to marginal cost, because that measures the degree of excess profit. Where there are several sellers their monopoly power can be measured by the Herfindal Index, which is a measure of the degree of concentration in an industry. The index calculates the sum over all firms of the square of each firm's market share expressed as a proportion. The lowest value would be where all firms have equal market share the highest value being 1—a perfect monopoly. So monopoly power is the degree of power held by any seller to set the price for a good. If it is a pure monopoly, it has full power (still constrained by demand), but big firms with a large share of the market, while still subject to some competitive constraints, can set the price to a large degree. Hence the monopoly power of a market is assumed to be equivalent to the degree of concentration, understood as how closely the market approaches a monopoly.

[Page 425]In the United States, the Sherman Anti-Trust Act of 1890 identifies in its Section 2 two violations: first, the possession of monopoly power; and second, the willful acquisition of monopoly power (as opposed to growth or development due to a superior product, business acumen, or historical accident). This has been understood within law as the ability of a business to control price within its relevant product or geographic market or to attempt to exclude a competitor from doing business within that market. It is only necessary to demonstrate that a firm has that power, not that it has exercised it, in order for the plaintiff to get a ruling that a firm has committed a Section 2 violation. Similar competition laws operate in many countries and within the European Union.

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