A monopoly is a market structure in which there is only one producer/seller for a product. Monopoly is derived from Greek “monos” meaning ‘alone’ or ‘single’ and “polein” meaning to ‘sell’. In other words, the single business is the industry.
A monopoly is free to set any price it chooses and will usually set the price that yields the largest possible profit. Entry into such a market is restricted due to high costs or other impediments, which may be economic, social or political. For instance, a government can create a monopoly over an industry that it wants to control, such as electricity. Another reason for the barriers against entry into a monopoly industry is that many a times, only one firm or entity has the exclusive rights to a natural resource. A monopoly may also form when a company has a copyright or patent that prevents others from entering the market.
In real world monopoly is a little hard to find. But, we can find near perfect situations of monopoly, for ex: in Saudi Arabia the government has sole control over the oil industry and Microsoft as the leader of Operating System seller with its overwhelming sales is the dictator and the other firms with their little market share have no or little impact.
As there is only one firm in a monopoly, the firm’s demand curve is identical to the market demand curve, and the firm need not consider what it’s competitors as there are none. Thus a monopoly will keep selling units as long as the marginal amount he receives by selling marginal units. 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 its 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. Now for the market to remain in this state there must be some barrier to entry. A few common ones are:
Legal Barriers to Entry – This is a situation where a law prevents other firms from entering the market to sell a product. In the United States, only the USPS can deliver first class mail, so this would be a legal barrier to entry. In many jurisdictions alcohol can only be sold by the Govt. run corporation and in some countries the railways is owned and operated by the Govt., creating a legal barrier to entry in this market.
Patents – Patents are a subclass of legal barriers to entry, but they’re important enough to notice. A patent gives the inventor a monopoly right in producing and selling that product for a limited amount of time. Patents are tools that governments use to promote innovation, as companies should be more willing to create new products if they know they’ll have monopoly power over those products.
Natural Barriers to Entry – In monopoly, other firms cannot enter the market because either the startup costs are too high, or the cost structure of the market gives an advantage to the largest firm. Most public utilities would fall into this category. Economists generally refer to these monopolies as natural monopolies.
Monopolies are unique relative to other market structures, as it only contains one firm, and thus a monopoly firm has much more power to set prices than the firms in other markets.
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