What is Monopoly in Economics?

When most people hear the term monopoly, they think of the board game with the fake englishman on the board. They think of buying houses and hotels and charging rent. Surprisingly enough, a monopoly in economics refers to something different. However, the game was born out of the concept.

 

In economics, a monopoly refers to a market system where there is only one seller and many buyers. Whenever we hear the term monopolistic powers or monopolizing the market, it refers to the practices a business undertakes to become the sole seller of their respective goods and services. 

 

In theory, a monopoly represents a company with complete and absolute control over the sale and supply of a good. The company can decide whom to sell to, at what rate and what quantity. 

 

The entire terms of the interaction are on the business’s terms. They can decide everything regarding the transaction with the sole exception of not being able to control demand. However, in case of inelastic goods, this point is overridden.

 

An inelastic good is a good whose demand does not readily respond to price. That is, if the good’s price is hiked up, people will continue to buy it, making these goods in direct contradiction with the law of demand which states that the demand for a good is inversely related to its price.

 

Companies in a monopoly market system have an undue advantage over those in competition. But before reading into the pros and cons, it is important to gain a grasp on the features of a monopoly after which its advantages and disadvantages along with state restrictions make a lot more sense. 

 

(Recommended blog - Elasticity of Demand)

 

 

Features of a Monopoly

 

The features of a monopoly are all based on the fact that there is only one seller and many buyers thus creating only one source of supply. This leads to an extraordinary amount of power to the company at the center of a monopoly. The features of monopolies are as follows:

 

1. Single seller and multiple buyers: The single most important feature of a monopoly is that there is only one seller of the goods. Take the Indian Railways for example. 

 

In the business of railway transportation, the Indian railways are the sole enterprise in that particular business. This point is the central tenet for defining a monopoly system. 

 

2. No close substitutes: In economics, substitute goods refer to goods and services that are closely related to each other and perform similar functions. For example, a Reynolds pen and a Linc pen both perform the same function and hence are substitutes of each other. 

In the case of a monopoly, however, there are no substitutes for goods produced rendering the business in monopoly the sole source of the commodity. This ties into the next point regarding competition.
 

3. No competition: The lack of any substitutes eliminates competition for commodities sold in a monopoly market. 

 

This lack of competition is a powerful incentive for firms as without competition they are not subject to price wars or vying for larger market share when in fact, they control all the market share in that particular sector

 

No competition also allows the firm a lot of liberty in setting price and supply giving them a lethal advantage. When you can set your own price giving people no choice but to buy, your firm is profitable irrespective of the situation.
 

4. Firm is a price maker: As the firm is a sole source of supply for the commodity, they can virtually set their own price. 

 

Take the case of insulin in the United States, when pharma companies create a monopoly on the sale and supply of such an essential drug required to save millions of people, they can virtually charge any rate they want and people will have to pay.

 

This feature is one of the strongest arguments for antitrust laws which are laws regulating the monopoly power of companies.
 

5. Restriction on entry of firms: An auxiliary feature to no close substitutes, the restriction of entry of firms in a monopoly set up is one of the biggest factors enabling companies to create their kingdoms. 

 

When firms cannot enter a particular industry, the already prevalent enterprises stand to benefit from that reduced competition.

Barriers to entry can be legal barriers, as in the case of industries that require licenses from the government. They can also be financial, as in the case of the telecom industry where investment requirements empty a hole in your pockets, wallets and the bank you would need a loan from.

 

(Suggested Read - Types of Trade Barriers)

 

 

Advantages and disadvantages of a Monopoly system

 

Advantages of Monopoly System

 

A monopoly system is extremely beneficial to the business but highly detrimental to the consumers as they are often subject to exploitation. The advantages are usually tailored in the same manner. The advantages would be as follows:

 

1. High profit margins: For companies in a monopoly system , the ability to set their own price and ensure that the product is only sold when they want allows for some ludicrous profits. 

 

Let’s take the case of the De Beers corporation. The De beers corporation are an international diamond company who through superb marketing and predatory policies have made the diamond industry into what it is today.

 

The corporation is in a virtual monopoly for the sourcing and sale of diamonds. It is an open secret that they have created an artificial scarcity for diamonds thereby driving up its prices. 

 

Diamonds historically were not a precious material and available in relative abundance rendering them inferior to the real precious substances such as gold and silver.

 

However, using their position of monopoly and their marketing advertisements, they have marketed the diamond into a requirement for modern marriage effectively skyrocketing their profits.
 

2. Low expenditure on advertisement: When a company is in a monopoly set up, its advertising and marketing budget needs to be the bare minimum only. 

 

The only advertising a company needs to do is make consumers aware of their product. There is no need for the usual product feature show off or any of its accomplices in conventional advertising.

 

Since the element of competition no longer exists in a monopoly, companies do not have to worry about another’s products being any better or whether or not their product can appeal to a consumer better than the other.

 

Take the Indian railways, who do a minimal advertisement simply to let people know of new schemes and offers undertaken by them. There are no marketing campaigns directed at extolling the virtues of the Indian railways, simply information campaigns .

 

Evidently, the advantages of a monopoly system only applies to the business in monopoly. In cases of government enforced monopoly, it also helps to ensure quality control of the goods sold. 

 

Take the case of state manufactured opium, through a legal monopoly on the manufacture of opium, the government can ensure the sale and supply of proper quality morphine and other derivatives so that patients get only the pure substance and not chemical induced mixtures.

 

(Check out our blog on Targeted Advertising)

 

Disadvantages of Monopoly System

 

The disadvantages, on the other hand, number into the millions. The fundamental disadvantage behind a monopoly system is that it leaves the consumers exposed to large scale exploitation. Its disadvantages are as follows:

 

1. Inefficiency: Companies in a monopoly are not required to maintain the same standards of efficiency as a company in a competitive market. 

 

The reason being that a company in a monopoly set up is completely free from fear of going out of business. When you're the only seller, there is no one else to steal your business which allows these enterprises to be inefficient.
 

For example, if your business is the only business that sells trucks, then you are not obligated to provide the highest quality maintenance or service because even if consumers hate your service, they have no choice but to stick with your business as there are no alternatives to it. 

 

This has been highlighted in the United States again in their telecommunications industry where only certain companies are available in select areas enabling them to ensure a virtual monopoly.
 

2. Exploitation: More than inefficiency, consumers will have to worry about consumer exploitation. With prices surging and consumers not having a choice to pay, it makes a monopoly system extremely dangerous and frankly, a little classist. 

 

To prevent this from occurring, governments undertake competition and antitrust laws that regulate how much of a market share a company can have as well as the extent to which their price can go. 

 

In essential goods such as food grains, governments are known to impose price ceilings so that the costs do not skyrocket denying the poor their basic necessities.

 

Ultimately, a monopoly is a dangerous situation for all except the owners of the company. Since monopoly is also accompanied by all the labor force being employed in one place, it puts workers in a difficult situation without being out of their respective jobs. 

It represents the biggest difference between capitalism and socialism, set up with capitalism encouraging a monopoly. However, it can act as a power incentive for businesses and must not be completely curtailed, just regulated.