Why monopoly arise

From the standpoint of the owners of the firm, the high price makes monopoly very desirable. We use total surplus as our measure of economic well-being.

Producer surplus is the amount producers receive for a good minus their costs of producing it. In this case, there is a single producer — the monopolist. Because a monopoly leads to an allocation of resources different from that in a competitive market, the outcome must fail to maximize total economic well-being. A social planner tries to maximize total surplus, which equals producer surplus profit plus consumer surplus. The socially efficient quantity is found where the demand curve and the marginal cost curve intersect.

This is the quantity the social planner would choose. The monopolist chooses to produce and sell the quantity of output at which the marginal revenue and marginal cost curves intersect. The area of the deadweight loss triangle between the demand curve and the marginal cost curve equals the total surplus lost because of the monopoly pricing. A monopoly firm does earn a higher profit by virtue of its market power. Welfare in a monopolized market includes welfare of both consumers and producers.

Whenever a consumer pay an extra euro to a producer because of a monopoly price, the consumer is worse off by a euro, and the producer is better off by the same amount. Meaning the monopoly profit is not a social problem. The problem in a monopolized market arises because the firm produces and sells a quantity of output below the level that maximizes total surplus. The deadweight loss measures how much the economic pie shrinks as a result.

The anti-trust laws USA give the government various ways to promote competition. The anti-trust laws also allow the US-government to break up companies. While it is a publicly-traded company, it is held down by government regulation to prevent consumers from being in-directly overcharged. When companies have sole ownership of a key resource, they are usually heavily regulated by government.

This is so that they do not take advantage of their monopolistic position in the market. Another cause of monopoly is when the government grants a patent to businesses. This is a form of intellectual property that gives the owner the legal right to be the sole producer of a product. The owner of the patent must provide details of the product and make them public.

In exchange, the government guarantees the protection of such rights in court for a period of time. Any business infringing on this right will be in violation of the patent and can be sued. While this grants the inventor a monopoly, it is designed to incentivize innovation. If the inventor of a product knew there was no legal production, they may not invest the time, energy, and funds into developing it. There is little incentive for the inventor if they know the product will be copied by Mr.

Bloggs the very next day. Nevertheless, it creates a monopoly on that product for a set period of time. Import quotas, tariffs, and other trade restrictions can limit competition and be a cause of monopoly.

If cheaper foreign competition is unable to enter the market, there are fewer pressures on domestic companies. For example, when the patent of a small niche drug runs out; there may be few pharma companies that would want to compete. This may be because the drug only serves a few hundred people, so there is little profit to be made. Therefore, there is a domestic monopoly. However, foreign drugs would be able to compete as they can access multiple national markets, which creates a larger consumer base and a greater potential for profit.

By being able to access more markets, what was a niche product, becomes a large and quite a lucrative market. Yet many countries prevent this. This stops perfectly safe drugs from Europe from coming in and serving as a competition to the domestic monopoly. During the infancy of a market, the first entrant will be able to establish an initial monopoly position.

This is because they are the first company in the market, without competition. For example, if a business was to create a hypothetical teleportation device, it would be the first to do so. In the early stages at least, it may have a monopoly until competitors are able to enter and create a similar product. During these initial stages of a new market, it is easy for the first entrant to establish a monopoly.

However, this usually does not last long as competitors see an opportunity. Geographic monopolies can be characterised by the sole presence within a local market. For example, there may only be one restaurant in the local town.

If you want a meal out, you may have to travel half an hour to the nearest restaurant. When considering the local market; it can be considered as a monopoly. Other examples of local monopolies may include a gas station that is the only supplier on the motorway. Whilst it does not have a monopoly over gas, it does within the bounds of its location. It is important to distinguish the difference between a monopoly, and monopolistic power.

In a monopoly there is only one supplier in the market. This is different from monopolistic power in a number of ways. The difference is that monopolistic power means a company has monopoly like powers, but is not the sole provider. In monopolistic competition, there are many firms in the market, but they compete on factors other than price.

Monopolistic markets are also characterized by low barriers to entry; something that is usually non-existent in monopoly markets. This allows new firms to easily come in and compete; in stark contrast to monopolies. Budget Surplus Definition Read More ». Capital Markets Definition Read More ». Businesses have developed a number of schemes for creating barriers to entry by deterring potential competitors from entering the market.

One method is known as predatory pricing , in which a firm uses the threat of price cuts to discourage competition. Predatory pricing is a violation of antitrust law, but it is difficult to prove. Consider a large airline that provides most of the flights between two particular cities. A new, small start-up airline decides to offer service between these two cities.

The large airline immediately slashes prices on this route so that the new entrant cannot make any money. After the new entrant has gone out of business, the incumbent firm can raise prices again. After this pattern is repeated once or twice, potential new entrants may decide that it is not wise to try to compete.

Small airlines often accuse larger airlines of predatory pricing: in the early s, for example, ValuJet accused Delta of predatory pricing, Frontier accused United, and Reno Air accused Northwest. In , the Justice Department ruled against American Express and Mastercard for imposing restrictions on retailers who encouraged customers to use lower swipe fees on credit transactions.

In some cases, large advertising budgets can also act as a way of discouraging the competition. If the only way to launch a successful new national cola drink is to spend more than the promotional budgets of Coca-Cola and PepsiCo. A firmly established brand name can be difficult to dislodge. Table 8. This list is not exhaustive since firms have proved to be highly creative in inventing business practices that discourage competition.

When barriers to entry exist, perfect competition is no longer a reasonable description of how an industry works. When barriers to entry are high enough, a monopoly can result. Barriers to entry prevent or discourage competitors from entering the market. These barriers include: economies of scale that lead to natural monopoly, control of a physical resource, legal restrictions on competition, patent, trademark and copyright protection, and practices to intimidate the competition like predatory pricing.

Intellectual property refers to the legally guaranteed ownership of an idea, rather than a physical item. The laws that protect intellectual property include patents, copyrights, trademarks, and trade secrets. A natural monopoly arises when economies of scale persist over a large enough range of output that if one firm supplies the entire market, no other firm can enter without facing a cost disadvantage.

Skip to content Topic 8: Imperfect Competition. Learning Objectives By the end of this section, you will be able to:. Distinguish between a natural monopoly and a legal monopoly. Explain how economies of scale and the control of natural resources led to the necessary formation of legal monopolies Analyze the importance of trademarks and patents in promoting innovation.

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