Creation of a Statutory Monopoly
When a policy of nationalisation was being pursued, key industries were taken over into state ownership and run as public corporations with monopoly status. An example of this is the Royal Mail (also known as Consignia), which has had a statutory monopoly in delevering letters for many years. Although this is set to end as the government seeks to promote competition in the industry.
Franchises & Licences
These give a business the right to operate in a particular market and are usually open to renewal every few years, i.e. commercial television and radio licences, Camelot – national lottery has renewed its licence for another seven years in the year 2000.
Internal Expansion of a Firm
Firms can generate higher sales and increase market share by expanding their operations and by exploiting economies of scale. This is an internal factor and is also known as Organic Growth.
Barriers to entry are the means by which potential competitors are blocked. Monopolies can then enjoy higher profits in the long run as rivals have not diluted market share. Monopoly power is created as a result of barriers to entry. There are various types of barriers (Structural, Strategic and Statutory), which prevent rival firms entering the market, some of which are;
Patents
Patents are government enforced property rights to prevent the entry of rivals. They are usually valid for around 15 to 20 years and it gives the owner an exclusive right to prevent others from using their patented products, inventions or processes.
Vertical Integration
When a firm gains control over supplies and distribution, it can prevent rival firms entering the market. Many major oil companies are fully integrated, meaning they control all stages of production, oil extraction, oil refining and also controlling retail outlets (petrol stations). Consequently they maintain a high market power.
Absolute Cost Advantages (ACA)
Firms may lower, perhaps through experience of being in the market for some time, which allows existing monopolists to cut prices and win price wars.
Advertising and Marketing
Developing consumer loyalty by establishing branded products can make successful entry into the market by new firms much more expensive and less successful. This can make firms operate at a loss and increase their expenses, as they will need to invest in new marketing techniques to gain sales. Advertising can also cause an outward shift of the demand curve and also make demand less sensitive to price.
Brand Proliferation
In many industries multi-product firms engaging in brand proliferation can give a false appearance of competition to the consumer. This is common in markets such as detergents, confectionery and household goods – it is an essential part of non-price competition.
These are the sources of monopoly power because they do not allow/restrict rival firms entering their markets, so they can be the sole producer/provider in that particular market.
Diagrammatical analysis of the monopoly diagram
Are monopolies a bad thing? Cost Benefit Analysis
The economic and social costs of monopoly
Exploitation of the consumer: The main case against a monopoly is that these businesses can earn higher profits at the expense of allocative efficiency. The monopolist will seek to extract a price from consumers that is above the cost of resources used in making the product. And higher prices mean that consumers’ needs and wants are not being satisfied, as the product is being under-consumed. Consumer sovereignty has been replaced by producer sovereignty if the monopolist exploit’s their market dominance.
The diagrams above show a market where demand is price inelastic (i.e. Ped <1) and one where demand is sensitive to price changes (i.e. Ped >1). The first is associated with a monopoly where consumers have few close substitutes to choose from. When demand is inelastic, the level of consumer surplus is high, raising the possibility that the monopolist can reduce output and raise price above cost thereby operating with a higher profit margin (the difference between price and average cost). One way of showing the loss of economic welfare that comes from monopolistic firms exploiting their power is to use supply and demand analysis and the concepts of consumer and producer surplus. If a monopoly reduces output from the equilibrium at Q1 to Q2 then it can sell this at a higher price P2. This results in a transfer of consumer surplus into extra producer surplus. But because price is now about the cost of supplying extra units, there is a loss of allocative efficiency. This is shown in the diagram by the shaded area, which is not transferred to the producer, merely lost completely because output is lower than it would otherwise be in a competitive market.
Higher costs – loss of productive efficiency:
Another possible cost of monopoly power is that businesses may allow the lack of real competition to affect them leading to a rise in production costs and a loss of productive efficiency. When competition is very tough, businesses must seek to keep firm control of their costs and keep productivity high because otherwise, they risk losing market share. Some economists go further and say that monopolists may be even less efficient because, if they believe that they have a protected market, they may be less inclined to spend money on research and improved management. These inefficiencies can lead to a waste of scarce resources.
Monopolies being price makers in the market can cause consumers dissatisfaction by charging high prices for their products as they are likely to be the sole provider of that good, or that substitute goods are restricted. A good example of this could be a petrol station, which has no competition within its regional area; therefore they are likely to charge higher prices. This is seen at service stations in the UK along the motorways where petrol prices are considerably higher than in towns and cities, where competition is far higher.
Price discrimination is another disadvantage of a monopoly, as they charge different prices for the same good to different types of consumers in different geographical locations. Businesses use this technique to boost profits by charging higher prices to those with more inelastic demand and lower prices to those whose demand is relatively more elastic, this is becoming more common in today’s world. McDonalds is a prime example of this; they charge different prices for their meals in different countries and they also provide bigger or smaller portions of food, resulting in either good or bad value for money.
The potential economic and social benefits of monopoly
The possible economic benefits of monopoly power suggest that the government and the competition authorities should be careful about intervening directly in markets and try to break up a monopoly. Market power can bring advantages both to the firms themselves and also to consumers and these should be included in any evaluation of a particular market or industry.
Research and Development Spending
Huge corporations enjoying a high level of profits are well placed to allocate some of their profits to fund high-cost capital investment spending and research and development projects. The positive spillover effects of research can be seen in a faster pace of innovation and the development of improved products for consumers. This is particularly the case in industries such as telecommunications and pharmaceuticals. This can lead to gains in dynamic efficiency and social benefits (i.e. positive externalities).
Exploitation of Economies of Scale
Because monopoly producers are often supplying goods and services on a large scale, they may achieve economies of scale – leading to a fall in long run average costs. Lower costs will lead to an increase in profits but gains in productive efficiency might be passed onto consumers through lower prices. Economies of scale provide gains in welfare for both producers and consumers.
Monopolies and International Competitiveness
One argument in support of businesses with monopoly power is that the British economy needs multinational companies operating on a scale large enough to compete in global markets. A firm may enjoy domestic monopoly power, but still face competition in overseas markets. Two good examples of these are UK Coal and Corus, the steel manufacturer.
Intervention in markets – the role of competition policy
Competition policy involves the regulation of markets so that consumer welfare is protected and improved. It operates in different ways – three of the main competition bodies are the Competition Commission, the Office of Fair Trading and the European Union Competition Authority.
National Security
Having nationalised monopolies, this can be a way to safeguard a country in drastic times i.e. wars when supplies are restricted. An example of this could be to re-open the British coalmines depending on foreign imports.
Monopoly case study
Most people are aware that Microsoft is the operating system used on the majority of the world's PCs, probably as much as 90%, therefore Microsoft being a monopoly. For Microsoft the challenge is now maintaining its position of dominance against a variety of threats.
As technology develops, the skills and creativity of those who use it also grows.
In addition, the weaknesses of the monopolist's product become more apparent making it the target for those seeking to fill the gaps in the market.
This is the position that Microsoft is now in, because they are so successful they have attracted plenty of detractors possibly spiteful of its success but also only too keen to point out the limitations of Microsoft's products. The widely reported attacks on PC systems by hackers has exposed the security frailties of Windows. It seems to some that Microsoft are always one step behind the hackers instead of being one step ahead which one might expect of a corporation with its vast resources.
Microsoft is also facing challenges from regulatory authorities over its monopoly position. The EU Competition Commission is not convinced that a year after it made demands to Microsoft about opening up its business to more competition that it has done anything like enough suggesting that further, more punishing, fines could be on the horizon.
It is the creativity of individuals that is likely to be the most serious threat to Microsoft, however, the vast majority of users of information technology came to it through Windows.
There are plenty of people who want to know more and see the limitations that Windows has and are looking to develop new software and it could be argued, better products.
Linux is one such example. Linux is an operating system that rivals Windows, originally produced by Linus Torvalds, a Swedish speaking Finn now living in the United States. Its users are convinced its stability and security is better than that of Windows and the fact that it is open source available to anyone who wants to use it, and that it is developed and improved by a community of users is an important factor in its success; it has been developed in spite of the monopoly position that Microsoft exerts and this makes it attractive for those who like to support the battle against the corporate giants.
Mozilla Firefox is another challenger to Microsoft. Firefox is a browser, the same as Internet Explorer but better according to those who use it regularly. It has, reputedly, seen 50 million downloads in the last nine months alone.
A firm gaining a monopoly, certainly in the private sector, is not therefore in a position where it can beat off all challengers and can sit back secure in the knowledge that it will remain powerful for evermore. It constantly needs to monitor its performance, the needs of its customers and seek new innovative and more effective products to be able to combat the challenges that will come from pretenders to the throne.