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MONOPOLY

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Definition:
Monopoly is a situation where there is a single seller in the market.

In conventional economic analysis, the monopoly case is taken as the polar opposite of perfect competition. By definition, the demand curve facing the monopolist is the industry demand curve which is downward sloping. Thus, the monopolist has significant power over the price it charges, i.e. is a price setter rather than a price taker.

Context:
Comparison of monopoly and perfectly competitive outcomes reveals that the monopolist will set a higher price, produce a lower output and earn above normal profits (sometimes referred to as monopoly rents). This suggests that consumers will face a higher price, leading to a deadweight welfare loss. In addition, income will be transferred from consumers to the monopoly firm.

The preceding arguments are purely static in nature and constitute only part of the possible harm resulting from monopoly. It is sometimes argued that monopolists, being largely immune from competitive pressures, will not have the appropriate incentives to minimize costs or undertake technological change. Moreover, resources may be wasted in attempts to achieve a monopoly position However, a counter argument advanced is that a degree of monopoly power is necessary to earn higher profits in order to create incentives for innovation.

Monopoly should be distinguished from market power. The latter is a term which refers to all situations in which firms face downward sloping demand curves and can profitably raise price above the competitive level. Market power may arise not only when there is a monopoly, but also when there is oligopoly, monopolistic competition, or a dominant firm.

Monopolies can only continue to exist if there are barriers to entry. Barriers which sustain monopolies are often associated with legal protection created through patents and monopoly franchises. However, some monopolies are created and sustained through strategic behaviour or economies of scale. The latter are natural monopolies which are often characterized by steeply declining long-run average and marginal costs and the size of the market is such that there is room for only one firm to exploit available economies of scale.

For purposes of competition law and policy, monopoly may sometimes be defined as a firm with less than 100 per cent market share. Different jurisdictions approach "monopoly" in different ways depending upon market share criteria.

Source Publication:
Glossary of Industrial Organisation Economics and Competition Law, compiled by R. S. Khemani and D. M. Shapiro, commissioned by the Directorate for Financial, Fiscal and Enterprise Affairs, OECD, 1993.

Cross References:
Dominant firm
Perfect competition

Hyperlink:
http://www.oecd.org/dataoecd/8/61/2376087.pdf

Statistical Theme: Financial statistics

Created on Thursday, January 3, 2002

Last updated on Monday, March 10, 2003