Defining Monopoly
As we mentioned earlier, the supply and demand model of a market is not universally
valid. Instead, it’s a model of perfect competition, which is only one of several types of
market structure. A market will be perfectly competitive only if there are many firms,
all of which produce the same good. Monopoly is the most extreme departure from
perfect competition.
Amonopolistis a firm that is the only producer of a good that has no close substi-
tutes. An industry controlled by a monopolist is known as a monopoly.
In practice, true monopolies are hard to find in the modern American economy,
partly because of legal obstacles. A contemporary entrepreneur who tried to consoli-
date all the firms in an industry the way Rhodes did would soon find himself in
court, accused of breaking antitrustlaws, which are intended to prevent monopolies
from emerging. Monopolies do, however, play an important role in some sectors of
the economy.
Why Do Monopolies Exist?
A monopolist making profits will not go unnoticed by others. (Recall that this is “eco-
nomic profit,” revenue over and above the opportunity costs of the firm’s resources.)
But won’t other firms crash the party, grab a piece of the action, and drive down prices
and profits in the long run? If possible, yes, they will. For a profitable monopoly to per-
sist, something must keep others from going into the same business; that “something”
is known as a barrier to entry.There are four principal types of barriers to entry: con-
trol of a scarce resource or input, economies of scale, technological superiority, and
government-created barriers.
Control of a Scarce Resource or InputA monopolist that controls a resource or input
crucial to an industry can prevent other firms from entering its market. Cecil Rhodes
made De Beers into a monopolist by establishing control over the mines that produced
the great bulk of the world’s diamonds.
Economies of ScaleMany Americans have natural gas piped into their homes for
cooking and heating. Invariably, the local gas company is a monopolist. But why don’t
rival companies compete to provide gas?
In the early nineteenth century, when the gas industry was just starting up, compa-
nies did compete for local customers. But this competition didn’t last long; soon local
gas companies became monopolists in almost every town because of the large fixed
cost of providing a town with gas lines. The cost of laying gas lines didn’t depend on
how much gas a company sold, so a firm with a larger volume of sales had a cost advan-
tage: because it was able to spread the fixed cost over a larger volume, it had a lower av-
erage total cost than smaller firms.
The natural gas industry is one in which average total cost falls as output increases,
resulting in economies of scale and encouraging firms to grow larger. In an industry
characterized by economies of scale, larger firms are more profitable and drive out
smaller ones. For the same reason, established firms have a cost advantage over any po-
tential entrant—a potent barrier to entry. So economies of scale can both give rise to
and sustain a monopoly.
A monopoly created and sustained by economies of scale is called a natural mo-
nopoly. The defining characteristic of a natural monopoly is that it possesses
economies of scale over the range of output that is relevant for the industry. The source
of this condition is large fixed costs: when large fixed costs are required to operate, a
given quantity of output is produced at lower average total cost by one large firm than
by two or more smaller firms.
The most visible natural monopolies in the modern economy are local utilities—
water, gas, electricity, local land-line phone service, and, in most locations, cable televi-
sion. As we’ll see later, natural monopolies pose a special challenge to public policy.
module 57 Introduction to Market Structure 571
Section(^10)
(^) Behind
(^) the
(^) Supply
(^) Curve:
(^) Profit,
(^) Production,
(^) and
(^) Costs
Amonopolistis the only producer of
a good that has no close substitutes. An
industry controlled by a monopolist is
known as a monopoly.
To earn economic profits, a monopolist
must be protected by a barrier to
entry—something that prevents other
firms from entering the industry.
Anatural monopolyexists when
economies of scale provide a large cost
advantage to a single firm that produces
all of an industry’s output.