Monopoly Power: The Ability to Control Price and Supply
From Perfect Competition to Market Domination
To understand monopoly power, it helps to start with its opposite: perfect competition. Imagine a huge farmers market where many sellers offer identical apples. No single farmer can charge more than the going price because buyers can easily go to another stall. The price is set by the overall supply and demand in the market. This is a competitive market with many firms and no individual control over price.
Now, imagine if one company bought all the apple farms and became the only seller of apples in the country. This single firm is a monopoly. It has monopoly power: the ability to influence the market price by controlling the total supply. It is a price maker, not a price taker. A small group of firms working together (a cartel) can also wield similar power, forming an oligopoly.
The Sources of Monopoly Power
How does a firm become the only or dominant player? Several barriers can prevent other companies from entering the market and competing.
| Barrier Type | Description | Simple Example |
|---|---|---|
| Legal Barriers | Government grants exclusive rights, such as patents[1], copyrights, or licenses. A patent gives a firm the sole right to produce a new invention for a limited time. | A pharmaceutical company holds the patent for a new vaccine. For 20 years, no other company can legally make that exact vaccine. |
| Control of a Key Resource | A single firm owns or controls the entire supply of a resource essential for production. | In the early 20th century, the De Beers company controlled most of the world's diamond mines, influencing global diamond supply and price. |
| High Startup Costs | The initial investment needed to enter an industry is so large that it discourages potential competitors. | Building a nationwide network of water pipes or electrical grids is incredibly expensive, leading to natural monopolies[2]. |
| Economies of Scale | As a firm produces more, its average cost per unit falls. A large existing firm can produce at a much lower cost than any new, small competitor. | A giant tech company like Google benefits from massive data centers. A new search engine startup cannot match the cost efficiency. |
The Monopoly's Playbook: Price, Output, and Profit
So, what does a firm with monopoly power actually do? Its goal is to maximize profit, but its strategy differs from a competitive firm.
In a competitive market, firms produce where price equals marginal cost ($P = MC$). Marginal cost is the cost of producing one more unit. A monopoly, however, reduces the quantity supplied to a level lower than what would be supplied in a competitive market. By creating artificial scarcity, it can then charge a higher price. The monopoly produces where its marginal revenue[3] equals its marginal cost ($MR = MC$), and then sets the price based on what consumers are willing to pay for that limited quantity.
This difference creates what economists call deadweight loss. It represents the loss of economic efficiency and the potential trades that do not occur because the monopoly restricts output. Some consumers who would have bought the product at a competitive price are priced out, and society overall loses out on that value.
Case Study: The Standard Oil Trust
A classic historical example of monopoly power is John D. Rockefeller's Standard Oil Company in the late 19th and early 20th centuries. Through aggressive tactics, secret deals with railroads, and buying out competitors, Standard Oil gained control over nearly 90% of oil refining in the United States.
With this immense market share, Standard Oil could:
- Control Supply: It could choose how much oil to refine and sell.
- Set Prices: It could set high prices in regions where it faced no competition and lower prices (even at a loss) in areas where small rivals operated, to drive them out of business—a practice called predatory pricing.
- Influence the Entire Industry: Its power extended to railroads, pipelines, and related industries.
The public and government backlash against this concentration of power led to the Sherman Antitrust Act of 1890 and, eventually, the breakup of Standard Oil into 34 smaller companies in 1911. This case study highlights both how monopoly power can be built and why societies often act to limit it.
Modern Monopolies and Oligopolies
Today, pure monopolies (one firm controlling 100% of a market) are rare due to laws, but monopoly power in the form of dominant firms or tight oligopolies is common.
Consider the operating system for personal computers. Microsoft Windows held a market share well over 80% for decades. This dominance gave Microsoft significant power to set prices for PC manufacturers and influence software development standards. In the 1990s, the U.S. government sued Microsoft for using this power to stifle competition, particularly in the web browser market.
Another modern form is the platform monopoly or network effect. Social media platforms like Facebook (Meta) gain power because their value to each user increases as more people join. This creates a huge barrier for a new social network to compete. While not a monopoly in the strictest sense, such platforms wield enormous influence over digital advertising markets and user data.
Important Questions
Q: Is monopoly power always bad for consumers?
Not always, but often. The main downside is higher prices and restricted choice. However, the promise of monopoly profits (from patents) can encourage companies to invest heavily in research and development (R&D), leading to new inventions like medicines or technology. The challenge for society is balancing this incentive to innovate with the need to protect consumers from abuse of power.
Q: How do governments try to control monopoly power?
Governments use several tools:
- Antitrust Laws: Laws like the Sherman Act prohibit monopolization and anti-competitive agreements. They allow the government to break up companies or block mergers that would create too much market power.
- Regulation: For natural monopolies like water or electricity, governments often allow one firm to operate but regulate the prices it can charge to prevent abuse.
- Promoting Competition: Governments can remove unnecessary licenses, make it easier for new firms to enter markets, and ensure a level playing field.
Q: Can a company have a monopoly without being the only seller?
Yes. A company can have monopoly power if it holds a very large market share and its product has no close substitutes. For example, a popular video game console might dominate its niche. Even if there is one competitor, the dominant firm can still significantly influence price and supply. This is sometimes called "monopoly power" or "market power" even in markets with a few players.
Footnote
[1] Patent: A government license that gives the holder exclusive rights to a process, design, or new invention for a designated period of time.
[2] Natural Monopoly: A market where the most efficient number of firms is one, typically because high fixed costs mean average costs fall as output increases over the entire relevant range of demand (e.g., public utilities).
[3] Marginal Revenue (MR): The additional revenue a firm gains from selling one more unit of a good or service. For a monopoly, marginal revenue is less than the price because to sell more, it must lower the price on all units sold.