In accordance with its etymological meaning of “one seller,” the term “monopoly” in a strict sense refers to a situation in which a seller is the sole source of supply for an economic good that has no significant substitutes. The term is also applied more broadly, however, to any market in which the behavior of sellers is other than purely competitive. Since the price confronting the individual seller in pure competition, as determined by demand and supply in the market as a whole, is essentially independent of the quantity that he chooses to sell, monopoly in the broad sense characterizes the market position of any seller who has a significant degree of discretion about his price and whose quantity sold varies inversely with the price selected. In this sense, at least some degree of monopoly power is both widespread and practically unavoidable. Furthermore, monopoly and competition are not mutually exclusive elements but may both be present in any given market. Finally, even when the behavior of individual sellers is purely competitive, any artificial restriction on their number or on the quantities that they are permitted to sell may also be classified as monopolistic.
The elementary static theory of the profit-maximizing equilibrium of a simple monopolist may be illustrated by Figure 1. With the monopolist’s product quantity, q, measured on the horizontal axis and such magnitudes as his price, p, and his unit cost, c, on the vertical axis, the diagram depicts illustrative revenue and cost schedules, both average and marginal. The nature of these data can be briefly explained.
If the monopolist’s total revenue and total cost are designated by R and C, respectively, the corresponding average magnitudes are defined as AR = R/q = p and AC =C/q = c. The AR schedule reflects the demand confronting the seller, since it shows the quantities that customers are willing to buy from him at various alternative prices. Its significantly downward slope, the hallmark of the seller’s monopoly power, is in contrast to the essentially horizontal demand that would apply to the individual seller in pure competition. Depending on the context of the analysis, the cost curves may refer to either (1) the long run, when a firm can vary all relevant factors of production, including the number and sizes of its plants, or (2) a short run, when certain components of the firm’s plant and equipment are temporarily fixed (giving rise to the distinction between fixed and variable costs). In the long run the AC curve slopes down-ward, at least initially, as a reflection of the economies of large-scale production. If it turns upward at some point, that reflects an eventual dominance of diseconomies of scale. In the short run AC slopes even more sharply downward initially, as a reflection of the spreading of the fixed or overhead
costs over an increased output; it turns upward primarily because of plant-capacity limitations.
The concepts of marginal revenue and marginal cost refer to the rate of increase of the corresponding total magnitudes per unit of extra output. If output is increased by some finite amount, Δq, giving rise to similarly finite increments of total revenue, ΔR, and total cost, ΔC, marginal revenue and marginal cost in their discrete versions are defined as MR = ΔR/Δg and MC = ΔC/Δg. For example, if Δg equals one unit, MR and MC reflect the increments of total revenue and total cost, respectively, occasioned by the production and sale of the one unit of extra output. If the basic variables are treated as continuous, the marginal concepts in their continuous versions become MR = dR/dq and MC = dC/dq—the first derivatives of the corresponding total-revenue and total-cost functions, R = R(q) and C=C(g). In this version MR and MC again represent the additional R or C per unit of additional output, but only as the limiting values that are approached when the addition to output is viewed as becoming indefinitely small. It is this definition that is implied when MR and MC are represented by continuous curves, as in Figure 1. As can readily be proved, a marginal magnitude is less than, equal to, or greater than its corresponding average according as the average curve is decreasing, constant, or increasing.
The principal analytical significance of these marginal concepts is that the firm’s profit-maximizing output is determined where the MR curve cuts the MC curve from above, as at the output q0 in Figure 1. This follows from the definitions of MR and MC, which imply that the firm’s total profit (π =R−C) is increased or decreased by an expansion of output according as MR is greater or less than MC. The profit-maximizing price, p°, and unit cost, c,,, are then indicated on the AR and AC curves, respectively, at q°. This identifies the equilibrium profit per unit as π°/q° = P° – c°; the maximized total profit, π° = (P° – C°)g°, is represented by the area of the shaded rectangle.
In a popular layman’s phrase, monopolists are often represented as “charging what the traffic will bear,” but this is, at best, ambiguous. Notice that a smaller “traffic” than q° would “bear” both a higher price and a higher profit per unit, whereas a lower price than p° would allow a “traffic” greater than q°. In other words, to maximize total profit the monopolist must balance the favorable effect of a greater quantity against the unfavorable effect of a lower profit per unit, maximizing neither.
On the other hand, a positive profit is not a defining characteristic of monopoly. Thus, if the AR
curve is tangent to the AC curve at a single point (with AR < AC everywhere else), as in Figure 2, total profit is merely zero when maximized. As may be relevant in a short run, furthermore, a maximized profit may also be negative—when AR lies below AC at all possible outputs. Conversely, a purely competitive firm may also have positive profit, not only in a short run but in the long run as well (provided only that “profit” is defined in a consistent manner, as the excess of total revenue over the minimum total cost that must be covered if the firm is to be willing to go on producing the given output indefinitely).
“Simple” (sometimes called “pure”) monopoly, implying essentially a complete absence of competitive influence, is a rare phenomenon, because of the strict conditions that must be met. First, there must be no significant relationship of substitution or complementarity with the products of any other firm or group of firms, save for the inevitable interdependence of all products in the economy as a whole. Second, there must be no threat of potential competition from the possible entry into the market of a supplier of a significantly substitutable product. Then, if the monopolist can vary the output that he produces and sells without having any appreciable effect on the situation or decisions of any other firm in the economy, his equilibrium can be treated in analytical isolation from the remainder of the economy—as that of a one-firm “industry.”
Other forms of monopoly, to be distinguished from this simple species, include several forms of oligopoly, complementary monopoly, and the nonoligopolistic type of competition among a large number of suppliers of “differentiated” products—that is, products that are relatively close, but not perfect, substitutes.
Oligopoly exists when there are relatively few suppliers of at least relatively close substitutes or when relatively few suppliers account for the pre-dominant part of the industry’s total supply [see Oligopoly]. It is classified as “pure” or “differentiated” oligopoly according as the oligopolists’ products are perfect or imperfect substitutes. The distinctive feature of oligopoly is the appreciable effect that the individual firm has on the situation of its rivals through its own price, output, and other business decisions, since induced reactions of one kind or another on the part of the rivals are then highly likely. This means that it is highly unlikely that an oligopolist would suppose that the demand curve relevant for his market decisions would be one drawn on an assumption that either the prices or the outputs of his rivals were constant. Yet, since the reactions of rivals are, in general, uncertain, there is a corresponding uncertainty about the relevant demand confronting each oligopolist. This is why the oligopoly problem is such a conundrum, with a wide range of possible outcomes that embrace (1) various forms and degrees of collusion, whether explicit or tacit, toward one extreme and (2) various types and intensities of economic warfare toward the other. Except under conditions of warfare, however, the mutual awareness by oligopolists of their distinctive interdependence typically leads to higher prices and lower outputs than would be the case if that interdependence were ignored.
Although less important in reality and comparatively neglected by analysts, cases in which a small number of monopolists supply goods that are either perfect or imperfect complements involve essentially the same type of interdependence as in oligopoly. Here, however, collusion works in the direction of lower prices and greater quantities sold than is the case when the interdependence is ignored or imperfectly appreciated.
When differentiated products are supplied by a large number of small firms, oligopolistic relation-ships may be absent for much the same reason as in pure competition, because the small individual firm has only a negligible impact on the market position of any one of its many rivals even when it brings about a large relative change in its own sales. Accordingly, the demand relevant for this type of firm’s decisions may be drawn on the assumption that all of its rivals’ prices are constant—that is, independently determined. Given a sufficient degree of product differentiation, however, the demand confronting this type of firm slopes downward significantly, in contrast to the essentially horizontal demand facing the pure competitor. This market form may be called “differentiated competition” to distinguish it from pure competition in the same way that differentiated oligopoly is distinguished from pure oligopoly.
As to the equilibrium of the individual firm in differentiated competition, this is much the same as in simple monopoly. These two market forms differ, however, in that there is a problem of “group equilibrium” in differentiated competition, just as there is in pure competition. Differentiated competition typically involves not only a simultaneous equilibrium of each individual firm but also an equilibrium adjustment of the number of firms in the long run, through entry or exit in response to profits or losses. In a theoretically important, though hardly realistic, case in which all the actual and potential members of the group have like costs and face like demands, the ultimate long-run equilibrium is of the zero-profit type—with each firm’s demand, or AR, curve just tangent to its AC curve, as in Figure 2. As emphasized by Edward H. Cham-berlin (1933), the pioneer in the analysis of this and other forms of “monopolistic competition,” this heroically simplified special case is merely a convenient illustration of the group-equilibrium concept. Realistically, various asymmetries of both demand and cost are overwhelmingly likely, with resulting differences of price, output, and profit among various firms in the group even in a state of long-run equilibrium.
In the sense that the situation of an individual seller may differ by much or little from that of a pure competitor, his monopoly power is a matter of degree. In the limiting case of pure competition, where the individual seller faces a horizontal demand so that AR and MR coincide, the maximizing of profit at the point where MR= MC also implies an equating of AR and MC. When the AR curve slopes downward so that the MR curve lies below it, however, the equating of MR and MC implies that AR > MC. This led Abba P. Lerner (1934) to formulate as a quantitative measure of a firm’s degree of monopoly power the ratio M= (AR–MC)/AR. That ratio is then zero for the profit-maximizing pure competitor, whereas for the profit-maximizing monopolist it is positive and would approach unity as an upper limit if his price or AR was visualized as becoming indefinitely large, relative to a given positive MC.
The degree of monopoly power of a firm in static profit-maximizing equilibrium is closely related to the “elasticity” of demand at the equilibrium point. That elasticity, defined as E= (dq/dp)(p/q), measures the percentage change in quantity demanded, q, relative to the associated percentage change in price, p. It can then be shown that E= AR/(MR–AR). Accordingly, when MR= MC it follows that M= −l/E. This is consistent with the implication that the horizontal demand facing a purely competitive firm is “perfectly” or “infinitely” elastic, whereas the elasticity of the downward-sloping demand facing a monopolist is finite and greater than unity in absolute value at a point where profit is a maximum and MC is positive.
On the other hand, the relevance of M as a measure of the degree of monopoly power is not limited to situations of static equilibrium. Thus, whether or not MR is equated with MC or is determinate at all, the definition of M in terms of AR and MC makes it a measure of the degree of currently “exerted” monopoly power, even if its value would be different in some alternative position of static equilibrium. This is important, for sometimes (especially in oligopoly) MR may be basically uncertain or indeterminate, and very often monopolists of various types are persuaded by dynamic or “long run” considerations not to seek to maximize profit with respect to the demand and cost data that apply in a given short run. Furthermore, it is precisely the relationships of AR and MC in all of the firms throughout the economy that are of central interest in evaluating the efficiency of allocation of the economy’s resources, as will be further discussed below.
As a reflection of the horizontal demand facing a pure competitor and the resulting equilibrium equality of AR and MC, each pure competitor sells all that it wishes to at the prevailing price. By contrast, since the firm that faces a downward-sloping demand regularly chooses to operate where AR > MC, it remains eager to sell more at its chosen price. If it could sell more at that price, its profit would rise by the amount AR – MC for every extra unit of product sold. A variety of important implications follows from this basic contrast between monopoly and pure competition.
As an analytical matter, it means that only in pure competition can equilibrium price and quantity be explained by means of the famous law of supply and demand, for only in pure competition can the aggregate willingness of all eligible producers to sell be summarized in an industry supply curve, whose intersection with the industry demand curve then determines the equilibrium price and quantity. Under any form of monopoly, by contrast, supply regularly exceeds demand in the sense that each producer is willing to sell more than he actually sells at the price he chooses to set. Nor is it possible to analyze a monopolist’s equilibrium with reference to any sort of quasi supply curve traced out by a series of hypothetically shifting demand curves, for a different locus of price–quantity equilibrium points would be traced out by every different set of shifting demands, as a reflection of the different relationships between AR and MR that apply when the slope and elasticity of demand are altered.
The monopolist’s eagerness to sell more at his currently chosen price is also closely related to what is called “nonprice competition,” including the two major categories of selling effort and product variation. Advertising, for example, is never relevant for a purely competitive firm, which can always sell what it pleases anyway, at a price over which it has no control. When AR > MC, however, advertising will pay if it induces a sufficient expansion of demand relative to the advertising expense. The higher is M= (AR– MC)/AR, moreover, the greater are the chances that this will be so. If M= .1, for example, an extra dollar spent on advertising will be profitable only if it raises the sales revenue R by more than ten dollars, but if M= .25, it will be profitable if it raises R by more than four dollars. This follows because an extra dollar of R, from expanded sales at an unchanged price, augments profit by a fraction of a dollar equal to the magnitude of M.
Naturally, advertising may also change the equilibrium price, and if it does so, the foregoing relationships apply with reference to the new price and the new value of M. In general, advertising may either raise or lower the profit-maximizing price. Thus, if MC is constant over the range of expanded output, the static-equilibrium price will rise or fall according as the elasticity of demand is lowered or raised in absolute value at the level of the original price—as can be proved from the relationship E= AR/(MR–AR). Similarly, if E is unchanged at the original price as the demand curve is shifted to the right, the equilibrium price will rise or fall according as the MC curve is rising or falling. These relationships apply to the “comparative statics” of a spontaneous increase in demand as well as to an increase induced by advertising, since advertising expense is in the nature of a fixed cost, having no impact on marginal cost. At least as a matter of static analysis, it is worth emphasizing that the effect of a shift in demand on the equilibrium price depends on MC, not on AC, as popular discussions would usually have it. Since AC is much more likely to be downward sloping than MC is, the correct analysis is less favorable to the possibility that price will fall as demand is increased than is the erroneous theory so widely held in the advertising profession.
When the products of rival firms are inherently homogeneous, as in pure competition or pure oligopoly, strategies of product variation are ruled out by definition. When there is scope for product differentiation, however, the “product” itself becomes a variable, so that deliberate variations in its characteristics become an eligible part of the total market strategy, with simultaneous effects on both cost and demand. From an economic standpoint, the “product” involves not just its physical features but all of those ancillary characteristics that influence its acceptability to customers, such as its packaging, the location and personality of its sellers, any accompanying services, and so on. This gives a very wide scope to the various possible strategies of product variation. Thus, some firms may seek to imitate as effectively as possible the more popular products of their rivals, while the rivals seek to maintain or increase the distinctiveness of theirs. Especially when the magnitude of M is great, consumers may be at least partially compensated for the weakness of price competition by an intensified effort by producers to improve quality and service. When consumers are relatively poor judges of quality differences, however, they may be victimized by deliberate product deterioration.
In general, the comparative strengths of price and nonprice competition often tend to be inversely related. Not only is nonprice competition wholly absent when M= 0 and price competition is of maximum effectiveness, but also, as price competition is increasingly inhibited, there is a natural tendency for the various forms of nonprice competition to be correspondingly intensified. To the extent that at least certain types of nonprice competition are deemed desirable, a difficult problem is posed for public policy as to the desirable degrees of both price and nonprice competition.
Restraints on competition may be natural, artificial, or both in some Combination. Perhaps the simplest illustration of artificially created monopoly power is that based on the exclusive right granted by government in the form of a patent, whether as a gratuitous privilege bestowed by a monarch or, as in the more modern practice, as a reward for invention [see Patents]. The modern policy reflects another significant conflict between the social advantages and disadvantages of competition, for it is precisely when unrestrained competition is most likely to prevent the successful innovator from recovering adequate compensation for his costs and risks that some artificial incentive is most needed to induce his inventive and innovating activity. Although alternative forms of compensation would be possible, the patent systems of most modern nations reflect a judgment that, in the simplest and most favorable case, it is better to have a new product or process available under monopoly control than not to have it available at all. Similar considerations underlie the provisions for copyrighting literary and artistic productions.
Other types of franchise may be granted because of the inherent scarcity of an otherwise unappropriated resource. For example, the limited space on city streets may call for the limited licensing of taxicabs, and the limited number of television channels makes unique allocation necessary. More nearly absolute monopolies may also be enfranchised as a recognition of their status as “natural monopolies,” where any relevant output can be produced much more efficiently by a single firm than by two or more. This is the case with a variety of “public utilities,” which are then typically subjected to governmental regulation to limit their prices and profits [see Regulation Of Industry]. Contrasting types of regulation of numbers of producers, outputs, or prices—as in agriculture, oil production, and even liquor retailing in some states—are designed only to limit competition in the interests of the existing producers.
Another possible source of monopoly power is the concentrated ownership of distinctive natural resources, such as ore deposits. Whether the consequences are monopolistic in the classical sense or just oligopolistic, such resource ownership frequently leads to monopoly power also over the products for which the distinctive resources are essential. On the other hand, the mere fixity of supply of a natural resource does not make it a monopoly. Modern economists do not follow Adam Smith’s dictum that the rent of land is naturally a monopoly price.
In general, since pure competition requires that a homogeneous product be produced by a large number of firms, each large enough to exhaust all net economies of large-scale production, the more “natural” bases of monopoly power are to be found in the impediments to the fulfillment of these necessary conditions for pure competition. These impediments involve considerations that widen the scope for product differentiation, whether real or fancied, and also the conditions that underlie economies of scale, which limit the numbers of eligible producers of any given product and its relatively close substitutes.
Product differentiation would be important even if consumers were both exceedingly mobile and well informed about the inherent properties and relative prices of the various available products. It is all the more important in view of the actual imperfections of consumers’ mobility and knowledge, which lead both to a good deal of inertia in consumer behavior and to the choice of products on the basis of reputation and prestige, whether deserved or not. Brand names and trade-marks, protecting the identity of given products, thus have the dual effects of guiding consumers to desired choices and fixing product differentiation in consumers’ minds. Whatever its basis, strong consumer loyalty to a given brand strengthens the monopoly power of the supplier, against both existing and potential rivals.
Just as economies of scale sometimes produce natural monopolies, so under slightly weaker conditions they may cause some industries to be “natural oligopolies,” when only a few firms at most can simultaneously achieve substantially all the potential economies of scale. In this connection there is an important distinction between the economies of the large-scale plant and the further possible economies of the large-scale, multiplant firm.
Given the number, sizes, and locations of firms producing a set of substitute products in a specified region, it should be emphasized that the market consequences further depend on the relative mobility of the customers, the products, or both. Thus, much retailing is inherently limited, as far as the spatial extent of the market is concerned, to relatively small neighborhoods. Toward the other extreme, there are meaningful “national” and “world” markets; but these markets are also inherently im-perfect because of the costs and delays of communication and transportation. Just as space itself is a continuum, so are markets typically incapable of unique spatial definition.
The establishment, maintenance, and exercise of monopoly power also depend on the legal frame-work of permitted and prohibited acts. Clearly, mergers provide an easier path to monopoly than an increased market share that must be fought for competitively. Likewise, explicit agreements to limit competition among otherwise independent firms, whether in formal cartels or more informally, are consistently more effective techniques for achieving monopolistic behavior than the alternative of merely tacit collusion. Collusion, consisting of a mutual self-restraint from at least some forms of aggressively competitive behavior, frequently relies on one or more of such techniques as price leadership (the imitation of one firm’s prices by the others) and market sharing (the policy on the part of each firm not to seek to increase its percentage of industry volume above some mutually recognized “normal” level). Full compliance with the “rules” of price leadership or market sharing is, however, typically difficult to achieve, especially on a lasting basis.
Although there is no necessary connection between a firm’s degree of monopoly power (as reflected by the relationship of price and marginal cost) and its profitability, these are presumably linked in at least a rough empirical correlation. The persistence of profits through time depends, in turn, on barriers to the entry of potential rivals. Where entry is at least legally free, these barriers depend on net advantages of cost or product acceptance enjoyed by existing firms as compared with would-be entrants. The industries most difficult to enter are usually those with large absolute capital requirements for an efficient scale of production and product distribution, complex patentable technology, strong allegiance to existing brands by consumers, or some combination of these elements. When the nonrecurrent costs of building an efficient organization and achieving a sufficient degree of product acceptance are high, existing firms can continue to enjoy substantial profits without excessive danger of inviting actual attempts at entry.
Conversely, concern for potential competition is also a limiting factor on the degree of monopoly power that existing firms can afford to exert. Firms may also be deterred from the fullest possible exploitation of their monopoly power by the fear of government action and by other considerations, such as public, consumer, and employee relations.
When a firm with monopoly power can divide its market into submarkets sufficiently distinct so that favored customers cannot readily resell to others, it is frequently more profitable for the monopolist to charge different prices in the different submarkets than to charge the same price throughout his whole market. In the limiting case where the various submarkets are wholly independent and costs per unit of product are the same, static profit-maximizing calls for equating marginal revenue in each submarket with the common marginal cost. This results in different prices when elasticities of demand differ from one submarket to another. Thus, from the previously noted relationship E= AR/(MR–AR), it follows that AR=MR . E/(l + E), where E < –1. Hence, when MR is the same in each submarket, AR, or price, will be higher the closer is the elasticity, E, to –1.
When submarkets are not wholly independent, either because some limited resale among customers is possible or because the customers are themselves competing firms, the profit-maximizing rules are more complicated. Here, in addition to considerations of relative elasticities, it is also necessary to take into account the tendency of an increase in sales in a particular submarket, resulting from a price cut, to reduce sales in other submarkets.
Price discrimination is said to be “personal” when it depends on such features as the age, sex, income, and trade status of customers—as when different prices are charged to children and adults or to men and women at entertainments, or when rich and poor are charged different fees by physicians, or when different prices are charged to retailers and wholesalers even for like quantities of products, or when individual bargaining with customers results in different prices. Another category is “geographical” discrimination, as in the “dumping” of goods abroad at lower prices than at home or as a feature of “delivered-price systems” involving zone pricing or the use of basing points, where the net factory price differs for goods shipped to different localities. Price discrimination may also be either systematic or sporadic.
Not all price differences for the “same” product are necessarily discriminatory. Thus, if marginal costs vary for different quantities, and if prices reflect only those cost differences, there is no price discrimination. Similarly, when marginal costs vary between periods of peak and off-peak operation, price differences with the season of the year or even the time of day are not necessarily discriminatory. Indeed, when marginal costs differ and prices do not, that represents a concealed discrimination.
The concept of price discrimination is frequently expanded to cover the comparative prices of products that are related but not identical, such as different models of a generic product or physically comparable products marketed as different brands. The general test of price discrimination, covering these cases as well as the simpler ones, is whether the proportion of price to marginal cost is the same or different from one piece of business to another. Indeed, price discrimination may be defined as the firm’s exertion of different degrees of monopoly power, as measured by the value of M= (AR – MC)/AR, from one submarket to another. This formulation serves to emphasize that price discrimination is inherently a monopolistic phenomenon; in pure competition, where price necessarily equals marginal cost in equilibrium, price discrimination is impossible.
Of theoretical interest, though of limited practical importance, is the polar concept of “perfect” discrimination. This involves not only the monopolist’s being able to treat each individual customer as a separate submarket but also his charging each customer, at least in effect, different prices for the different increments of product that he buys, in such a way that the monopolist arrogates to him-self something approaching the entire potential gain from trade. Under appropriate continuity assumptions, the monopolist then maximizes his profit by equating with his marginal cost the price that he exacts from each customer for the final increment purchased (also equal to marginal revenue). As an alternative technique, the monopolist can achieve this result with an appropriate all-or-nothing offer to each customer for the appropriate aggregate quantity.
In this section and the next some kindred concepts of monopoly will be briefly discussed.
Analogous to a seller’s monopoly power, a buyer is said to have “monopsony” power when he can significantly affect the price of what he buys by varying the quantity bought. Typically, the monopsonist faces an upward-sloping supply schedule, showing the prices or average costs, AC, at which he may buy alternative quantities. There is then a related schedule of marginal cost, MC, lying above the AC curve when the AC curve is positively sloped. Examples of such schedules are shown in Figure 3.
Although a monopsonist might conceivably be a large ultimate consumer, the more important in-
stances of monopsony concern the purchase of a factor of production by a firm. If the factor is passively supplied, as with unorganized labor or an intermediate product of a purely competitive industry, and if the buying firm is large enough to have the requisite influence on the factor price, the conditions for monopsony are fulfilled.
The monopsonist’s equilibrium further depends on schedules of “average benefit,” AB, and “marginal benefit,” MB, as illustrated in Figure 3. In the rudimentary case where the factor in question is the only variable one, these concepts would correspond to what are called the factor’s “average revenue product” and “marginal revenue product”—or R/f and dR/df, respectively, where R is the total revenue from the sale of the product and f is the factor quantity. When other factors are also variable, as in the firm’s long-run equilibrium, similar concepts involving a “net revenue product” are used instead.
The monopsonist’s equilibrium factor quantity is then determined where MC cuts MB from below, provided that AC does not exceed AB. In Figure 3, where the equilibrium factor quantity is at f°, the corresponding equilibrium price is determined on the AC schedule at w0, and the aggregate benefit from having that factor quantity (as compared with not producing at all) is indicated by the shaded area. In long-run equilibrium this would be the firm’s total profit; in a short-run situation it would be necessary to subtract the fixed costs of the fixed factors to determine the profit.
Just as a monopolist would like to sell more at his equilibrium price and may therefore have a motive for exerting himself through advertising and other forms of nonprice competition to do so, so the monopsonist has a similar interest in buying more at his equilibrium price. This is so because his MB would exceed the price for a certain increment of hypothetical extra purchases. Similarly, the analogue of a seller’s degree of monopoly power is the concept of a buyer’s degree of monopsony power, which may be defined symbolically as M'= (MB–AC)/MB, with static-equilibrium values that lie between zero and one when the AC schedule is positive and positively sloped. A monopsony equilibrium with zero profit is also possible. This would be illustrated in a diagram such as Figure 3 if, in the long run, the positively sloped AC curve were shifted upward until it was just tangent to the AB curve.
In monopoly or monopsony the discretionary power to set the price is uniquely on one side of the market, since the other side consists of passive price-takers. When competition is limited on both sides of the market at the same time, the usual consequence is a bargaining relationship. There are numerous possible patterns, involving either one or a few sellers, one or a few buyers, and homogeneous or differentiated goods. The application to union–management bargaining is obvious. Whether in the strict form of a single seller facing a single buyer or in the looser variants, this class of market relationships is known as “bilateral monopoly.”
A basic theoretical case, first analyzed by Edge-worth (1881), concerns two persons who each possess fixed stocks of two homogeneous goods and who can trade only with one another. The problem is best formulated and analyzed with reference to the ingenious “box diagram” shown in Figure 4, first employed by Edgeworth himself.
Initial stocks of the two goods are designated as x1 and y1 for the first person and as x2 and y2 for the second. The dimensions of the box are then set at X1 + x2 on the horizontal axis and y1 + y2 on the vertical axis. When the first person’s quantities are measured conventionally from the origin at I and the second person’s are measured in reverse directions from the origin at n, the point A represents the initial position and any other point within the box represents a possible redistribution of the fixed total quantities of the two goods. The tastes of the two traders are represented by selected indifference curves, such as those labeled I11, I12, and I13 for the first man and I21, I22, and I23 for the second. A person is made better off by any movement to another indifference curve lying farther away from his map’s origin.
Since the indifference curves through point A—namely, I11 and I21—are not tangent but, rather, intersect, mutually beneficial trade is possible. Specifically, any movement from A into the cigarshaped area bounded by those two curves represents a simultaneous improvement for both parties—that is, a movement to “higher” indifference curves. The potential benefits of trade are fully exploited, however, only when the traders move to a point where their indifference curves are tangent—on a locus that Edgeworth called the “contract curve.” The relevant range of this locus is depicted in Figure 4 by the curve drawn between D1 and D2. Naturally, the first person would prefer an
outcome as close as possible to D1, and the second would prefer an outcome as close as possible to D2. This conflict of interest is the source of the so-called indeterminacy of the bilateral-monopoly problem, since the analyst cannot confidently predict any unique outcome of the parties’ bargaining.
In the course of that bargaining each party can threaten to refuse to trade at all unless the other is willing to grant sufficiently favorable terms. Hence, one possible outcome is that the parties may simply remain stubbornly at point A. If either can make a plausible take-it-or-leave-it offer to the other, however, an offer of the all-or-nothing type might achieve a result corresponding to perfect monopolistic discrimination, indefinitely close to D1 or to D2 (where the trader with the strategic nitiative would reap all the potential gain and the passive trader none at all). Intermediate outcomes somewhere on the contract curve between D1 and D2 are, of course, more plausible under assumptions of a more nearly symmetrical bargaining process. Indeed, game theorists such as Nash (1950; 1953) and Harsanyi (1956), with the aid of further assumptions including the von Neumann–Morgenstern utility functions of the traders, claim to identify a unique solution point on the contract curve, but their reasoning is too complex for brief summary.
Other special outcomes, such as those at C, M1, and M2, also emerge from appropriately special assumptions. Thus, if each trader is assumed to be free to trade at some specified exchange ratio, along a straight line through A with a slope reflecting the given exchange ratio, he maximizes his benefit by moving to the point where the specified line is just tangent to one of his indifference curves. The locus of such points for various alternative exchange ratios is known as an “offer curve.” It is illustrated in Figure 4 by the dashed curves through A, M2, and C for the first person and through A, M1, and C for the second.
The possible outcome at C, where the offer curves intersect, corresponds to the “competitive” solution, since it implies an equating of supply and demand. On the other hand, if either person has the privilege of setting the exchange ratio and the other then trades in accordance with his offer curve, the best ratio for the active strategist is the one implied at the point of tangency between one of his indifference curves and the offer curve of the other. These outcomes, corresponding to simple monopoly or monopsony solutions, are illustrated at M1 and M2, according as the first person or the second has the privilege of setting the exchange ratio. It should be noticed that these monopoly points fall short of the contract curve, in contrast to the competitive point which necessarily lies on it.
Bilateral monopoly in the context of a monopsonistic firm hiring organized labor or bargaining with a monopolistic supplier of an intermediate product is subject to similar analysis. By comparison with the monopsonistic equilibrium previously identified in Figure 3 (at f0, w0), for example, the competitive solution would call for the higher factor price and quantity at the intersection of AC and MB. Still higher prices and correspondingly reduced quantities along the MB schedule would illustrate a movement toward a monopolistic solution. A linear contract curve passing vertically through the inter-section point of AC and MB is also implied in some cases, although not usually in the one involving labor.
The “evils” of monopoly and its kindred market situations, together with some possibly offsetting advantages, are at least to some extent in the eye of the beholder. This is especially so with respect to some of the sociopolitical issues involving “big” versus “small” business or the social implications of “economic power”—to the extent that these issues overlap with monopoly in the economic sense. Similarly, the tendency of monopoly to intensify the inequality of the distribution of income, though far from clear-cut, is in any event also subject to different evaluations.
The remaining aspect of monopoly and monopsony, on which economic analysis has had rather more to say, is the effect on the efficiency of resource allocation. Here the relevant analytical approach is that of welfare economics, with its central concept of “Pareto-optimality.” As initially formulated by Vilfredo Pareto, a situation is said to be Pareto-optimal if there is no reallocation of resources or goods that can make one person better off without injury to at least one other person [see Welfare Economics].
It is a principal theorem of welfare economics that a universally purely competitive general equilibrium is Pareto-optimal, provided that people’s individual tastes are respected and that there are no “externalities,” such as a dependence of any firm’s output or any household’s welfare on the factor employment of other firms or the goods consumption of other households. Short of a full demonstration of that theorem, it may be said that its essence lies in the implied equality of price and marginal cost for all produced goods and the similar equality of price and marginal benefit for all hired factors. By the same token, then, if these ideal conditions are disturbed by a monopolistic inequality of price and marginal cost or by a mo- nopsonistic inequality of factor price and marginal benefit, the result is a departure from Pareto-optimality. Typically, the monopolist produces and sells too little at too high a price, and the monopsonist buys too little at too low a price.
Note that if excessive profit were the only evil of monopoly, the equating of price with average cost would be the remedy—as in the conventional philosophy of public-utility regulation. When average cost is decreasing, however, an excess of price over marginal cost is still implied. Under such circumstances the Pareto-optimal equating of price with marginal cost involves a loss, which must then be made good by external subsidy.
Even under the indicated ideal conditions, universally pure competition is only a sufficient—not a necessary—condition for Pareto-optimality. As already illustrated for the simplified two-person ex-change economy portrayed in Figure 4, there are various ways in which the Pareto-optimal contract curve can be reached, including perfect discrimination as well as pure competition. At the same time, however, that analysis also showed how simple monopoly or monopsony systematically falls short of Pareto-optimality.
When universal pure competition is not naturally viable (for example because of persistently decreasing costs) or when externalities are present, Pareto-optimality cannot be achieved by simply preventing monopoly and monopsony. Furthermore, the attainment of that ideal by elaborate special regulations, though theoretically conceivable, obviously involves attendant difficulties and costs that force us to aim at less than the ideal. Under these circumstances there are no simple rules for attaining a “second-best” result. In this context, a blanket indictment of monopoly and monopsony as inefficient is no longer valid. In the wider context of a dynamic economy where technological progress is to be encouraged, this observation acquires still greater force.
Robert L. Bishop
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Burns, Arthur R. 1936 The Decline of Competition: A Study of the Evolution of American Industry. New York and London: McGraw-Hill.
Chamberlin, Edward H. (1933) 1962 The Theory of Monopolistic Competition: A Re-orientation of the Theory of Value. 8th ed. Cambridge, Mass.: Harvard Univ. Press.
Cournot, Antoine Augustin (1838) 1960 Researches Into the Mathematical Principles of the Theory of Wealth. New York: Kelley. → First published in French.
Edgeworth, Francis Y. (1881) 1953 Mathematical Psychics: An Essay on the Application of Mathematics to the Moral Sciences. New York: Kelley.
Fellner, William 1947 Prices and Wages Under Bilateral Monopoly. Quarterly Journal of Economics 61:503–532.
Harsanyi, John C. 1956 Approaches to the Bargaining Problem Before and After the Theory of Games: A Critical Discussion of Zeuthen’s, Hicks’ and Nash’s Theories. Econometrica 24:144–157.
Lerner, Abba P. 1934 The Concept of Monopoly and the Measurement of Monopoly Power. Review of Economic Studies 1:157–175.
Lerner, Abba P. 1944 The Economics of Control: Principles of Welfare Economics. New York: Macmillan.
Machlup, Fritz (1952) 1964 The Economics of Sellers’ Competition: Model Analysis of Sellers’ Conduct. Baltimore: Johns Hopkins Press.
Mason, Edward S. (1957) 1964 Economic Concentration and the Monopoly Problem. New York: Atheneum.
Nash, John F. JR. 1950 The Bargaining Problem. Econometrica 18:155–162.
Nash, John F. JR. 1953 Two-person Cooperative Games. Econometrica 21:128–140.
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Robinson, Joan (1933) 1961 The Economics of Imperfect Competition. London: Macmillan; New York: St. Martins.
Stocking, George W.; and WATKINS, MYRON W. 1951 Monopoly and Free Enterprise. New York: Twentieth Century Fund.
Triffin, Robert 1940 Monopolistic Competition and General Equilibrium Theory. Harvard Economic Studies, Vol. 67. Cambridge, Mass.: Harvard Univ. Press.
Universities—National Bureau Committee For Economic Research 1955 Business Concentration and Price Policy: A Conference of the Committee. National Bureau of Economic Research, Special Conference Series, No. 5. Princeton Univ. Press.
MONOPOLY. Monopoly and competition are diametric terms used to describe complex relations among firms in a single industry. Simply put, monopoly is the exclusive control by one firm or group of firms of the means of producing or selling a commodity or service. As sole supplier, the monopolist can set any price, provided the sales generated are acceptable. Generally that price will be beyond production costs, and it will return profits in excess of normal return on investment.
When Adam Smith (1723–1791) wrote his sustained attack on monopolies in An Inquiry into the Nature and Causes of the Wealth of Nations (1776), he did not have single-firm monopolies in mind. These are relatively rare, except for those established by state policy or subject to state regulation. Rather, Smith directed his criticism toward multifirm industries with statutory protection, like medieval guilds.
The medieval economy appears to have had a positive aversion to competition, which occurs in a free or atomistic form when the number of producers or sellers in a single industry is so large that each seller's share of the market is too small to affect the market share or income of any competitor. Thus, each seller must adjust output and price to reflect established market conditions. These conditions are affected, in turn, by the ease of entry into the industry, the concentration of sellers in the industry, and the degree of product differentiation in the industry. Given the widespread medieval presumption of fixed resources and limited growth, where pure competition would lead to failure and suffering, these conditions had to be regulated. So, medieval polities opted for monopolistic structures.
Monopoly constituted a form of political protection in most sectors of the medieval economy. Manorial agriculture relied on the guaranteed tenure of peasants on the land and the guaranteed rights of landlords, both of which were types of monopoly. Guilds strictly regulated access to markets and differentiation of products, thus establishing monopolies in most medieval industries. Shipping corporations exercised monopoly rights over transportation along certain routes, such as the Alpine passages. Merchant companies received extraction-and-purchase monopolies for metal ores from mines in certain regions, such as Tyrol or Saxony, in some instances expanding these to near domination of entire industries, as by the Fugger in copper or the Höchstetter in mercury. Nearly all corporations sought monopoly rights for themselves. In most cases, these were thought to guarantee the shared interests of all, producers and consumers alike.
EARLY MODERN OPPOSITION
Attitudes began to change as early as the fifteenth century. More accurately, attitudes began to be recorded, published, and preserved more consistently at this time. Merchant companies came under suspicion of manipulating prices through monopoly. The 1425–1429 guild rising in the south German city of Constance demanded the dissolution of commercial firms, and the Reformatio Sigismundi (1438–1439) reflected this sentiment. (The Reformatio Sigismundi, a document attributed to the Emperor Sigismund [ruled 1433–1437], set forth a program of social and ecclesiastical reform within the Holy Roman Empire. Though not accepted in its day, many of its ideas resonated in the Protestant Reformation a century later.) Complaints multiplied against "monopolists," who hoarded commodities to keep prices artificially high. By the sixteenth century, "monopoly" had become a clarion call of opposition not only to monopolies in the strict sense, but also to cartels, syndicates, hoarders, and usurers who did not deserve it, however questionable their dealings.
Matters came to a head in the Holy Roman Empire, where large mercantile companies, such as the Fugger, Rehlinger, and Höchstetter, engaged in interest-bearing credit and investment transactions as well as price-manipulating monopolies and cartels to increase their profits. Such activities inspired opposition from many strata of society, not only artisans and peasants but also merchants and princes, all of whom saw their expenses rise and incomes fall within the environment of the "price revolution" of the sixteenth century. They found a compelling spokesman in Martin Luther (1483–1546), who viewed such commercial enterprises with a "peasant's mistrust." He wrote and preached repeatedly against interest and usury. His 1524 pamphlet "Von Kaufshandlung und Wucher" lumped monopoly among these other abuses according to the rationale that any price beyond a just price constituted usury—a violation of divine law.
By this time the issue had already engaged the attention of the imperial government for more than a decade. At the urging of estates in the territories of the Hanseatic League and Franconia, centers of opposition to monopolistic practices, the Imperial Diet of 1512 first considered limiting the activities of the great mercantile houses. In 1523, the Reichsfiskal, an institution of the imperial government charged with overseeing taxation and expenditures, lodged a formal complaint against the monopolistic practices of six Augsburg firms, the Fugger above all others. Only the refusal of Emperor Charles V (ruled 1519–1558) to support the measure—prompted by the personal influence of his banker, Jacob Fugger himself—prevented the measure from becoming law. Yet the antimonopoly forces were not ready to admit defeat. The Reichsfiskal renewed its complaint and brought the matter before the Imperial Diet of Augsburg in 1530. Its members moved to form a commission, which prepared a report for the "common good" on the monopolistic abuses of these great companies. It referred specifically to their trade in Oriental spices and metal ores, their use of interest-bearing instruments and transactions, and their manipulation of prices through speculation and hoarding. These techniques allowed the monopolists to alter market conditions in such a way as to unjustly inflate their profits from these enterprises, thus driving their more modest competitors out of business and the "common man" into the streets. The report also proposed that monopolistic practices be forbidden by law, that commercial firms be limited in size, that imported goods be subjected to price controls, that imperial subjects be forbidden to engage in overseas enterprise, and that foreign merchants in the empire be similarly regulated.
In the midst of such dangerous opposition, mercantile interests found a spokesman in Conrad Peutinger (1465–1547), merchant son, universitytrained jurist, Augsburg councillor, and renowned humanist. In a 1530 legal opinion, he defended monopoly as essential to the economic well-being of the nation. Through their entrepreneurship and audacity the accused monopolists drew international trade to the empire and, he argued, created profit and advantage for princes and plebeians alike. Their firms traded in large volumes of goods, thus lowering prices. Their capacity to concentrate capital enabled them to undertake ventures that were too costly or risky for smaller competitors. He argued that risk and profit should be linked. Indeed, the pursuit of individual advantage in economic life was not opposed to the common good, rather contributed directly to it and, as such, was both economically and morally justified. Peutinger became one of the first advocates of a truly modern economic ethos. Whether his arguments had any immediate bearing cannot be determined. Emperor Charles V saw fit to let the matter die an administrative death.
The resort to monopolies—as well as opposition to them—continued in the Holy Roman Empire and elsewhere. Inspired by mercantilist thought, which emphasized protectionist legislation to shield domestic industries from competition, German princes granted production monopolies as a privilege to German manufacturers. Indeed, the catalogue of princely prerogatives, referred to collectively as Regalien, included the granting of monopoly rights. Although denied to the Holy Roman emperor by the Treaty of Westphalia (1648), these prerogatives came into increasingly frequent use among territorial princes who were anxious to expand their power and increase their revenue. Nor were the Germans alone. State-sponsored monopolies were a common economic contrivance in Bourbon France and Tudor-Stuart England. Everywhere, trading monopolies played an essential role in commercial and colonial development. They involved the creation of charter trading companies to which the crown gave monopoly rights. The Company of Merchant Adventurers, the Levant Company, and the East India Company used political influence to exclude foreign competitors and limit export quotas in order to maintain market share and stabilize profits. Members paid a fee to trade under the aegis of company direction, a fact that led to bitter resentment among those excluded. An attack on trading companies was launched in Parliament in 1604, but their monopolies were not relaxed until late in the 1600s, when regulation of monopolies was no longer viewed as essential to commercial security. Monopolies were not limited to commerce. The reign of Elizabeth (ruled 1558–1603) witnessed the expansion of the patent system as a spur to English manufacturing, whereby patents were granted the sole right to produce a given product by a given process, in effect monopoly control of a certain manufacturing process. Reliance on monopolies did not yield to faith in competition until physiocratic thinking made its influence generally felt in the course of the eighteenth century.
The early modern economy relied to a surprising extent on monopoly and monopolistic practices. Their effects were not uniformly deleterious. Yet the period initiated a passionate debate about commercial activities and a turn toward freer competition that continues to this day.
See also Capitalism ; Fugger Family ; Luther, Martin ; Smith, Adam ; Trading Companies .
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Thomas Max Safley
The American Civil War (1861–1865) made it possible for men of varying degrees of ability to become wealthy overnight. During the postwar decades these new fortunes were used for the exploitation of natural resources and for industrial development. Men such as Andrew Carnegie (1835–1919) and John D. Rockefeller (1839–1937) became folk heroes, although in Rockefeller's case, there were also many who feared and despised him. Few laws regulated competition and few taxes were levied on their profits. In time some of these men exerted considerable influence on their state legislatures and on their senators. Even the philosophy of the age was tailored to their needs. Social Darwinism applied the biological concept of survival of the fittest to human society and decreed the successful businessman the fittest of all. Eventually, the Progressive movement confronted some of the more unsavory practices of the business elite and the corrupt politics of the time. The first faint indication that a change in conditions might be close at hand came in 1887 with the passage of the Interstate Commerce Act followed a few years later by the Sherman Antitrust Act in 1890.
Even in a period when business predominated there were certain activities that alarmed the public. The financial manipulations of Rockefeller, for example, indirectly affected the lives of millions who came to fear his company while admiring his personal life. Rockefeller's Standard Oil Company was the first trust or monopoly. It effectively controlled the petroleum refining industry by 1879. Other large combinations followed suit, so that by 1890 large companies controlled the production of such products as whiskey, sugar, and lead, and dominated the nation's railroads. The combinations used their size to exploit markets to the fullest.
In 1889 Kansas became the first state to enact antitrust legislation and the regulatory effort spread across the South and West. Within a year at least 14 other states and territories had enacted similar laws. Pressure mounted for the federal government to take action since individual states were powerless in dealing with the greatest offenders, the trusts and monopolies which were interstate in scope. Both major political parties incorporated antitrust planks in their platforms for 1888, but neither rushed to submit appropriate legislation at the next congressional session. Many Senators may have preferred to ignore the matter, but they were forced to act because of the public clamor and the gentle prodding of President Benjamin Harrison (1889–1893). The result was the passage of the Sherman Antitrust Act in 1890.
The Sherman Antitrust Act had deficiencies that were becoming evident at the turn of the century. One major problem was that the act did not define what a trust or monopoly was. The lack of such a definition left the interpretation of the law up to the judicial branch of the government, and the result was confusion and contradictory court cases. Moreover violation of the Sherman Antitrust Act was only considered a misdemeanor, an offense for which punishment was not serious enough to deter those who saw their interests served by monopolies.
With the accession of Theodore Roosevelt (1933–1945) into the presidency the antitrust movement gained momentum, even though Roosevelt believed it was important to distinguish between good trusts and bad trusts. To Roosevelt good trusts benefited the public with their infusion of capital and products into the economy, while bad trusts consisted of greedy financiers interested only in profits at the general public's expense. Early in his presidency Roosevelt realized that the monopoly situation had reached a critical point and that something had to be done. In 1902 Roosevelt's administration brought suit against the giants of the railroad industry and the "Beef Trust."
The Supreme Court ordered dissolution of the Morgan-Hill-Harriman railroad holding company in the Northern Securities Case (1904), and in the case of Swift and Company vs. United States (1905), the Supreme Court enjoined the "Beef Trust" from engaging in collusive price fixing activities. In 1906 and 1907 Roosevelt had the Justice Department bring suit against the American Tobacco Company, the E.I. Du Pont Chemical Corporation, the New Haven Railroad, and the Standard Oil Company. The Supreme Court ordered the dissolution of the American Tobacco (1910) and Standard Oil (1911) companies. Between 1890 and 1905 the Department of Justice brought 24 antitrust suits while the Roosevelt administration brought suit against 54 companies. The administration of President William Howard Taft (1909–1913) later prosecuted 90 antitrust cases.
Despite many successful prosecutions during his administration Roosevelt realized that the trust problem would not be resolved by judicial review and that a more organized approach was needed. To regulate business Roosevelt specifically advocated a commission similar to the Interstate Commerce Commission, one that had jurisdiction over all businesses engaging in interstate commerce, not just railroads. Big business interpreted this additional governmental regulation as borderline socialism and in response argued for laissez-faire policies. Realizing that big business would invoke any means necessary to avoid regulation, Roosevelt maintained that his idea was not meant to "strangle" business but only regulate trusts, and that legitimate businesses need not be concerned. Roosevelt's proposal was partially implemented in 1913 when the Departments of Commerce and Labor were separated. On October 15, 1914, Congress passed and President Woodrow Wilson (1913–1921) signed the Clayton Antitrust Act which was designed to strengthen the Sherman Antitrust Act of 1890 by fully codifying specific illegal antitrust activities. The Clayton Act forbade a corporation from purchasing stock in a competitive firm, outlawed contracts based on the condition that the purchaser would do no business with the seller's competitors, and made interlocking stockholdings and directorates illegal. It also contained provisions designed to make corporate officers personally responsible for antitrust violations. The Clayton Act also declared that labor unions were not conspiracies in restraint of trade, thus exempting them from provisions of the bill. This pleased Samuel Gompers, the head of the American Federation of Labor (AFL) so much that he called it "labor's Magna Carta." To carry out and enforce the Clayton Act and the Sherman Act, Congress created the Federal Trade Commission in a related measure.
The Clayton Act proved to be an enduring piece of legislation, and it has been strengthened a number of times since its passage. Just after its passage, however, the antitrust movement began to fade away. Late in 1914 Wilson stated that he believed federal regulation had gone far enough. The president viewed the Clayton Act as the concluding act in the antitrust movement.
The large corporations did not suffer as much from regulation as might be thought. In many ways, the regulatory authority that the government imposed on business made it more difficult for new companies to break into competition with the big companies. Thus, the main thing that they feared and that they formed monopolies to avoid—"ruinous competition"—was killed in its crib by the very regulation that was passed to put a collar on the monopolies.
Many historians have contended that although the antitrust movement reached a natural decline, World War I (1914–1918) further undermined it. War mobilization required coordinated efforts from the leaders of many industries. Economic concentration and collusive efforts were necessary and accepted for the war effort. Some economic historians contend that the Clayton Act actually promoted economic concentration. The Clayton Act clarified illegal actions, thereby helping to eliminate some monopolistic activities, but in so doing it allowed business combinations and trusts to engage in collusive activities not specifically prohibited. By codifying illegal behavior, some historians believe that Congress tacitly sanctioned other collusive activities designed to reduce chaotic competition and ensure stability. Large corporations such as General Motors and the Du Pont Chemical Company grew much larger just immediately after the Clayton Act and especially during the war effort.
Desire for further antitrust reform was rekindled when the Robinson-Patman Act of 1936 and the Miller-Tydings Act of 1937 both supplemented the Clayton Act by attempting to protect small business from wholesalers that practiced price discrimination and by establishing "fair trade" price floors on numerous items. In 1938, Congress created the Temporary National Economic Committee to hold hearings on the issue of antitrust. Attorney General Thurman Arnold reinvigorated federal antitrust prosecution. Arnold brought a number of antitrust suits, notably against General Electric and the Aluminum Company of America. Like the earlier antitrust effort of the Progressive Era, this campaign lost its strength and direction as a result of foreign policy concerns and economic mobilization for a war effort.
There were some important antitrust cases after World War II (1939–1945) as well. In 1945 the Aluminum Company of America was found to be in violation of the Sherman Antitrust Act. In 1948 the federal government forced a number of major U.S. film studios to divest themselves of studio-owned theaters. In 1961 the Supreme Court ordered the Du Pont Company to divest itself of its holdings in General Motors Company. In 1967 the Federal Communications Commission ordered the American Telephone and Telegraph Company (AT&T) to lower its rates. In 1982 after eight years of battling a private antitrust suit in federal court AT&T agreed to be broken up, and a number of rival long-distance communication companies came in to challenge AT&T's control over the market.
In 1950 the Celler-Kefauver Act extended the Clayton Act by tightening prohibitions on business mergers that lessen competition and lead to monopoly. In 1976 Congress passed the Hart-Scott-Rodino Act or Concentrated Industries Act. This was a mild reform law that attempted to strengthen provisions of existing antitrust laws. Monopolistic behavior clearly remained a factor of U.S. economic life while federal prosecution of anti-competitive mergers and acquisitions became rare.
See also: Clayton Anti-Trust Act, Interstate Commerce Act, Northern Securities Case, Sherman Anti-Trust Act, Tobacco Trust, Trust-Busting
Kolko, Gabriel. The Triumph of Conservatism: A Reinterpretation of American History, 1900–1916. New York: Free Press of Glencoe, 1963.
Link, Arthur S. Wilson: The New Freedom. Princeton, NJ: Princeton University Press, 1956.
Thorelli, Hans B. The Federal Antitrust Policy: Origination of an American Tradition. Baltimore: Johns Hopkins University Press, 1955.
An economic advantage held by one or more persons or companies deriving from the exclusive power to carry on a particular business or trade or to manufacture and sell a particular item, thereby suppressing competition and allowing such persons or companies to raise the price of a product or service substantially above the price that would be established by a free market.
In a monopoly, one or more persons or companies totally dominates an economic market. Monopolies may exist in a particular industry if a company controls a major natural resource, produces (even at a reasonable price) all of the output of a product or service because of technological superiority (called a natural monopoly), holds a patent on a product or process of production, or is otherwise granted government permission to be the sole producer of a product or service in a given area.
U.S. law generally views monopolies as harmful because they obstruct the channels of free competition that determine the price and quality of products and services that are offered to the public. The owners of a monopoly have the power, as a group, to set prices, to exclude competitors, and to control the market in the relevant geographic area. U.S. antitrust laws prohibit monopolies and any other practices that unduly restrain competitive trade. These laws are based on the belief that equality of opportunity in the marketplace and the free interactions of competitive forces result in the best allocation of the economic resources of the nation. Moreover, it is assumed that competition enhances material progress in production and technology while preserving democratic, political, and social institutions.
Economic monopolies have existed throughout much of human history. In England, a monopoly originally was an exclusive right that was expressly granted by the king or Parliament to one person or class of persons to provide some service or goods. The holders of such rights, usually the English guilds or inventors, dominated the market. By the early seventeenth century, the English courts began to void monopolies as interfering with free of trade. In 1623, Parliament enacted the Statute of Monopolies, which prohibited all but specifically excepted monopolies. With the Industrial Revolution of the early nineteenth century, economic production and markets exploded. The growth of capitalism and its emphasis on the free play of competition reinforced the idea that monopolies were unlawful.
In the United States, during most of the nineteenth century, monopolies were prosecuted under common law and by statute as market-interference offenses in attempts to stop dealers from raising prices through techniques such as buying up all available supplies of a material, which is called "cornering the market." Courts also refused to enforce contracts with harsh provisions that were clearly unreasonable restraints of trade. These measures were largely ineffective.
Congress intervened after abuses became widespread. In 1887, Congress, pursuant to its constitutional power to regulate interstate commerce, passed the interstate commerce act (49 U.S.C.A. § 1 et seq.) in response to the monopolistic practices of railroad companies. Although competition among railroad companies for long-haul routes was great, it was minimal for short-haul runs. Railroad companies discriminated in the prices they charged to passengers and shippers in different localities by providing rebates to large shippers or buyers, in order to retain their long-haul business. These practices were especially harmful to farmers because they lacked the volume of traffic necessary to obtain more favorable rates. Although states attempted to regulate the railroads, they were powerless to act where interstate commerce was involved. The Interstate Commerce Act was intended to regulate shipping rates. It mandated that charges be set fairly, and it outlawed unreasonable discrimination among customers through the use of rebates or other preferential devices.
Congress soon moved ahead on another front, enacting the sherman anti-trust act of 1890 (15 U.S.C.A. §§ 31 et seq.). A trust was an arrangement by which stockholders in several companies transferred their shares to a set of trustees in exchange for a certificate that entitled them to a specified share of the consolidated earnings of the jointly managed companies. The trusts came to dominate a number of major industries, destroying their competitors. The Sherman Act prohibited such trusts and their anticompetitive practices. From the 1890s through 1920, the federal government used the act to break up these trusts.
The Sherman Act provides for criminal prosecution by the federal government against corporations and individuals who restrain trade, but criminal sanctions are rarely sought. The act also provides for civil remedies for private persons who start an action under it for injuries caused by monopolistic acts. The award of treble damages (the tripling of the amount of damages awarded) is authorized under the act in order to promote the interest of private persons in safeguarding a free and competitive society and to deter violators and others from future illegal acts.
The Clayton Anti-Trust Act of 1914 (15 U.S.C.A. §§ 12 et seq.) was passed as an amendment to the Sherman Act. The clayton act specifically defined which monopolistic acts were illegal but not criminal. The act proscribed price discrimination (the sale of the same product at different prices to similarly situated buyers), exclusive-dealing contracts (sales on condition that the buyer stop dealing with the seller's competitors), corporate mergers, and interlocking directorates (the same people serving on the boards of directors of competing companies). Such practices were illegal only if, as a result, they materially reduced competition or tended to create a monopoly in trade.
The Federal Trade Commission Act of 1914 (15 U.S.C.A. §§ 41 et seq.) established the federal trade commission, the regulatory body that promotes free and fair competitive trade in interstate commerce through the prohibition of price-fixing arrangements, false advertising, boycotts, illegal combinations of competitors, and other methods of unfair competition.
Congress passed the robinson-patman act of 1936 (15 U.S.C.A. §§ 13 et seq.) to amend the Clayton Act. The act makes it unlawful for any seller engaged in commerce to directly or indirectly discriminate in the sale price charged on commodities of comparable grade and quality where the effect might injure, destroy, or prevent competition unless the seller discriminated in order to dispose of perishable or obsolete goods or to meet the equally low price of a competitor.
Despite these legal prohibitions, not all industries and activities are subject to them. labor unions monopolize the labor force and take concerted action to improve the wages, hours, and working conditions of their members. The Clayton Act and the norris-laguardia act of 1932 (29 U.S.C.A. §§ 101 et seq.) recognized that unions would be powerless without this monopolistic behavior and therefore made unions immune from antitrust laws.
A government-awarded monopoly, such as the right to provide electricity or natural gas to a region of the country, is exempt from antitrust laws. Government agencies regulate these industries and set reasonable rates that the company may charge.
Sometimes an industry is a natural monopoly. This type of monopoly is created as a result of circumstances over which the monopolist has no power. A natural monopoly may exist where a market for a particular product or service is so limited that its profitable production is impossible except when done by a single plant that is large enough to supply the entire demand. Natural monopolies are beyond the reach of antitrust laws.
Special-interest industries, such as agricultural and fishery marketing associations, banking and insurance industries, and export trade associations, are also immune from antitrust laws. Major league baseball has been exempted from antitrust laws as well.
The phenomenal popularity of the personal computer (PC) in the 1980s and 1990s catapulted Microsoft Corporation past manufacturing corporations as a preeminent business organization in the United States and the world. With the explosion of interest in the internet in the mid-1990s, Microsoft moved aggressively to market its Internet Explorer (IE) web browser and to crush its competitor, Netscape. Having already secured a monopoly with its Windows Operating System, Microsoft seemed poised to dominate Internet software. However, in 1998, 19 state attorneys general joined the U.S. justice department in filing an antitrust lawsuit against Microsoft. The suit alleged that the software company forced computer manufacturers (known as original equipment manufacturers or OEMs) to license and distribute Microsoft's IE in exchange for the right to pre-install Microsoft's Windows 95 operating system on new PCs. Microsoft contended that IE was an integral part of Windows 95 and that it could not be separated without causing the operating system as a whole to malfunction. The plaintiffs argued that Microsoft was engaged in an illegal tying arrangement, by conditioning the purchase of a popular product (Windows 95) on the purchase of an additional, unrelated product (IE.)
The case came to trial in October 1998 before U.S. District Court Judge Thomas Pen-field Jackson, sitting without a jury. Jackson ruled for the plaintiffs in November 1999, finding that the facts fully justified the conclusion that Microsoft had sought monopoly power through illegal means. He appointed Chief Judge richard a. posner of the U.S. Court of Appeals for the Seventh Circuit to mediate the case, in hopes of bringing the bitter conflict to a quick conclusion. However, Posner could not broker a settlement, and Jackson issued his final order in April 2000. He ordered that Microsoft be split into two companies and that the companies desist from monopolistic conduct. A federal appeals court overturned this decision in June 2001. Although the panel agreed that Microsoft had engaged in monopolistic practices, it found that Judge Jackson had committed misconduct by making derogatory comments about Microsoft. The case was sent back to another district court judge, who encouraged new settlement talks. In August 2002, the U.S. Department of Justice and the states agreed to a settlement in which Microsoft did not have to split apart. Instead, Microsoft agreed to allow OEMs and consumers to add and remove access to certain Windows features and to set defaults for competing software. Microsoft also made available to software developers a host of software interfaces and tools at no charge, to allow the developers to write Windows applications.
Lucarelli, Bill. 2004. Monopoly Capitalism in Crisis. New York: Palgrave Macmillan.
Ottosen, Garry K. 1990. Monopoly Power: How It Is Measured and How It Has Changed. Salt Lake City, Utah: Crossroads Research Institute.
Scherer, F.M. 1993. Monopoly and Competition Policy. Brook-field, Vt.: Edward Elgar.
Zoninsein, Jonas. 1990. Monopoly Capital Theory: Hilferding and Twentieth-Century Capitalism. New York: Greenwood Press.
Monopoly in its pure form is an extreme market form with complete lack of competition. A monopoly firm, or a monopolist, is the only seller, facing no competition in the marketplace for the good or service it is selling. The product in question is unique and has no close substitutes. An example is a single ferry service between two islands, or a pharmaceutical firm that is the sole manufacturer of a particular drug.
Pure monopolies, where there are no close substitutes for the product or service offered, are uncommon in the modern world due to the availability of substitute products and/or government mandates, but monopoly power is exercised by producers in various markets. Monopoly power is a broad term that refers to the ability of sellers to hike prices above costs. For instance, although the seller of a famous clothing label is not considered to be a pure monopolist, it has monopoly power to charge prices above those of less popular labels. Conversely, sellers facing many competitors (e.g., newspaper vendors) must price at or very close to costs, and have little monopoly power.
Less common variants of a monopoly include monopsony and a bilateral monopoly. A monopsonist is a single buyer facing many sellers: for example, the Department of Defense is the sole buyer of the wares of various defense equipment manufacturers. A bilateral monopoly is the special scenario where a single buyer faces a single seller. Exchange in a bilateral monopoly takes place depending upon the relative bargaining strengths of the buyer and seller. In the case of a natural monopoly structurally there is room for only one firm in a market. In such cases, a single firm’s costs decline as it serves more customers. Hence, one firm can continue to lower costs by producing more, and competitors with small market shares are unable to survive due to higher costs. Public utility companies such as power and water companies are prime examples of natural monopolies.
The primary reason for the emergence and long-term viability of a monopoly is the presence of entry restrictions, or entry barriers, for new competitors (see Bain 1956). These entry restrictions include exclusive ownership of raw materials, patents, franchises (both public and private), and so on. Some entry restrictions may be natural or independent of the monopolist’s efforts, whereas others may be deliberately created by the monopolist (e.g., lobbying to make entry more difficult for firms that follow by having them satisfy stricter environmental restrictions). Governments sometimes create artificial monopolies for limited periods by mandating entry restrictions. Patents are a principal example of this. A patent confers a monopoly upon the patent holder until its expiry. In certain instances, governments enter into business by themselves to ensure service and reliability, or for national security considerations.
The longevity of a monopoly depends on the strength and the height of entry barriers. A monopolist can continue to earn supernormal profits over the long term if entry barriers are successful at preventing the entry of competitors. A monopolist ferry operator can continue to earn supernormal profits if the transit authority does not award another ferry license over the foreseeable future. On the other hand, a monopoly will be eroded as competitors are able to circumvent entry restrictions over time. For example, successful innovations are often copied as time passes.
The measurement of monopoly power is essential before any government action can be undertaken to dismantle monopolies to promote competition. A common (and easy to calculate) measure is the concentration ratio. The concentration ratio is the percentage of industry sales accounted for by the largest firm(s) in question. A pure monopoly has the concentration ratio of 100 percent. Thus, the farther away (less than) the concentration ratio is from 100 percent, the more competitive (or less like a monopoly) a market is. Although concentration ratios have the advantage of ease of computation, their primary drawback lies in their inability to reveal the actual behavior of firms (e.g., are firms aggressive or passive competitors?). There are other measures of monopoly power that overcome these shortcomings, but they are relatively difficult to compute.
There are some common misperceptions about monopolies. First, it is not true that a monopolist can charge whatever price it pleases, including the highest possible price, because at the highest price for most goods, consumers either buy poor substitutes or do not buy at all. Second, a monopolist does not always make profits. In reality, monopolists initially might have to take losses as consumers are educated about their new product(s). This explains the losses of some Internet startup companies.
Economists have shown that compared to a competitive firm, a monopolist’s price is higher and production is smaller (Intriligator, 1971). For example, a single airline serving a town will have higher fares and a less frequent schedule than if there were numerous airlines serving the same route. The monopolist’s behavior with regard to other strategic variables such as advertising and research and development (R&D) is less clear; that is, it is not clear whether a monopolist would advertise more (or conduct more R&D) than would a competitive counterpart. On the one hand, a monopolist might not have an incentive to advertise because it has no competitors to take customers from; on the other hand, a monopolist might advertise if advertising were to expand the total market by bringing in new buyers. With respect to R&D, a monopolist has the resources to innovate but might not have the desire to introduce new products (Goel 1999).
Public policy in most countries is driven by a procompetitive, antimonopoly stance. Government regulators try to break up monopolies and make markets more competitive, though government tolerance of monopolies varies across nations. The recent antitrust proceedings against Microsoft Corporation and the earlier breakup of American Telegraph and Telephone (also known as AT&T or the “Bell System”) are examples. The main criticism against monopoly is that it deliberately reduces production to raise prices. This quantity restriction shuts out some buyers who otherwise would have benefited from buying the product at the (lower) competitive price. Less significant criticisms of monopoly are that it promotes corruption (potential monopolists might be willing to bribe public officials to obtain exclusive contracts) and organizational waste (due to a lack of competition, a monopolist is likely to have a “fatter” organization than is essential to successfully conduct business). Taxation of a monopolist might also pose problems. Given a captive market, a monopolist might see a higher excise tax as an opportunity to raise the price of the product by more than the amount of the tax. This is in contrast to the behavior of a competitive firm, whose post-tax price increase is equal to or less than the amount of the tax.
Joseph Schumpeter (1942) provided the main redeeming grounds for a monopoly in arguing that monopolies were perhaps better at producing innovations because of their deep pockets (resources). Competitive firms with rather limited resources, in contrast, are less willing to undertake risky research projects. Empirical evidence on the advantage of monopoly firms over other (competitive) firms in producing innovations is inconclusive, however. The state-run patent programs in various countries are driven by the recognition that state-sanctioned monopolies granted by patents will spur innovation. Technology, therefore, has the potential to create as well as to dismantle monopolies. A successful new inventor receives a patent and establishes a monopoly. On the other hand, some technologies might create substitutes for existing monopoly products or services; an example of this is Internet companies creating online travel agents to compete with conventional travel agents.
Even for sellers, having a monopoly might not be such a desirable scenario when pricing decisions for a durable good are being considered (see Coase 1972). Durable goods are goods such as cars and washing machines that last a number of years. The dilemma facing monopolist sellers of durable goods is whether to lease them or sell them, and at what level of longevity (durability) to market the durable product. Relatively low initial prices for durable goods do not generate repeat business because the customers use durable goods for such long periods, and high selling prices encourage second-hand (used goods) markets that do not make any money for the monopolist. In contrast, there are no resale markets when a good is leased rather than sold, but complex lease clauses might scare some buyers away.
In sum, although monopolies are not very common in their pure form, monopoly power exists in many markets. Whereas government policy across the world continues to generally favor competitive markets, there are some redeeming features of monopolies. However, as new technologies emerge, we can expect more monopolies (at least in the short term) and destruction of existing ones.
SEE ALSO Competition, Perfect
Bain, Joe S. 1956. Barriers to New Competition. Cambridge, MA: Harvard University Press.
Coase, Ronald H. 1972. Durability and Monopoly. Journal of Law and Economics 15: 143–149.
Goel, Rajeev K. 1999. Economic Models of Technological Change. Westport, CT: Quorum Books.
Intriligator, Michael D. 1971. Mathematical Optimization and Economic Theory. Englewood Cliffs, NJ: Prentice-Hall.
Leibenstein, Harvey. 1966. Allocative Efficiency vs. X-Efficiency. American Economic Review 56: 392–415.
Schumpeter, Joseph A. 1942. Capitalism, Socialism, and Democracy. New York: Harper and Brothers.
Tirole, Jean. 1988. The Theory of Industrial Organization. Cambridge, MA: MIT Press.
Rajeev K. Goel
What It Means
A monopoly is a company that is the only seller of a particular product. If Joe’s Pest Control is the only exterminator service in a small town, it is a monopoly. At the other end of the spectrum, the energy company Con Edison was, as of 2007, the only supplier of electricity to New York City’s approximately eight million residents.
A monopoly is free from the danger of losing customers to competing companies. This means that, without government intervention, a monopoly can set any price it chooses. Usually the company will set prices to guarantee a higher level of profits than it would have generated under competitive conditions. Additionally, it often means that a monopoly can offer products of inferior quality without losing customers.
Under normal conditions monopolies should not be able to survive for long if they charge prices that unduly enlarge their profits. If they do this, competitors can enter the industry and charge lower prices, forcing the monopoly to lower its prices and compete for business. Monopolies are thus very rare. Joe’s Pest Control may be a monopoly because the town in which it is located is only big enough to support one such company. Con Edison is a government-granted monopoly. Electricity is difficult to produce affordably in small volumes, so state and city governments often grant utility companies monopoly rights, while closely regulating their business practices.
When Did It Begin
Among the most prominent early monopolies were those granted by the monarchs or other rulers of European nations to companies that participated in international trade. The British East India Company, for example, was granted a charter by Queen Elizabeth I in 1600, making it the sole British company authorized to import goods such as cotton, silk, and tea from India. Similarly, the parliament of the Netherlands in 1602 gave the Dutch East India Company exclusive rights to the Dutch trade with Asian countries.
In the United States the late nineteenth and early twentieth centuries saw the creation of numerous business trusts, a form of company that combined individual business firms under one set of owners with the intent of eliminating competition and creating monopolies. Standard Oil, headed by John D. Rockefeller, was one of the largest trusts. It used unfair practices to put competitors out of business on its way to gaining control of around 90 percent of the U.S. oil industry by 1900. Another prominent trust was U.S. Steel, composed of Andrew Carnegie’s enormous Carnegie Steel Company as well as other steel producers. In 1901 U.S. Steel controlled two-thirds of its industry in the United States.
Public and governmental concern about trusts during this era led to federal laws limiting a company’s ability to control its industry. The Sherman Antitrust Act of 1890 made it illegal to restrain or monopolize interstate or international trade. In 1911 the act was used to break up Standard Oil into 30 individual companies. The Clayton Antitrust Act of 1914 further restricted unfair business practices that large companies typically used to get rid of their rivals, and the Celler-Kefauver Act of 1950 placed restrictions on mergers (the joining of two separate companies into one larger company). These laws have been, since that time, the basis for judging whether or not a company is operating as a monopoly.
More Detailed Information
The economic argument against monopolies differs from moral arguments against them. Moral objections to monopolies include the fact that they have the ability to charge unfair prices and take advantage of consumers, but economic theory is essentially amoral. According to economists, the problem with monopolies is that they are inefficient.
Prices in the economy are set by the competing forces of supply and demand. Sellers are generally willing to supply more and more goods the higher prices rise, whereas buyers generally buy fewer and fewer goods the higher prices rise. As sellers realize how high they can drive prices without losing too many buyers, they settle on a price that represents a compromise between supply and demand. When there are numerous, equally matched competitors in an industry, prices are naturally kept as low as they can go without eliminating profits. This means that a company must use its resources (land, labor, and equipment) as efficiently as possible, keeping costs low throughout the production and distribution process. Thus, the economy under conditions of healthy competition uses its resources efficiently.
When a business gains complete control over its industry, however, it loses the incentive to keep prices at levels that promote efficiency. Instead, the company will naturally seek to increase its profits and keep them high over the long term. This results in a mismatch between supply and demand. At artificially high prices consumers buy less of the product than they would if market forces set prices. Less is produced, and society as a whole is worse off, because its resources are not being used efficiently.
How does a business become a monopoly? One way, of course, is for a government to grant a company monopoly powers, as occurred in the seventeenth century with European trading companies and as occurs today in the utilities industry, among other industries. In the case of present-day utility companies, government control may prevent a monopoly from gouging consumers, but problems of efficiency are still likely to result from the fact that market forces are not responsible for setting prices. For instance, a power company may put off making costly repairs in order to keep its profits high even as the government restricts the prices it can charge consumers. This could result in blackouts during the energy-intensive summer months. Customers who lose power, in such a situation, do not have the choice to switch to another company.
Companies can also become monopolies by outperforming the competition. A company that produces better briefcases than its competitors, and that is able to sell its cases for lower prices, might eventually drive those competitors out of business simply by being efficient. This is not necessarily a problem, but problems are more likely to arise once the company has achieved its monopoly status. It is at this point that the briefcase maker would have an incentive to raise prices to artificial levels, since there would be no competition capable of undercutting its prices.
Economists generally believe, however, that such a monopoly will be naturally short-lived. If the briefcase company keeps prices high for an extended period of time, new companies are bound to enter the industry offering prices that more accurately reflect the market forces of supply and demand. This will force the monopolizing company to lower its prices if it wants to compete.
Once a company has a monopoly, though, it might have ways of perpetuating its dominance. It can do so by erecting, sometimes with a government’s help, various barriers to entry. One barrier to entry might be a patent. A drug company that develops a cure for a disease will have the sole right to produce and sell that cure; rivals will be kept out of that particular drug market until the patent expires. Another barrier to entry can exist in the form of cost advantages. This refers to an existing company’s ability to use its size and experience to buy resources such as raw materials at cheaper prices than would be available to a new firm. A dominant company might also have brand recognition among consumers that will make it hard for new firms to enter the market. For example, Microsoft makes the dominant form of computer operating system (the software that serves as the foundation for all of a computer’s operations) in most of the world today. Among the barriers of entry to new competitors is the almost universal consumer recognition of the Microsoft brand name. To compete, a new brand would have to spend huge amounts of money advertising its own name.
The business trusts of the nineteenth and early twentieth centuries, such as Standard Oil and U.S. Steel, were easily identifiable as monopolies (or near-monopolies) that threatened the public interest, but the laws devised to prevent such trusts from forming do not always apply to today’s corporate world.
Mergers of already-gigantic companies such as America Online and Time Warner in 2000 seem, on the surface, little different from the building of trusts in the late nineteenth century. In fact, there are significant differences. Whereas Standard Oil blatantly attempted to create a monopoly, a company such as AOL/Time Warner can assert that its merger allows it to increase economic efficiency by combining various business operations that work better together than separately. Whether or not this is the truth or just a pretext for eliminating competition is difficult to say.
Similarly, few economists would argue against the assertion that Microsoft has monopoly power over the operating-system market, but many economists argue that this is not necessarily a bad thing. In an environment of rapid technological change, the possibility of developing a monopoly gives innovators the incentive to spend the enormous amounts of time and money that are often necessary to come up with good ideas. This is essentially the rationale for patents, which give innovators a temporary monopoly in the production of certain inventions. In the case of Microsoft, many of its ideas were not subject to patents, so the reward of monopoly control over its industry was necessary to spur the innovation that has delivered the company to its current position of dominance.
MONOPOLY occurs when a single seller or provider supplies all of a particular product or service. Typically, the term is used to describe a private, commercial situation—a market containing only one seller in a private enterprise economic system. Non-business sources of supply also can hold monopoly power, such as when the government owns the only provider of a product and precludes others by law. Government also can grant exclusive right to a single business entry or group to produce a product or service, thereby creating a monopoly, albeit a private one. A monopoly thus can be legal when a government determines who will produce. Other monopolies may be technological, whereby economies of scale in production lead to decreasing average cost over a large range of output relative to demand. Under these conditions, one producer can supply the entire market at lower cost per unit than could multiple producers. This is the case of a "natural monopoly," which reflects the underlying cost structure for firms in the industry. Monopoly also can stem from mergers of previously independent producers.
The definition of monopoly requires definition of a "product" to determine whether alternative suppliers exist. With no close substitutes, the supplier has monopoly power. The price elasticity of demand, measured as the percentage change in quantity of the product demanded, divided by percentage change in price, indicates the likely proximity of near substitutes; the lower the price elasticity of demand in absolute value, the greater is the ability of the monopolist to raise the price above the competitive level.
A social and political hostility toward monopoly had already developed in Western Europe long before economists developed a theoretical analysis connecting monopoly power to inefficient use of resources. Aristotle, for example, called it unjust. Large-scale enterprise was rare in manufacturing before the nineteenth century, but local producers and workers sought to protect their incomes through restrictions on trade. Capitalism evolved over time, superimposed on preexisting economic and social relationships. During this evolution, economic literature focused frequently on the abuses of monopoly, but without specificity. Well before large manufacturing firms formed, the nation-state granted monopoly rights to colonial trade and domestic activities, often creating resentment toward all forms of monopoly related to royal favoritism. England's Statute of Monopolies (1623) reflected this resentment by limiting governmental grant of monopoly power.
The writings of Adam Smith, his contemporaries, and his nineteenth-century descendents display antipathy toward monopoly, an antagonism perhaps more pronounced in England than elsewhere. This antagonism extended to situations of a few sellers and to practices designed to limit entry into an industry, as well as monopoly per se. English common law generally found abuses of monopoly illegal, but the burden fell upon the aggrieved to bring suit. The United States followed English common law, though that law was really a multitude of laws.
In the 1830s, August Cournot formalized the economic analysis of monopoly and duopoly, apparently the first to do so. His analysis—not very well known among economists of the nineteenth century—showed that profit maximizing, monopoly firms produce less and charge a higher price than would occur in competition, assuming that both industry structures have the same cost condition. It also led eventually to the demonstration, within the context of welfare economics, that single-price monopoly reflects underlying cost structures. Price discrimination, though prohibited and vilified, might lead to a competitive, single-price level of output and efficiency. Cournot's static analysis did not take into account the effect of firm size on technological change, one potential benefit of large firms able to invest in research and development.
Public outcry about trusts—an organizational form associated with mergers that create large firms with substantial market power in many industries—led American legislators to pass the Sherman Antitrust Act in 1890. This act was the first major federal antitrust legislation in the United States and remains the dominant statute, having two main provisions. Section one declares illegal every contract or combination of companies in restraint of trade. Section two declares guilty of misdemeanor any person who monopolizes, or attempts to monopolize, any part of trade or commerce. The Clayton Act of 1914 prohibited a variety of actions deemed likely to restrict competition. Early legislation and enforcement of antitrust law reflected popular opposition to monopoly. Better understanding of economic theory and the costs of monopoly, however, gradually transformed the policy of simply opposing monopoly (antitrust) into one that more actively promotes competition. When the promotion of competition was likely to result in firms too small to exhaust economies of scale, public policy moved to regulate the natural monopoly, presumably to protect consumers from abuse of monopoly power.
Formal economic analysis of monopoly locates that industry structure at the far end of the spectrum from competition. Both are recognized as stylized types, useful in determining the extreme possibilities for industry price and output. Competitive and monopolistic models are relatively simple, because each participant is assumed to act independently, pursuing optimizing behavior without consideration of the likely reaction of other participants. The limitations of monopoly theory in predicting behavior of actual firms stimulated work on imperfect competition. Numerous case studies of American industry structure in the mid-twentieth century yielded detail about firm behavior, but no universally accepted theory.
More recently, developments in game theory permit better analysis of the interdependent behavior of oligopolistic firms. Game theory analyses during the last two decades of the twentieth century—though lacking a unique solution and easy generalizations—also permit more dynamic examination of behavior. This includes considering how a monopolist might behave strategically to maintain monopoly position. Thus, a firm might behave so as to forestall entry. Game theory models have led to reevaluation of the effects of various practices, creating a more complex interpretation of the relationship between industry structure and economic efficiency.
Church, Jeffrey, and Roger Ware. Industrial Organization: A Strategic Approach. Boston: Irwin McGraw-Hill, 2000.
Cournot, Antoine Augustin. Researches into the Mathematical Principles of the Theory of Wealth. New York: Augustus M. Kelley, 1971.
Ellis, Howard, ed. A Survey of Contemporary Economics. Philadelphia: Blakiston, 1948. See especially the article by John Kenneth Galbraith, "Monopoly and the Concentration of Economic Power."
Schumpeter, Joseph A. History of Economic Analysis. New York: Oxford University Press, 1994.
Stigler, George, and Kenneth Boulding, eds. Readings in Price Theory: Selected by a Committee of the American Economic Association. Chicago: Richard D. Irwin, 1952. See especially the article by J. R. Hicks, "Annual Survey of Economic Theory: The Theory of Monopoly."
Tirole, Jean. The Theory of Industrial Organization. Cambridge, Mass.: MIT Press, 1988.
A monopoly is a market condition in which a single seller controls the entire output of a particular good or service. A firm is a monopoly if it is the sole seller of its product and if its product has no close substitutes. Close substitutes are those goods that could closely take the place of a particular good; for example, a Pepsi soft drink would be a close substitute for a Coke drink, but a juice drink would not. The fundamental cause of monopoly is barriers to entry; these are technological or economic conditions of a market that raise the cost for firms wanting to enter the market above the cost for firms already in the market, or otherwise make new entry difficult. If the barriers to entry prevent other firms from entering the market, there is no competition and the monopoly remains the only seller in its market. The seller is then able to set the price and output of a particular good or service.
A monopoly—in its pure form—is actually quite rare. The majority of large firms operate legally in a market structure of oligopoly, which means that a few sellers divide the bulk of the market. People often have the impression that the goals of a monopolist are somehow evil and grasping, while those of a competitor are wholesome and altruistic. The truth is that the same motives drive the monopolistic firm and the competitive firm: Both strive to maximize profits. A basic proposition in economics is that monopoly control over a good will result in too little of the good being produced at too high a price. Economists have often advocated antitrust policy, public enterprise, or regulation to control the abuse of monopoly power.
BARRIERS TO ENTRY
For a monopoly to persist in the long run, barriers to entry must exist. Although such barriers can take various forms, they have three main sources:
- A key resource is owned by a single firm.
- The government gives a single firm the exclusive right to produce a specific good.
- The cost of production makes a single producer more efficient than a large number of producers.
The first and simplest way for a monopoly to come about is for a single firm to own a key resource. For example, if a small town had many working wells owned by different firms, no firm would have a monopoly on water. If, however, there were only one working well in town, the firm owning that well would be considered a monopoly. Although exclusive ownership of a key resource is one way for a monopoly to arise, monopolies rarely come about for this reason.
In many cases, monopolies have arisen because the government has given a firm the exclusive right to sell a particular good or service. For example, when a pharmaceutical company discovers a new drug, it can apply to the government for a patent. If the patent is granted, the firm has the exclusive right to produce and sell the drug for a set number of years. The effects of such a government-created monopoly are easy to see. In the case of the pharmaceutical company, the firm is able to charge higher prices for its patented product and, in turn, earn higher profits. With these higher profits, the firm is able to complete further research in its quest for new and better drugs. The government can create a monopoly when, in doing so, it is in the interest of the public good.
A natural monopoly occurs when a single firm can supply a good or service to an entire market at a lesser cost than could two or more firms. An example of a natural monopoly is the distribution of water in a community. To provide water to residents, a firm must first put into place a network of pipes throughout the community. If two or more firms were to compete in providing the water distribution, each would have to pay the fixed cost of building a network. In this case, the average total cost of water is lowest when one firm serves the entire market.
MONOPOLY VERSUS COMPETITION
The major difference between a monopoly and a competitive firm is the monopoly's ability to influence the price of its output. Because a competitive firm is small relative to the market, the price of its product is determined by market conditions. On the other hand, because a monopoly is the sole producer in its market, it can often alter the price of its product by adjusting the quantity it supplies to the market.
An example of a company that garnered monopoly power is the case of Microsoft. In 2000, in an antitrust lawsuit brought against Microsoft, a U.S. federal court judge ruled against the company. Microsoft, a computer company, had established first MS-DOS and later Windows as the dominating operating system for personal computers. Once it had achieved a position of strength in the market, would-be competitors faced insurmountable hurdles. Software developers face large costs for every additional operating system to which they adapt their applications. Because Microsoft had the dominant operating system, any rival personal computer operating system would have only a handful of applications, compared to tens of thousands of applications for Microsoft's Windows system. This applications barrier to entry gave Microsoft enduring monopoly power.
The judge's ruling in this case made it clear that, besides being illegal, Microsoft's monopoly was not in the public interest and legal measures would be put into place in order to break the monopoly that Microsoft had created.
For another example, in many cities trash-collecting businesses are invited to bid, perhaps every three years or so, for the exclusive right to operate their business. The successful bidder, selected by the city, has the legal right to own and operate the business, keeping out all competitors for at least three years. Monopoly situations such as this, called utilities, are generally considered to be beneficial for the users and therefore for the public. Some discussion, however, about this issue does occur. In a public letter published by the Economic Times on August 22, 1999, among other points, it was stated that utilities profits are constrained. This, of course, may seem a limiting factor in attracting investors.
Laws pertaining to monopolies have been passed. In 1890 the Sherman Antitrust Act was enacted. It forbade mergers of companies that would result in restraint of trade. In 1914 the Clayton Antitrust Act was passed as an amendment to the Sherman act. It made certain practices illegal when their effect was to lessen competition to create a monopoly.
see also Antitrust Legislation ; Oligopoly
Busted. (1999). The Economist, 353 (8145), 21, 23.
Heilbroner, Robert L., and Thurow, Lester (1998). Economics explained: Everything you need to know about how the economy works and where it's going (rev. ed.). New York: Simon and Schuster.
Jethmalani, Arun (1999, August 22). Of monopolies and utilities [Public letter]. Economic Times.
Mankiw, N. Gregory (2006). Principles of economics (4th ed.). Mason, OH: Thomson South-Western.
G. W. Maxwell
An economic advantage held by one or more persons or companies deriving from the exclusive power to carry on a particular business or trade or to manufacture and sell a particular item, thereby suppressing competition and allowing such persons or companies to raise the price of a product or service substantially above the price that would be established by a free market.
FTC Rules That Rambus Illegally Acquired Monopoly Power
The Federal Trade Commission in 2006 ruled that Rambus Inc., a technology licensing company, had acquired monopoly power related to computer memory technologies. The case arose from the activities of Rambus during the 1990s when Rambus convinced various trade groups to adopt a standard technology for memory used in computers and other devices without informing those groups that Rambus owned the patents for those technologies. Despite the ruling, however, the FTC withdrew part of its order related to penalties that it imposed on Rambus, and the company said it would appeal the remainder of the order.
Two developers founded Rambus in 1990 as a technology licensing company. Rambus specializes in the invention and design of high-speed chip interfaces that are used in computers and other electronic devices. More specifically, the company designs, develops, licenses, and markets the chip technology to enhance performance of the computers and other devices. Rambus licenses its technology to semiconductor companies to use in their products. As of 2006, Rambus owned the rights to 480 issued patents, and the company had 485 pending patent applications. During 2006, Rambus earned $194.2 million in revenues, up 24 percent from the previous year.
Rambus has been involved with the development of dynamic random access memory (DRAM). This standard has been a competitor with another type of memory, known as static random access memory, or SRAM, for much of the past two decades. Early in the 1990s, the company became involved with the development of its own DRAM standard, known as Rambus DRAM or RDRAM. Rambus hoped that this would become the industry standard. This did not occur, however, and manufacturers instead resorted to a standard-setting industry body known as the Joint Electronic Device Engineering Council, or JEDEC, to develop the next-generation technology for DRAM.
Throughout much of the decade, JEDEC worked to establish newer standards. These efforts eventually resulted in the development of synchronous dynamic random access memory, or SDRAM, which was adopted as an industry standard. Rambus participated in the JEDEC DRAM process along with the DRAM manufacturers. During this process, Rambus' patent applications for its own DRAM technologies were still pending, and the company changed its patent applications to incorporate the changes that were being discussed as part of the JEDEC process. Others that were involved in this process were not aware that Rambus had made these changes.
Once the standards had been finalized, various manufacturers began using them in their memory chips. In 2000, Rambus sued these manufacturers, claiming patent infringement. In one case involving a German DRAM manufacturer, a jury in the U.S. District Court for the Eastern District of Virginia decided that Rambus had committee fraud for failing to disclose its patents and patent applications related to the SDRAM standards. On appeal, the Federal Circuit Court of Appeals disagreed, ruling that Rambus was not required to disclose its patents. The appellate court reviewed the JEDEC's disclosure policy and determined that Rambus was under no duty to disclose the changes in the patent applications. Thus, according to the court, even if Rambus' actions may have been unethical, these actions did not constitute a breach of duty. Rambus Inc. v. Infineon Technologies, A.G., 318 F.3d 1081 (Fed. Cir. 2003).
Chip manufacturers in 2002 raised a different argument when they filed a complaint with the FTC in 2002. The manufacturer argued that the Rambus had engaged in monopolistic behavior in violation of federal law. An administrative law judge that reviewed the case ruled in favor of Rambus, reaching a conclusion similar to the one in the Federal Circuit. According to the judge, Rambus was only required to disclose the existence of certain "essential" patents that could be read onto the JEDEC DRAM standard. Because Rambus did not have any such patents or patent applications, the judge ruled in favor of the company.
On August 2, 2006, the FTC reversed the judge's decision, finding that Rambus had acted deceptively, and in doing so, acquired monopoly power. In re Rambus, No. 9302, 2006 WL 2330117 (Aug. 2, 2006). The commission determined that Rambus misled other JEDEC committee members to believe that the company was not seeking patents that would cover the technologies. However, Rambus was secretly amending its applications so that they would cover the technology that was being discussed in the JEDEC committee meetings. "'Rambus's conduct was calculated to mislead JEDEC members by fostering the belief that Rambus neither had, nor was seeking, relevant patents that would be enforced against JEDEC-compliant products," the commission wrote. "Rambus's silence, in the face of members' expectations of disclosure, created a misimpression that Rambus would not obtain and/or enforce such patents."
Despite the ruling, the FTC was more lenient than some commentators expected when the commission levied penalties on Rambus in February 2007. The commission established limits on the amount of royalties that Rambus could receive for some of its older chip designs, but it did not place limitations on designs that were developed after the JEDEC process had concluded. The February ruling also placed bookkeeping and record-keeping requirements on Rambus to ensure that the company was complying with the order. Despite the fact that the order was not as harsh as expected, Rambus officials expressed disappointment, claiming that the commission disregarded part of the record when reaching its decision.
About one month after issuing its ruling, the FTC modified the order to allow Rambus to continue to collect royalties for all past uses of the DRAM technology. Under an order issued in March, the FTC limited the amount of royalties that Rambus can collect on future uses of the technology. Rambus officials indicated that they were satisfied with modified part of the order but would appeal the rest of the February order that remained intact.
monopoly (mənōp´əlē), market condition in which there is only one seller of a certain commodity; by virtue of the long-run control over supply, such a seller is able to exert nearly total control over prices. In a pure monopoly, the single seller will usually restrict supply to that point on the supply-demand schedule that will maximize profit. In modern times, the accelerated production and competition brought about by the Industrial Revolution led to the formation of monopoly and oligopoly. Since the notion of monopoly is antithetical to the free market ideal, it has never been popular in capitalist nations. In the United States, the most famous monopoly was John D. Rockefeller's Standard Oil Trust in the late 19th cent. Despite such legislation as the 1890 Sherman Antitrust Act (the first significant legal statute against monopoly), it was the Supreme Court that forced the break-up of Standard Oil, along with other monopolies. Since the 1960s, however, the U.S. Justice Dept. has occasionally been more active in attacking monopolies or near monopolies (such as AT&T and IBM); a major case in the 1990s involved the Microsoft Corp. (see Bill Gates).
Many governments, however, have created public-service monopolies by laws excluding competition from an industry. What resulted were generally publicly regulated private monopolies, such as some power, cable-television, and local telephone companies in the United States. Such enterprises usually exist in areas of "natural monopoly," where the conditions of the market make unified control necessary or desirable to the public interest. Some socialists have advocated the extension of the principle of public monopoly to all vital industries, such as coal and steel, that have an immediate effect on the general welfare of the economy. By the 1990s, however, many public utilities in the United States and elsewhere were deregulated, allowing for competition and lower prices (see utility, public).
Aside from utility companies, privately controlled monopolies without state support are rare. However, the concentration of supply in a few producers, known as oligopoly, is not uncommon. In the United States, for instance, several large companies have dominated the automobile and steel industries. Since the Progressive era, the U.S. government has made most forms of monopoly, and to a lesser extent oligopoly, illegal under antitrust laws. The objective of such measures is to guarantee that price will be determined by market forces rather than by arbitrary price setting among corporations. In recent years oligopolies have grown through mergers and acquisitions. The government still grants temporary monopolies in the form of patents and copyrights to encourage the arts and sciences.
See J. Robinson, The Economics of Imperfect Competition (2d ed. 1969); D. Dewey, The Antitrust Experiment in America (1990); T. Freyer, Regulating Big Business: Antitrust in Great Britain and America, 1880–1990 (1992).