An industry that is controlled by a monopolist is called a monopoly. A monopolist is a firm that is the only producer of a certain good that has no close substitutes. In most cases, a monopolist will increase the price and reduce production in order to gain abnormal economic profits. When a monopolist raises the competitive price of a good, they are exercising market power. However, since the monopolist is restricted by market demand, an increase in price will cause quantity demanded to decrease. Although unrestricted by competition, the monopolist is still restricted by the market. Monopolies are rare in modern day, but can be caused as a result of large mergers, government regulation or naturally.
Natural monopolies are those where the market cannot support two firms, so one firm exits the market. Natural monopolies will often emerge when there are large fixed costs that are associated with production. An example of natural monopolies are local utilizes like water and gas. Monopolies emerge when parts of the industry keep other firms out, also called barriers to entry. There are four types of barriers to entry:
1. Network externalities
2. Economies of scale
3. Control of scare resource
4. Legal barriers to entry
One of the issues with a monopoly is that there is usually a high amount of inefficiency due to the artificial lowering of quantity produced in order to raise prices. A market under monopoly is typically not allocatively efficient and exhibits deadweight loss. Sometimes monopolists argue that they actually reduce prices because without market segmentation they can leverage their large market share to use economies of scale to reduce the costs of production.
- Ragan, Chrisopher. Macroeconomics/Christopher T.S. Ragan, Richard G. Lipsey. – 13th Canadian ed.