What Is a Monopoly in Economics?
In economics, the term monopoly often conjures images of a single, all-powerful firm that charges whatever price it wishes and operates with no incentive to provide quality customer service. Monopolies have existed throughout history and arise from various sources. Their dominance enables them to control the quantity produced and price charged for a product or service, but government policy makers have a series of options at hand to reduce the influence and power of monopolies.
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Identification
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In economics, a monopoly arises when a single firm is the sole provider in the market of a particular good or service. Often, the product or service in question has no close substitutes, enabling the monopoly to charge whatever price it wishes for the good it controls.
Types
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Harvard economist Gregory Mankiw, in his "Principles of Economics" textbook, identifies three types of monopolies. One type of monopoly is a single firm that controls a key resource. He cites DeBeers, the South African diamond company, as an example. DeBeers controls more than 80 percent of the world's diamond production, enabling it to influence diamond prices. Another type is a firm to which the government grants the exclusive right to produce or sell a good. Mankiw writes that the U.S. government has given the firm Network Solutions Inc. the exclusive right to maintain a database of Internet addresses on the grounds that such data should be centralized. A third type of monopoly, known as a natural monopoly, arises when a single firm can serve the market at a lower cost than multiple competitors.
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Effects
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Because a monopoly is the sole producer or supplier of the product or service it controls, it can affect prices simply by changing the quantity it produces. If a monopoly firm wants to receive a higher price for its product, it can reduce the quantity of the good it produces. A monopoly that operates with government protection exists free of the potential for competition, since the government can prevent potential competitors from entering the market and challenging the monopoly's position. A firm that controls most of a key resource can use advertising to distinguish its product from any potential substitutes. Mankiw writes that DeBeers advertises heavily to distinguish diamonds from other gems, using the advertising slogan "a diamond is forever."
Prevention/Solution
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Government policy makers have a variety of tools for responding to the power of monopolies, Mankiw writes. One of these is antitrust law. The United States enacted the Sherman Antitrust Act in the late 19th century to reduce the power of large firms that Congress believed dominated the economy at the time. Through antitrust law, the government can break up large trusts, thus fostering competition. In the 1980s, for example, the government split up AT&T into smaller regional telephone service providers. Antitrust laws also allow the government to prevent mergers of large firms. Another tool against monopoly is regulation, in which the government regulates the actions of monopolies. For example, government agencies regulate the rates charged by utility providers, such as water and power companies. Finally, the government can take over a monopoly by making it a public-owned enterprise. This occurs in Europe, where the government owns many utilities.
Expert Insight
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The various public policy responses to monopolies have their share of drawbacks. The late George Stigler, a Nobel Laureate in economics, noted that antitrust policy is expensive to enforce and slow moving because of the legal process. Public regulation has been the preferred response to monopolies in the United States, but Stigler wrote that the effect has generally been to reduce competition rather than eliminate monopolies.
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References
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- Photo Credit diamond image by sumos from Fotolia.com
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