Monopoly in Economics

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“Monopoly” is a  market structure which is formed and differentiated from other markets on the basis of number of sellers, substitute of products, procedure for entry and exit etc. It is the strict opposite of perfect competition. Let’s learn more about Monopoly.

Monopoly – Definition

The word ‘Monopoly’ is derived from Greek words ‘mono’ which means single, and ‘polus’ which means seller. Monopoly refers to a market situation where there is a single seller , selling a product which has no close substitutes. For example, Indian railways is a Monopoly  India.

Features of Monopoly

1. Single Seller

Under Monopoly, there is only one seller , who is selling a certain product. Therefore, the monopoly firm (single seller) and industry (since there is only one seller, he would constitute the industry) are the same entities. The monopolist,  has complete control over the supply and price of the product. However, there are large number of buyers of monopoly product,  and no single buyer can influence the market.

2. No Close Substitute

Th product produced by a monopolist has no close substitute.So the firm has no fear of competition from the existing or new  products.

3. Restrictions on Entry and Exit

There are strong barriers to entry of new firms , and exit of existing firm. As a result, a firm under monopoly can earn abnormal profits and losses in the long run. Such barriers might be due to legal limitations like licensing (it is difficult to obtain license) or patent rights (the product made by monopolist is patented which restricts others from producing it)  or due to restrictions created by other firms in form of cartel.

4. Price Discrimination

A monopolist may charge different prices for their product , from different sets of consumers at the same time. It is known as ‘Price Discrimination’. Price discrimination refers to the practice of the seller charging different prices from different buyers at the same time for the same product.

5. Price Maker

Firm and industry are one and the same thing in such a type of market. So, the firm has complete control over the industry output. As a result, monopolist is a price maker and fixes his own price. He can influence the price in the market by changing the supply of the product.

Reasons for Emergence of Monopoly

A firm enjoys monopoly when it is the only seller of a certain product,  and the product has no close substitutes. The fundamental cause of this is the barrier to entry. The reasons for emergence of such a market are –

  1. Government Licensing – It means that before a firm can enter an industry, it needs to take permission from the government. Licensing is used to assure certain minimum standards of competency. By not granting licenses to new firms, the government aims to ensure that only one firm operates in the market.
  2. Patent Rights – Certain big private companies are engaged in research and development activities. At times, they come up with new products or new technologies. As a reward for their risk and investment in research, government grant them patent rights. The period for which patent rights are granted are known as patent life.
  3.  Cartel – Under cartel, some firms retain their individual identities but coordinate their output pricing policy in order to act as a monopoly. The firms agree among themselves to restrict their total output to the level that maximises their joint profit.
  4. Control on Raw Materials – Monopoly also arises due to sole ownership or control of certain essential raw materials required in a particular industry.

Demand Curve under Monopoly

A monopoly firm is like an industry as there is only one single seller that constitutes the entire market for the product, which has no close substitutes. So, a monopolist has full freedom and power to fix the price for the product. However, the demand of the product is not in the control of the firm. In order to increase the output to be sold, the firm will have to lower the price. As a result, the firm faces a downward sloping demand curve.

(graph 1)

In the figure given above, output is measured along the X-axis and revenue and price is measured along the Y-axis. At OP price level, a seller can sell OQ quantity of product. As the price is reduced to OP1, demand rises to OQ1. So, the demand curve under a monopoly is negatively sloped because more quantity can be sold only at a lower price.

AR & MR Under Monopoly

A firm in monopoly faces a downward sloping demand curve as more output can be sold only by reducing the price. As a result, revenue generated from every additional unit, i.e. MR, is less than price, i.e. AR, of the product. Due to this reason, MR is less AR (MR<AR).

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