Section 2 Monopoly

Preview

Objectives

After studying this section you will be able to:

1. Describe characteristics and give examples of monopoly.
2. Describe how monopolies are formed, including government monopolies.
3. Explain how a firm with a monopoly sets output and price, and why companies practice price discrimination.

Section Focus

A firm has a monopoly when it controls an entire market. Because a monopolist controls the price of its product, a monopoly produces less and charges higher prices than would a perfectly competitive firm.

Key Terms

• monopoly
• economies of scale
• natural monopoly
• government monopoly
• patent
• franchise
• license
• price discrimination
• market power

You've gone to the emergency room with a high fever and a sharp pain in your leg. The doctor diagnoses a rare infection and writes a prescription for ten pills of a new medication that the government approved just last year. The doctor tells you that without this medication, your recovery will be slow.

At the pharmacy, you find that the medicine costs $97.35, or nearly ten dollars a pill! The pharmacist tells you that only one company has the right to produce the medicine, and it charges a high price because its scientists worked for years to develop the medication. You feel that you have no choice, so you hand over the cash.

The market for prescription medicines is one of many markets in which monopolies can develop. In this section you will read about different types of monopolies and how they form.

Describing Monopoly

A monopoly forms when barriers prevent firms from entering a market that has a single supplier. While a perfectly competitive market has many buyers and sellers, monopoly markets have only one seller, but any number of buyers. In fact, barriers to entry are the principal condition that allows monopolies to exist.

While you can probably think of several companies that look and act like monopolies, economists use a strict set of requirements to define a monopoly. If we define the good or service provided by a company broadly enough, we can usually find substitute goods from a different source. For example, you might think that a convenience store on a highway in the middle of the desert has a monopoly. However, you could have carried more water in the car, or, if you had enough money, you might have flown across the desert instead of paying high prices for food and water during the car trip.

One company, DeBeers of South Africa, has almost total control over the world's diamond supply.

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