Types of Markets » Monopoly Markets

What is a monopoly market?

Imagine a small island with one company that supplies all of its electricity. Customers cannot switch to a rival, because there is no rival. Whatever that company decides, customers have to accept. This is the opposite of the busy noodle market in Competitive Markets.

You met monopoly briefly in Public Goods, Merit Goods, Demerit Goods and Monopoly, where it was a cause of market failure. In this lesson we look at monopoly as a type of market, and at what it means for consumers and for the firm.

Key terms:

• Dominant firm: a firm that has a very large share of a market, even though a few small rivals may exist.
• Price maker: a firm that has the power to set its own price, because customers have few or no alternatives.
• Natural monopoly: a market where it is cheapest for one firm to supply everyone, because the costs of setting up are so high that two firms would waste resources.
• Research and development (R&D): spending on finding new products and better ways of producing them.

Characteristics of monopoly markets

A monopoly market usually has these characteristics:

Barriers to entry are what keep a monopoly in place. Here are some examples:

• High start-up costs: building a national railway network or a power grid costs a huge amount of money.
• Legal protection: a patent stops others copying a new medicine for a number of years, and a government licence may allow only one firm to operate.
• Economies of scale: a very large firm has such low average costs that a small new firm cannot match its prices.
• Control of a key resource: a firm that owns the only mine of a mineral can stop others getting it.
• Strong branding or advertising: a well-known brand can be hard for new firms to compete with.

The effect of having only one firm

With only one firm, the usual pressure from rivals disappears. This changes how the firm behaves.

• Price: prices tend to be higher. The firm is a price maker, and customers have nowhere else to go.
• Quality: quality may be lower, because the firm does not need to improve to win customers from rivals.
• Choice: consumers have less choice, with only one supplier and perhaps only one version of the product.
• Profit: profit tends to be higher, because the firm can charge higher prices and high barriers stop new firms copying it.

Here is a made-up example. In the country of Zandria, only one firm, Zandria Rail, runs trains between the two biggest cities. The table compares it with the same route if ten firms ran trains.

The monopoly charges more per ticket, but passengers pay more and have fewer trains to choose from.

Advantages and disadvantages

Notice that a monopoly does not always have to be bad. A natural monopoly, such as a firm supplying water through one set of pipes, can be sensible. Governments often watch these firms closely. You will meet ways to do this in Regulation and Direct Provision.

Exam-style question

Velmara is a made-up country. Only one company, Velmara Water, supplies water to homes. It would cost billions of dollars to build a second set of water pipes, and the government has given the company the only licence to supply water. The company says that its large size lets it keep costs low and spend money on improving its pipes.

(a) Identify two barriers to entry in the water market in Velmara. [2 marks]

(b) Explain how having only one firm may affect the price and the quality of water. [4 marks]

(c) Discuss whether a monopoly is good for consumers in Velmara. [6 marks]