Monopolies

Monopoly basics 

In theory, monopolies occur when a single firm controls a market. 

However, the UK government definition of 'monopoly power' is any firm with at least 25% market share. In the real world it is also possible for firms to have market power with even lower percentages of market share. 

Monopolists aim to maximise profits, which is done by reducing supply and therefore pushing prices up (compared to a competitive equilibrium). This results in a transfer of consumer surplus to the monopolist as well as deadweight loss of overall welfare. 

In the diagram above, as the supply shifts from Q1 to Q2, there is a deadweight loss ABC and there is a transfer of the surplus in the small rectangle below PmonA. The surplus gained from the monopolist was originally consumer surplus, so the consumer comes out worse off, and the monopolist's total surplus is the original surplus + the surplus transferred from the consumer. 

As you can see in the above diagram, in a perfectly competitive market firms are price-takers, so the demand curve is a straight horizontal line. Where the demand curve is depends on where the market supply and demand curves meet - the equilibrium point. 
In a monopoly however, the demand curve is downwards sloping, meaning that the firm has market power and is a price-maker. This is because the demand curve represents a range of price and quantity combinations, so the firm can choose a price at any point on the demand curve. 

In a perfectly competitive market, firms cannot make economic profit. This is when a firm's revenues exceed the cost of production and opportunity cost (so if the firm is making more profit than it could in the next best area that it's resources could be applied). This is different from accounting profit, which is simply when revenue exceeds cost of production. 

Causes of monopoly power 

There are several ways that firms can gain monopoly power - 

Mergers/takeovers 

Firms can merge with or acquire other firms to gain a greater share of the market. This can be done either horizontally or vertically. 

Horizontally -  firms are taking over other firms in the same market who provide the same service, so are usually acquiring competing firms. This means they are reducing the number of competitors and therefore increasing their share of market power. 

Vertically - firms are taking over other firms in the same industry but in different stages of the industry. So they are gaining greater control over their resources, and costs, through buying up stages in the production process closer/further away to the consumer. For example, by buying up a hops farm, a brewery can control how much they pay for hops, and are not limited to the market price for hops. 

Government granted monopolies 

These are legal barriers to entry. 

Patents - provide a lawful right to be the sole producer of a good/service for a certain amount of time. This is when the person has invented the good/service. Patents incentivise innovation and promote economic growth. They prevent others from entering the market for a certain product, creating a monopoly. 

Copyrights - a similar kind of legal protection for authors, composers or artists, preventing others from entering the market for similar creations. 

Branding and advertising 

Strong branding and advertising make it more difficult for others to compete with a firm, so act as another barrier to entry. It is very important as even if one has a good product, people may not know about it or may not want to buy it if it isn't branded/advertised well. 

Economies of scale 

In most markets, being bigger reduces costs and helps a firm become more competitive. Lower costs (per unit) help big firms grow more, and so act as another barrier to entry for smaller firms, who have higher costs per unit and generally less money. 

Government Solutions to Monopoly Power 

Regulation and control of mergers 

The government can prohibit mergers from forming if the merger will hold over 25% market share as this would be 'against public interest'. Or they can enforce laws that reduce the monopoly power of the merger. For example, the AB-InBev/SAB Miller merger were forced to sell off some of their brands to other breweries as part of the deal. 

Policies to enhance competition/stop abuse of market power

e.g.

• The EU ruling on mobile phone 'roaming charges'
• The EU lawsuit against Google. Google was accused of abusing its power in the search engine markets by promoting its own products over others that may have benefitted consumers more. 
• Preventing 'anti-competitive practices' such as predatory pricing (lowering prices for a period of time to drive competitors out of the market), market sharing, caramelisation, etc. 
• Removing barriers to entry where possible. 

Costs and benefits of monopolies

Costs 

Consumers have to pay high prices and lose consumer surplus. 

There is a deadweight loss of welfare/surplus, because the higher prices means some trade doesn't take place. 

Some monopolies result from government corruption (so-called 'crony capitalism'). 

Benefits

Other monopolies have countervailing benefits that many outweighs the above costs. For example, patents in the pharmaceutical industry fund development for other drugs. The supernormal profits that come with this are what allows firms to produce drugs. This applies to entertainment, technology, materials science and anywhere there are high costs of development but low marginal costs of production. 

There is a tradeoff between prices today and availability of new products in the future. 

Price discrimination 

Monopolies have the ability to charge people different amounts of money for the same product. For example, medication of AIDS is a lot more expensive in the Western world that it is in places in Africa. 

Natural monopolies

Sometimes the most efficient (lowest long-run average cost) market structure is that of a single seller - this is referred to as a natural monopoly. This is often seen in markets were high capital costs (fixed costs) serve as a barrier to entry and mean that economies of scale are large. 

Examples of this are sewage systems, Royal Mail, bus services in a city, railways. Often the government has to intervene to prevent these monopolies from overly abusing their power.