One of the anticompetitive practices that businesses use is the creation of monopolies. A monopoly is a situation in which there is only one dominant company on the market providing a certain good or service.
A pure monopoly is when a single business has 100% of the market share. However, in practice, the market leader is called a monopolist when the business is controlling at least 20%-30% of the certain market.
How monopolies develop?
Nowadays, a monopoly most often arises when a firm becomes so dominant in its market that it has the ability and the power to engage in anticompetitive behavior unless the government steps in with laws to prevent it.
- Integrations. Most monopolies are created by merging with other companies on the market. Monopolies can also develop through acquisitions or takeovers of smaller companies in the same industry.
- Patents. Invention of new products or processes that are then legally patented gives the original inventor a monopoly in the production process. While patents are designed to encourage innovation, they are often used to reduce new potential competition in a fully legal way.
- Legal protection. Legal protection from the authorities gives a legal monopoly to the specific firm. It usually occurs when the government chooses to protect its industry. It will give all the power to only one single business. Usually, it is going to be a public company owned and controlled by the government.
- Natural barriers to entry into a market. These barriers make it very difficult to start up new companies in the certain market, so called business moats. They also effectively prevent competitors from entering into the specific industry. Natural barriers to entry include advanced technical knowledge, expensive equipment, huge costs of building sophisticated facilities, the need to advertise extensively to get established on the market, etc.
How are customers affected by monopolies?
There are both positive and negative effects on consumers resulting from monopolies.
(+) POSITIVE:
- Lower prices. A monopolist is able to achieve large-scale production to produce millions of products sold nationally or even globally. Internal economies of scale will then reduce the average cost of manufacturing one single product.
- New products. In order to protect its monopolistic position on the market, a monopolist will increase spending on new products. So, customers will benefit from larger selection of goods and services.Â
- Better quality goods. Capital expenditure on purchasing new machines and equipment will be an important aspect for a monopolist to maintain this dominant position. Increased spending on technical advances will not only allow the monopolist to protect its market dominance, but also improve product quality.
(-) NEGATIVE:
- Higher prices. A monopolist does not have strong competition, hence can maintain high prices. As customers have no choice but to purchase goods from this one particular company, the monopolist has no incentives to lower prices. Therefore, by being able to minimize the average cost of production and to charge higher prices at the same time, the dominant company is able to achieve very high profitability levels.Â
- No new products. The monopolist may not have any intention to develop any new products. Without competitors, the company will not spend any money on development of new stuff.
- Lower quality goods. When a monopolist is able to achieve high profits by producing only one product of the mediocre quality, this business will have no competition forcing it to improve on quality.
How governments deal with monopolies?
Monopoly allows a monopolist to inflict barriers to entry on other potential competitors to keep the firm’s dominant position secure. In most cases, the government will act to stop and prevent unfair business practices such as integrations leading to the creation of obvious monopolies.
This is because monopolies are most likely to result in limited choices of products for customers, artificially high prices, less innovation, reduced output due to lack of competition, loss of economic efficiency and misallocation of resources.
The UK example: In the UK, The Competition Commission (CC), an independent public body, helps to ensure healthy competition between companies. The Competition Commission will study all proposed mergers, acquisitions and takeovers. It will also investigate any alleged abuse of market power by monopoly businesses. The main purpose of The Competition Commission (CC) is to ultimately benefits the customers and the whole economy.
The US example: In the US, The Federal Trade Commission (FTC) takes actions to prevent any unfair market practices, break up the monopoly or prevent business integrations. It is because anti-trust law is a collection of federal laws that regulate the activities of business organizations. The main purpose of The Federal Trade Commission (FTC) is to stop any illegal activities that would result in negative public interest – reduce competition that may lead to higher prices, reduced quality of products or lack of innovation.
