Monopoly: A Brief Introduction

Monopoly is a term used by economists to refer to the situation in which there is a single seller of a product (i.e., a good or service) for which there are no close substitutes. The word is derived from the Greek words monos (meaning one) and polein (meaning to sell).

Governmental policy with regard to monopolies (e.g., permitting, prohibiting or regulating them) can have major effects not only on specific businesses and industries but also on the economy and society as a whole.

Two Extreme Cases

It can be useful when thinking about monopoly to look at two extreme cases. One is a pure monopoly, in which one company has complete control over the supply or sales of a product for which there are no good substitutes. The other is pure competition or perfect competition, a situation in which there are many sellers of identical, or virtually identical, products.

There are various degrees of monopoly, and rarely does anything approaching pure monopoly exist. Thus, the term is generally used in a relative sense rather than an absolute one. For example, a company can still be considered a monopoly even if it faces competition from (1) a few relatively small scale suppliers of the same or similar product(s) or (2) somewhat different goods or services that can to some limited extent be substituted for the product(s) supplied by the monopolist. A business that produces multiple products can be considered a monopoly even if it has a monopoly with regard to only one of the products.

A company with a product that is just slightly different from other companies' products (e.g., a unique brand of food or clothing) could be considered to have a monopoly for that narrow range of product (assuming that it could not be copied due to protection by a patent, copyright, trademark, etc.). However, it might have very little monopoly power within the broader product category that includes both its and its competitors' products (e.g., food or clothing as a whole). In contrast, a company with exclusive rights to sell a product for which there are few if any good substitutes (e.g., steel or table salt1) would have tremendous monopoly power.

For a product characterized by perfect competition (or nearly perfect competition), each supplier or seller must set its price equal to (or very close to) those of its competitors. This equilibrium price tends to be close to the cost of producing the product due to price competition among its many sellers. It is difficult for any seller to charge a higher price than its competitors because it would be easy for buyers to purchase from other sellers instead. It is likewise difficult for a seller to charge a lower price, because profit margins (i.e., revenue minus cost) are already thin2.

Naturally, all businesses, regardless of their degree of monopoly power, generally want to be as successful as possible, and thus they attempt to maximize their profits. However, it is much easier for a monopolist to make large profits through profit maximizing behavior than it is for a firm in a highly competitive industry. The reason is that the former has much greater flexibility in setting prices than does the latter, which has little if any control over prices.

The monopolist has this flexibility because there is little or no direct competition to force the price down close to the cost of production. Of course, the monopolist will be acutely aware of the fact that the higher the price it charges, the smaller will be the number of units sold (what economists refer to as the law of demand 3). This is because at higher prices some purchasers will just decide to buy fewer units or no units at all. A reduction in the number of units sold will eventually occur when the price rises to a sufficiently high level, regardless of how much buyers think they want the product, because buyers are ultimately limited by their incomes and savings.

Assuming (unrealistically, but for the sake of simplification) that a monopolist could only charge a single price for a product, it would find the unique price that maximizes its profits. Raising the price above that level would reduce profits because the negative effect of the reduction in the number of units sold due to the higher price would more than offset the positive effect from the higher price. This profit maximizing price would generally be substantially higher than the product's cost of production, and it would thus also be substantially higher than the equilibrium price that would exist for the product if it were instead supplied by a number of competitive firms. Likewise, the volume of output and sales would be substantially lower than in a competitive situation.

The monopoly power of a company for a product is commonly thought of in terms of its market share for that product. However, it can also be measured by the ability that a company has to set the price for the product. In fact, this is the measure of monopoly used by some government agencies when studying competition in various industries.

Price Discrimination

A seller of a product in a competitive industry (i.e., one characterized by many competing sellers of a good or service) generally can only charge a single price (i.e., the price that its competitors are charging) to all of its customers. However, monopolists not only have the ability to charge a higher price than would competitive firms supplying the same product, but they also have the ability to charge significantly different prices to different customers for the same product.

Monopolists are invariably well aware both of this ability and of the fact that by taking advantage of it they can often gain much greater profits than they could by just charging a single price to all customers. That is, a monopolist can maximize its profits by charging a separate profit-maximizing price for each type or group of customers (e.g., different income levels, professions, education levels, geographic locations or ethnicities) rather than by charging one profit maximizing price to all customers taken as a whole, because of the differences that generally exist among the different types or groups of customers with respect to their ability and willingness4 to pay. This behavior is termed price discrimination.

The ability to engage successfully in price discrimination depends on the degree of separation of markets, that is, how difficult or costly it is for buyers to transfer the product among themselves. For example, small, easily transportable items (e.g., those that come in a small box or that can be delivered via the Internet) are generally easier to transfer among buyers than are large, heavy products (e.g., hydroelectric generators and steel beams), customized products (e.g., consulting services or dental work) or products that make extensive use of a local language (e.g., books and some computer software). If a product is easy for buyers to resell, then businesses or individuals who can buy it at lower prices would have a profit incentive to resell it to others who would be charged a higher price by the monopolist. Monopolists generally are strongly opposed to such transferring of their products among buyers, and they tend to devote considerable effort to attempting to stop or minimize it.

Among the many tactics used by monopolists to attempt to separate their markets are the use of warranties that are only valid in the country of purchase and labeling a product and manuals for it only in the local language for each country or region. For example, a software developer could charge a relatively low price for its product in Thailand (a relatively low income country) and discourage its transfer to Singapore or Japan (relatively high income countries) for resale there in competition with the higher prices it charges in those countries by having the software operate only in the Thai language, which is generally not understood by people outside of Thailand, rather than having it be adjustable by the user to operate in any of a number of languages.

Region codes for computer games and DVDs (digital versatile disks) are also an attempt at price discrimination. These are codes that incorporated into the games and disks as well as into the players for them. They are designed to allow any game or disk to play only in the region in which it was sold, thereby allowing the sellers to control release dates and charge the profit maximizing price for each region. However, this is not always effective because some countries have outlawed the practice and required that players sold in their country be able to play games or disks from any region. Also, some users have been able to circumvent such regional lockout by modifying their players so that they can play games or disks from any region.

Another common example is student discounts, which are often available for some products, such as computer software, because suppliers of such products are well aware that the profit maximizing price for this class of customers is lower than that for people who work full time. Sale of the products at the special student prices is restricted through the requirement of student identification at the time of purchase, and subsequent resale is discouraged through such means as identification checks in order to use warranties and obtain upgrades.

Lower prices on some products are likewise often available for senior citizens, because, as is the case with students, the profit maximizing price is lower for them as a group due to their lower average income. Such recipients of lower prices will, of course, feel happy and feel as if they are receiving something special. This will help make a monopolist seem benevolent and can create goodwill for it. However, what is often being overlooked is the fact that this is not necessarily just benevolence (although it might be in some cases), but it is definitely profit maximizing behavior. In any event, the recipients of the lower prices will still likely be paying much more than the actual cost of providing the product.

Airlines are very efficient at separating their markets. This can be seen by the fact that tickets to any given destination are typically sold for a wide range of prices (generally with little relationship to the cost of providing the trip), even for adjacent seats on the same airplane. For example, a number of techniques are used to charge higher fares for business travelers (who are typically more concerned about convenience and time saving than about fares) than for leisure travelers (who are usually on tighter budgets), including by charging higher fares for people not making reservations far in advance or not willing to stay at a destination through a weekend (both of which business travelers often prefer not to do). The airlines are able to prevent the reselling of their tickets (and thereby maintain their separation of markets) through the use of identification checks at check-in and boarding times5.

Types of Monopoly

Monopolies can be classified in various ways, including according to the degree of monopoly power, the cause of the monopoly, the structure of the monopoly and whether the monopoly is with regard to selling or buying.

Frequently, instead of a single company, a monopoly consists of a group of companies that collude to control prices and quantities. In particular, an oligopoly is a situation in which sales of a product are dominated by a small number of relatively large sellers who are able to collectively exert control over its supply and prices.

A cartel is a type of oligopoly in which a centralized institution exists for the purpose of coordinating the actions of several independent suppliers of a product. Probably the best known example today is the Organization of Petroleum Exporting Countries (OPEC). A problem with cartels and other oligopolies, at least from the participants' point of view, is the fact that they are inherently unstable. This is because there is a strong incentive for each individual supplier to cheat and supply more than its allotted quota; this instability tends to be greater the larger the number of participants.

In the latter half of the nineteenth century trusts became a popular way to form monopolies in the U.S. A trust was an arrangement by which stockholders in several companies transferred their shares to a single set of trustees. In exchange, the stockholders received a certificate entitling them to a specified share of the consolidated earnings of the jointly managed companies. The trusts came to dominate a number of major industries. The largest and most infamous of these was Standard Oil, but trusts were also formed in numerous other industries including railroads, coal, steel, sugar, tobacco and meatpacking.

Although monopoly is most often thought of as referring to sellers, it can also apply to buyers. A monopsony is the opposite of a conventional monopoly in the sense that there is only a single buyer (or only one dominant buyer) for a product for which there are multiple sellers. Some companies are both monopolies and monopsonies. By being also a monopsonist, a monopoly can increase its profits even further (i.e., as compared with being a competitive purchaser) by putting pressure on the companies that supply inputs for its product(s) to reduce their prices.

It is relatively easy for a monopolist to also become a monopsonist in some cases because, by definition, a monopolist has one or more unique products, and thus it is possible that it would also need some unique inputs to produce those unique products. Even if a monopolist does not require unique inputs, however, it can still wield considerable monopsony power if it is a large company.

Causes of Monopoly

Monopolies have existed throughout much of human history. This is because powerful forces exist both for the creation and maintenance of monopolies6. At the root of these forces is the natural human desire for wealth and power together with the fact that monopolies can be immensely profitable and provide their owners with tremendous financial, political and social power.

Monopolistic power existed even in primitive societies because limited technical knowledge, poor transportation and small, scattered populations left little room for the emergence of numerous, competitive suppliers for some goods and services. In medieval Europe, guilds arose as transportation improved, economies grew and competition increased. Guilds were cartels formed by artisans and merchants for the purpose of controlling output, setting prices and establishing restrictions on new producers and sellers.

When nation-states began to emerge in the late Renaissance, monopolies proved to be a useful device for their leaders to acquire the resources to maintain large armies and extravagant life styles. Major European nations also granted monopoly powers to private trading companies in order to stimulate the exploration and exploitation of new lands in the Americas, Asia, Africa, etc.

Monopolies can arise in some circumstances as the result of normal business practices that are characteristic of firms in a highly competitive industry. Or they can arise as a consequence of what economists term anti-competitive practices, that is, behavior that is intended to destroy competition through means other than competing on the basis on price and quality (including the quality of services associated with the product). More specifically, monopolies can arise in any of the following, non-mutually exclusive, ways:

(1) By developing or acquiring control over a unique product that is difficult or costly for other companies to copy. This can occur as a result of a purchase, merger or research and development. An example is pharmaceuticals, which can be extremely expensive and risky to develop (and which are also protected by patents), thereby locking out all but a few large, well funded companies with ample talent. Closely related to this is control over a unique input for a product, such as a unique natural resource.

(2) By having a lower production cost than competitors. This can result from having a more efficient (i.e., more output per unit of input) production technique or from having access to a unique source of low cost inputs (e.g., a mine containing exceptionally high grade ore). In some cases, a greater efficiency is the result of economies of scale, which means that the production cost per unit of product declines as the volume of output increases due to the ability to use some resource more intensively (e.g., a steel mill or railroad with lots of excess capacity).

This category includes natural monopolies. A natural monopoly exists for a product for which there are sufficient economies of scale such that the product can be produced or supplied by a single company at lower cost than by multiple, competing companies. Examples include utilities such as railroads, pipelines, electric power transmission systems and wired telephone systems. It is often wasteful (for consumers and the economy) to have more than one such supplier in a region because of the high costs of duplicating the infrastructure (e.g., parallel railroad networks in a region or two sets of telephone wires to every house).

(3) By using various legal and/or illegal tactics, often referred to as predatory tactics, aimed specifically at eliminating existing or potential competition, such as (a) buying out or merging with competitors, (b) temporarily charging prices below cost to drive competitors out of business (often referred to as predatory pricing or dumping), (c) using a monopoly in one product to create a monopoly with regard to another product (sometimes referred to as the bundling or tying of products), (d) taking control of suppliers of inputs required by competitors or conspiring with them to raise their prices (or lower their quality of service, etc.) to competitors (e) taking control of, or conspiring with, suppliers of other products used by competitors' customers, (f) threatening costly litigation (e.g., regarding allegations of patent or copyright infringements regardless of the legal merits of such claims), which large companies can easily afford but small companies often cannot and (g) using blackmail or threats of violence.

Horizontal integration is the gaining of control by one company over other producers or sellers of the same product. The acquired companies can appear to be quite diverse. Often the acquisition of control is not publicized, and sometimes different branding is used to create the illusion of competition. For example, a broadcasting company might acquire various radio and/or television channels each with a different focus in order to gain control of most of the entire listener or viewer market in a region and thereby prevent the emergence of competitors.

Such seeming diversity can also offer offer other benefits to a monopolist. In particular, it can be valuable in separating markets, thereby allowing the monopolist to charge separate, profit maximizing prices in each. It can also make the existence of a monopoly less conspicuous and less of a target for public criticism, government intervention and the emergence of new competitors.

(4) By controlling a platform and using vendor lock-in. A platform is a standardized specification for a product that allows its providers and users and their products to interoperate without special arrangement. This reduces the overall costs of conducting transactions by removing some of the costs of matching up products with buyers. Lock-in is the practice of designing a product that cannot interoperate with products made by other companies in order to make it difficult and/or costly for users to switch to competing systems. Lock-in is also used so that replacement parts or add-on enhancements must be purchased from the same manufacturer. Examples would include a computer operating system or a portable music storage/replay device that is controlled by a single company.

(5) By receiving a government grant of monopoly status, i.e., becoming a government-granted monopoly. Today this is usually accomplished through the acquisition of a license, patent, copyright, trademark or franchise. Common examples include a franchise for cable television for a certain city or region, a trademark for a popular brand, copyrights on certain cartoon characters or a patent for a unique product or production technique.

As governments usually have the final authority regarding the creation, maintenance and extension of monopolies, public relations, particularly lobbying and advertising, are important tools for monopolists for convincing politicians to ignore, approve or even bless anti-competitive acquisitions, mergers, etc. Among the arguments typically made by monopolists are that such acquisition or merger is in the public interest because it would allow them to (1) spend more money on research and development in order to develop new and improved products, (2) standardize what would otherwise be a chaotic market (i.e., vigorous competition) and (3) reduce costs, and thus prices, through (a) the reduction of redundant production facilities and employees, (b) concentrating production at the most efficient production facilities and (c) obtaining greater economies of scale. Monopolists also frequently support such requests with the claim that they are model corporate citizens and that they are great contributors to charitable and educational causes.

The term barriers to entry is used by economists to refer to obstacles to businesses or to individuals wanting to enter a given field. Some of these barriers occur naturally, whereas others are erected or strengthened by monopolies in order to maintain or enhance their monopoly positions. Examples include the extremely high cost of developing new drugs, limited sources for a low cost input, a dominant platform for software or other products, patent protection of a low cost production technique, the difficulty of trying to compete with famous brands and air transport agreements that make it difficult for new airlines to obtain landing slots at popular airports.

Why Monopolies Can Be Beneficial

Despite their reputation for evil, monopolies can actually generate a net benefit for society under certain circumstances. These are usually situations in which the power and duration of the monopoly are carefully limited.

Natural monopolies can be particularly beneficial. This is because of their ability to attain lower costs of production, often far lower, than would be possible with competitive firms producing the same product in the same region. However, it is almost always necessary for such monopolies to be regulated by a relatively uncorrupted government in order for society to obtain the potential benefits. This is because such monopolies by themselves, as is the case with all monopolies, have little incentive to charge prices close to cost and, rather, tend to charge profit-maximizing prices and restrict output. Likewise, there is often little incentive to pay much attention to quality.

It has long been recognized that government-granted monopolies (i.e., patents, copyrights, trademarks and franchises) can benefit society as a whole by providing financial incentives to inventors, artists, composers, writers, entrepreneurs and others to innovate and produce creative works. In fact, the importance of establishing monopolies of limited duration for this purpose is even mentioned in the U.S. Constitution7. In addition to being for limited periods of time, such monopolies are also generally restricted in other ways, including that there are often fairly good substitutes for their products8.

Why Monopolies Can Be Harmful

Large monopolies have considerable potential to damage both economies and democratic governments (although they can be very beneficial for other types of governments9). Unfortunately, the full extent of the damage is usually not as obvious, at least to the general public, as are the seemingly beneficial effects. And monopolists often go to extreme lengths to disguise or hide such harmful effects. Among the ways in which unregulated monopolies can harm an economy are by causing:

(1) Substantially higher prices and lower levels of output than would exist if the product were produced by competitive companies.

(2) A lower level of quality than would otherwise exist. This includes not only the quality of the goods and services themselves, but also the quality of the services associated with such goods and services.

(3) A slower advance in the development and application of new technology. Advances in technology can improve the quality (e.g., ease of use, durability, environmental friendliness) of products, and they can also reduce their costs of production. Innovation is not as necessary for a monopolist as it is for a highly competitive firm, and, in fact, it can be a bad business strategy. Research and development by monopolists is often largely focused on ways of suppressing new, potentially competitive technologies (and includes such techniques as stockpiling patents) rather than true innovation 10. This can be a serious disadvantage, because economists have long recognized that innovation is a key factor (and possibly the single most important factor) in the growth of an economy as a whole11.

The adverse effects of monopolies can be much more noticeable on an individual level than in the aggregate. These effects include the destruction of businesses that would have survived had competition been based solely on quality and price (with a consequent loss of assets of the owners and jobs of the employees) and prices for products so high as to cause hardship or be unaffordable for some people.

It is often said, even by those who have negative opinions about monopolies, that "monopoly itself is not necessarily bad, but rather it is the abuse of monopoly power that is harmful." This statement is an excessive simplification, and it can be indicative of a lack of understanding of the full extent of harm that can be caused by monopolies.

The abuse of monopoly power clearly can be harmful to an economy. The term abuse in this context refers to such tactics as predatory pricing, colluding with suppliers and the leveraging of a monopoly in one product to gain a monopoly for another product. But what is often overlooked, even by legislation whose supposed purpose is to restrain or regulate monopolies, is the fact that monopolies can be harmful even if they do not engage in such practices.

If a monopolist engages in behavior that produces results similar to that by firms in an industry that is characterized by intensive competition (i.e., charges prices close to cost and does not engage in price discrimination), then there might not be a problem. Unfortunately, however, this is rare even for a seemingly benevolent monopolist. The reason is that the very strong incentives to maximize profits that exist for virtually any business, whether pure monopolist, perfect competitor or somewhere in between, produce very different results for a monopolist than they would for a firm in a highly competitive industry. And monopolists (as is the case with competitive firms) usually do not rank benevolence as a top corporate priority.

Thus, the management and employees in a monopoly might not at all be aware that they are harming the economy, especially if their behavior is similar to that by a non-monopoly. In fact, they may even genuinely believe that they are benefiting the economy because of their conviction that they are more efficient and productive than a number of firms competing with each other would be.

Another reason that the positive effects of even a benevolent monopolist would not be as great as for a competitive company is that innovations that improve quality and reduce production costs are often the result of desperation. (This is something that is easy for many owners of struggling businesses to understand, but is often difficult for others to fully grasp without experiencing it firsthand.) Monopolists generally consider themselves successful, and thus, although they often are innovators to some extent (typically mainly in their earlier years), they usually just do not have that extra motivation to produce truly breakthrough innovations that smaller companies desperate to gain market share (or to just survive) have.

Monopolies and Political Corruption

An additional reason that monopolies can be harmful is that they are often linked to corruption of the political system. That monopolies have both the ability and the desire to use the government for their own ends has been demonstrated repeatedly throughout history.

A free market (i.e., large numbers of competing producers and purchasers, each acting in its own self interest) economy is usually very efficient at making the best decisions for the economy and society as a whole. However, there are some situations, termed by economists as market failure, in which free markets do not work for the best interests of the economy or society as a whole and in which it is thus beneficial to have government intervention (e.g., setting and enforcing rules) for such purposes as (1) protecting public health and the environment, (2) protecting businesses and the public from illegal or abusive behavior by other businesses and (3) regulating natural monopolies.

Businesses naturally have an incentive to try to influence the political process in order to obtain favorable legislation, such as easing costly environmental or safety regulations. It is also natural for them to want legislation that restricts competition in their industry in order to give them some extent of monopoly power. However, in a competitive industry such lobbying can be difficult because there will be many competitors fighting to prevent each other from getting special favors from the government.

In the case of a monopoly, however, the situation is very different. A large monopolist is in a much stronger position to influence the political process because (1) it has much greater financial resources than individual competitors due to the inherent profitability of monopolies, (2) it often can exert considerable pressure on its customers and/or its suppliers to influence politicians on its behalf and (3) there is less opposition because competitors, if they exist at all, are relatively weak.

Reasons that a monopolist would want to influence the political process include (1) to ensure that anti-monopoly measures are not undertaken or that, if they are undertaken, they are just superficial, (2) to strengthen and extend its monopoly position, including to additional products, (3) to prevent or weaken legislation regarding health, environmental, safety and labor relations (i.e., the rights of workers) and (4) to promote the philosophical views of its owner(s) (e.g., with regard to politics or religion).

There are several ways in which a monopolist can influence public policy. Some are legal, others might be illegal or, at least, unethical. They include (1) campaign contributions, (2) gifts, (3) lobbying, (4) putting pressure on suppliers and customers to influence the political process and (5) expenditures (e.g., for advertisements) to influence the public to persuade politicians.

The Philanthropy Argument

The argument is sometimes made that, regardless of whatever other faults that monopolies might have, they should be valued for their great contributions to philanthropic causes. However, there are several problems with this view.

One is that not all monopolies engage in substantial philanthropic activities. Moreover, even for those that do so, such expenditures generally involve only a small part of their total monopoly profits. It can also be argued that monopoly profits are merely taking away funds from other businesses and individuals who might have otherwise spent as much or more (but less conspicuously) on philanthropy.

Moreover, it should be kept in mind that the costs to society from the existence of a monopoly are often much higher than just a transfer of wealth from buyers to the monopolist in the form of higher prices (i.e., they also include the inferior quality, the stifling of innovation and the corruption of democratic political processes), and thus such costs tend to be far greater than any possible benefits from philanthropy.

Philanthropy is far from being an exclusive behavioral trait of monopolists, and it is, in fact, engaged in to some extent by the entire spectrum of organizations and individuals. (This even includes suppliers of illegal narcotics and terrorist organizations, who are well aware that charitable activities can be a very effective and relatively inexpensive means to consolidate and maintain local power.)

In addition, many economists contend that if philanthropic spending is to occur, there are are almost certainly more efficient ways to generate resources for it than by monopoly behavior.

Long-run Instability of Monopolies

Monopolies tend to eventually lose their monopoly power, often in a surprisingly short time, despite their usually vigorous efforts to resist such loss. The companies themselves, however, tend to survive much longer, largely as a result of the great market share, large production capacity and vast wealth and power that they accumulated during their period as a monopolist. The causes of this loss can be grouped into two broad categories: market forces and government intervention.

Just as there are very strong incentives to create and maintain monopolies, strong forces also exist to weaken and destroy monopolies. They can be intentional or unintentional. They likewise revolve around the eternal quest for wealth and power, and they are often at least partially the result of other businesses trying to weaken or destroy monopolies for their own competitive advantage.

Probably the most important such force is innovation or technological advance. This often leads to the development of lower cost production techniques for existing products or the development of completely new products that make it possible for other companies to successfully challenge monopolies. The causes of technological advance are complex, but clearly the hope of challenging an existing monopoly or even starting a new monopoly provides very strong incentives for potential competitors to push research and development aimed at creating new or improved products or production techniques.

Telephones are an often cited example. Wired telephone systems have many characteristics of natural monopolies and thus have been monopolies in most countries. However, technological advance has made it possible for cellular phones to emerge in recent years as a very strong competitor. Cellular phone companies have been able to offer substantially reduced calling charges as compared with wired phones in countries where wired phone charges have remained high and still be very profitable. This competition has greatly weakened the monopolies of wired telephone systems and has forced them to reduce their charges and improve service. Likewise, another new communications technology, VoIP (Voice Over Internet Protocol), is increasingly threatening the oligopolistic nature of conventional long distance telecommunications companies.

Thus, monopolies often make strenuous efforts to stifle the development of new technology and to prevent its application. This includes influencing governments to ban or strictly regulate new technologies, engaging in research and development efforts to patent new technologies before potential competitors can, buying up patents from other companies, and using litigation to claim rights to patents that they might not actually own.

The destruction of monopolies is hastened by their generally higher prices and inferior products. The higher the prices and the more shoddy the products, the easier (and more profitable) it is for new competitors to emerge.

Another possible weakness of monopolies can be their large size and the increasingly bureaucratic and rigid nature of their organizations as they grow in size and years. This can make it difficult for them to respond quickly or skillfully to changes in market conditions and to the emergence of new technologies. In fact, there are natural incentives for individual employees and groups of employees within a monopoly to become very conservative and do as little as possible to promote or facilitate any changes in the monopoly (as there are in most large organizations).

Specious Arguments for Tolerating Monopolies

The argument is often heard that "the government should leave monopolies alone, because their success is a result of market competition." This argument is very misleading for several reasons.

One is that, in many cases, monopolies that have arisen largely as a result of illegitimate or illegal tactics (rather than through competition based on lower prices and superior quality) and they have made great efforts to hide that fact from the general public and politicians.

A second reason is that, even if a monopoly arises by fully legitimate means, there are strong temptations for it to engage (even unknowingly) in practices that are bad for the economy as a whole (e.g., higher prices, lower output and less innovation than in a highly competitive situation), although such behavior and its consequences are usually not readily apparent to laymen or to political decision makers.

It has also been argued that governments need not intervene because monopolies always tend to break down in the long run anyway due to market forces. A major problem with this view is that the long run can be many years12, and the economy and society can suffer substantial damage in the the meantime. Another problem is that this approach does not provide a deterrent to the creation and abusive behavior of new monopolies.

Optimal Public Policy

Public policy with regard to monopolies should ideally be based on what is most efficient for the economy and society as a whole. For natural monopolies, it is generally most efficient to maintain the monopoly, but subject it to government regulation with regard to prices, quality of service, etc.

In the case of monopolies that are not natural monopolies (i.e., products for which there is no great advantage in terms of economic efficiency to having a monopoly), public policy decisions should depend in large part on the behavior of the monopolist. If the monopolist is regarded as charging reasonable prices, providing high quality products, being innovative and not engaging in abusive practices, then there might be good reason to leave it alone. One reason to leave a monopoly alone in such circumstances is to avoid what can be the very substantial costs involved in regulating it or breaking it up.

But if it is determined that a monopolist is charging prices substantially higher than, providing quality lower than, or being less innovative than would occur under competitive conditions or engaging in abusive practices, then there is good cause to take aggressive action.

The ways in which governments can intervene to reduce the adverse effects of monopolies can be classified into three broad categories: (1) strengthening of existing competition or promoting the emergence of new competition by such means as encouraging innovation, providing government contracts to competitors and providing favorable financing to competitors, (2) regulating the monopoly to limit prices, eliminate price discrimination, set quality standards, restrict political activities, etc. and (3) breaking up the monopoly.

When monopolies are permitted to exist, there are several types of policies that should be implemented in order to assure maximum benefit to the economy. They include (1) outlawing price discrimination, (2) outlawing the use of monopoly power with regard to one product for the purpose of gaining a monopoly with regard to other products, (3) setting standards for quality and (4) restricting the direct or indirect political activities of the monopolist.

Because of the strong consensus among economists that large monopolies, and particularly those that abuse their monopoly powers, can be harmful to an economy, most industrial countries have enacted laws aimed at preventing anti-competitive practices and have regulators to aid in the enforcement of such laws.

There has, in fact, been a long history of governments attempting to deal with the abusive practices of monopolists. For example, in 1624 the English Parliament passed the Statute of Monopolies, which greatly restricted the king's right to create private monopolies in the domestic economy. However, this legislation did not apply to the monopoly powers granted to companies formed for overseas exploration and colonization.

The U.S. first attempted to curb monopolies at a national level was through the enactment of the Sherman Antitrust Act in 1890 in response to the widespread revulsion to the highly abusive practices of Standard Oil. Despite the subsequent passage of a variety of additional antitrust (i.e., anti-monopoly) measures, the Sherman act remains in many respects the most important piece of legislation in the U.S. with regard to monopolies.

Unfortunately, the degree of enforcement of antitrust legislation has varied wildly, even within individual countries (or with regard to individual companies), and it has frequently been based more on political considerations than on economic merit. This is, of course, due to the great difficulty for governments to take effective action against even the most abusive of monopolies because of the exceptional political influence that monopolists tend to acquire and the fact that the adverse effects of monopolies are often less obvious to the public and to politicians than are the supposed beneficial effects.

1 Salt has a long history of being a monopoly in much of the world because it is naturally scarce in many regions and because of the strong demand for it (particularly for use as a food preservative and as a flavor enhancer). Salt monopolies have been a very convenient way for governments and large companies to raise vast amounts of money. For example, the rise of Venice to greatness is attributed in large part to its salt monopoly.

2 The exception would be if some company had a lower cost of production than the others, in which case it could become a monopoly if it could expand its output sufficiently.

3 The law of demand states that the quantity purchased is a negative function of the price. That is, the higher the price, the less will be purchased. Interestingly, there are virtually no exceptions to this principle. In terms of the demand curve that is studied in economics classes, this law means that the curve always slopes downward to the right, although some sections may be horizontal or vertical.

4 This is what economists refer to as the price elasticity of demand. A product which buyers urgently want and for which they are relatively insensitive to its price, such as drinking water or table salt, is said to have a low elasticity of demand. A product for which buyers are relatively sensitive to its price has a high elasticity of demand. Monopolists will be aware (even if they are not familiar with this terminology) that different types or groups of buyers may have different elasticities of demand, and they will take such differences into consideration in their profit maximizing calculations.

5 Airlines are not generally considered to be monopolies because there is usually a choice of airlines as well as other modes of transportation from which to choose. However, individual airlines often have substantial monopoly power on certain routes and/or for certain times because they might be the only choice for high speed travel or shipping for a particular route or for that route at a certain time.

6 The argument could be made that this implies that monopolies are the natural state of an economy and thus government intervention should not be used if one believes in a free market economy. However, kings or other dictatorships have also existed throughout most of history, and thus it could likewise be argued that dictatorship is the natural form of government and its citizens should not strive to break it up in order to attain or restore democracy.

7Article I, Section 8 of the U.S. Constitution states: The Congress shall have Power . . . To promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.

8 For example, the fair use doctrine allows people to make copies of copyrighted materials in some situations, trademarks can become invalid if they are not actively protected and patents can be ignored by the government if it wants to use an invention for its own purposes.

9 Large monopolies can be an efficient means of both raising revenue and consolidating power for governments whose primary goals are other than the prosperity of their citizenry (e.g., the accumulation of wealth and power for their leaders). As economic competition and political competition tend to go hand in hand, restricting economic competition through the tolerance for or encouragement of monopolies can be an effective way of restricting political competition (and thus restricting political freedom). In fact, monopolies have commonly been used throughout history for these purposes.

10 There have been a few major exceptions to this. Most notable was Bell Labs, the research and development arm of AT&T. AT&T was one of the largest and most pervasive monopolies in recent U.S. history, although a highly regulated and generally benevolent one. Bell Labs was perhaps the most prolific source of innovation that has ever existed, and it was responsible for such revolutionary inventions as the transistor, the single-chip 32-bit microprocessor, the UNIX computer operating system and the C and C++ programming languages.

11 For a more detailed look at how monopolies affect technological advance, see Why and How Monopolies Impede Technological Advance, The Linux Information Project, June 12, 2006.

12 As John Maynard Keynes, one of the most influential economists of the twentieth century stated so eloquently in what is possibly his most famous quote: "In the long run we are all dead." (No wonder economics is often referred to as the dismal science!) Keynes was referring to the Great Depression of the 1930s and to those economists who advocated letting the market mechanism eventually restore the economy to prosperity instead of calling for immediate government intervention.

Created January 20, 2005. Updated December 1, 2006.
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