What Are The Main Causes that Lead to Monopoly - Assignment Example

The inhabitants of the planet live in a world in which market structures determine the behavior of the economic activity of society. There are four market structures: perfect competition, monopolistic behavior, oligopoly, and monopoly. A monopoly is a market structure in which one firm makes up the entire market (Colander, 2004, p.264). If one firm controls the marketplace it means competition is non existent. In such a market structure the firm has control over the output produced or the price point of the product or service being rendered. The most common industry in which monopoly takes place is in the public utility industry. This paper analyzes monopoly by emphasizing in the factors that lead to manifestation of monopoly. In a monopoly market the firm doing business controls the price which means that it is not dependant on the marketplace to determine the price. The price is set at the quantity and price point that optimizes profit for the business entity. The fact that the company controls the price variable does not mean that a monopoly has immunity to the laws of demand and supply. The market demand curve just as in the perfect competition is downward sloping, but the difference is that in order to maximize profits price is not part of the equation and the formula is determined by the following equation, MR=MC. An example of an intangible asset or legal entry of barrier which allows the formation of a monopoly is a patent, which is legal protection of a technical innovation (Colander, 2004, p.271). A monopolist can achieve economic profits in the long run since the firm controls more variables than in other markets. The monopolist restricts overall output to find the price that reaps greater benefits for a firm. Since the monopolist marginal revenue is below its price equilibrium output is different than in a competitive market such as perfect competition. There are barriers of entry associated with a monopoly. The primary factor that leads to the creation of monopoly market structures is barrier of entry into the marketplace. A barrier of entry is a circumstance in a particular industry that creates a disadvantage for new competitors attempting to enter the market (Investorwords, 2008). The major barriers of entry that help in the creation of a monopoly are: natural, sociological, legal and technological factors (Kotler, 2003, p.246). An example of a way a company can achieve a monopoly market is through innovation. A firm awarded a patent for an invention obtains exclusivity to produce a product or service for period of time of 17 years. This constitutes a legal barrier of entry for any competitor that desired to compete against this firm. A company that created a monopoly market in 2005 with a patent award is Papyrus Australia (PPY) This firm created a method to produce paper out of banana trucks called banana ply paper (Papyrusaustralia, 2008). The company has the potential to create a billion dollar industry within this time span. By the year 2022 if this company continues to exist and achieve a high penetration of the market the accumulated knowledge the firm will achieve along with the learning curve gains will make it practically impossible for firms to penetrate their monopoly market which is a common characteristic of a natural monopoly. “If one firm is first to enter some market, it may have enough cost advantage to be able to discourage other firms from entering an industry” (Varian, 2003, p.434). A natural monopoly typically would not occur in a for a profit business entity since their objectives of maximizing profit and optimizing shareholder value are not aligned with the reality of this type of monopoly scenario. A natural monopoly occurs when there are large fixed costs and small marginal costs (Varian, 2003, p.430). The industry that has these types of characteristics is the public is the public utility industry. For example in the landline telephone business game the firms have huge costs to enter the industry due to the required infrastructure and high fixed costs associated with maintenance of the system. The marginal gains occur at a certain high level of production output after everything is set up and all costs are cover. At that point adding an extra customer does not costs anything and the firm can enjoy its marginal gains. In the past the traditional case was that the government would run public utilities businesses at an accounting breakeven point to provide the lowest possible price to the citizens in a region. The governmental bureaucracy caused huge business inefficiencies which forced many governments to sell off its public utilities business to private entities due to the high costs of maintaining them. Since the governments wanted to keep the prices down due to the tradition in the industry and voters expectations the solution to this natural monopoly industry was regulation prices. An economic concept that help governments entice the private sector who naturally were more efficient at running a business, but were not satisfied with the cost savings involved to make it worth their while was subsidies. A subsidy is an economic benefit or financial aid provided by government to (1) support a desirable activity, (2) keep prices of staples low, (3) maintain income of the producers of critical or strategic products, (4) maintain employment levels, (5) to induce investment in order to reduce the level of unemployment (Businessdictionary, 2008). The subsidies government provided to the private owners of utilities allowed firms to run at non negative profits while maintaining relatively equal or lower prices to the end-customers of the services. The quantitative or mathematical relation that causes monopoly is derived from a crucial factor called minimum efficient scale (MES). The minimum efficient scale is the output for a business in the long run where the internal economies of scale are exploited which corresponds to the lowest point in the long run average total cost curve (Tutor2u, 2008). In simple terms MES is the level of output that minimizes average costs in relative terms to the size of the demand or service offered. The geometric representation of the difference of the average cost curve in an open marketplace with many firms participating in it and a market with a dominant monopolistic firm is illustrated in appendix A. If the shape of the average cost curve is an open arc instead of a close constraint small arc then this is an indication of monopolistic behavior in the marketplace. This mathematical analogy is a relative statement, meaning that what matters is the scale relative to the market size (Varian, 2003, p.432). The economic policy practices of a nation can influence on whether or not a firm can attempt to establish a monopoly in a region. Non-restrictive foreign trade is a marketplace better suited for competition, while a restrictive trade political environment is an atmosphere that fosters monopolistic practices. The MES factor can induce a monopoly to rise in a region. When that occurs and the minimum efficient scale is large in relation to the size of the market then government intervention is recommended. The medium governmental entities utilize to intervene is typically through regulation. In order for a governmental intervention to be justified occurs if the cost of that intervention does not surpass the financial benefits for the people that come out of it. The resources of the government are limited and the citizens of the region are the taxpayers who directly fund governmental entities and their related activities. Thus it makes no sense for a government to intervene to lower the price of a firm that enjoys a monopoly if it takes away more resources than economic benefits the marketplace would receive otherwise. The cost of intervention includes the infrastructure, labor costs and material costs require to keep running a regulatory body. There is also additional opportunity costs associated with the intervention that also hurt the taxpayers of the region in the long run. Another way that monopolistic behavior can occur is when various firms in an industry plot together to collude and create output restrictions that diminish the supply intentionally in order to manipulate prices upwards and increase corporate profits. Such collusion which can manifest itself in other ways such as bribery, intimidation, fictitious price wars are not legal. Such collusion between firms in an industry creates an organization commonly referred too as a cartel. A cartel is an illegal monopolistic structure protected by antitrust laws due to their anticompetitive practices associated with such illicit activity. The cartel formation in essence creates a monopolistic conglomerate that prevents any other potential any other potential entrant into an industry from entering the marketplace. Looking at a monopoly as an undesirable market structure is a bias perspective that does not consider the social and economic benefits that a monopoly can bring to the table. The cartel example is the worst case scenario which in the 21st century is extremely difficult to occur since in the current economic cycle we are living in, the convergence age, information travels extremely fast and the investigative power of governmental entities as well as the legal consequences of attempting the formation of a cartel persuade corrupt business people from attempting them. An example of a company who legally achieved a monopoly without the creation of a cartel in the 21st century due to their technological superiority for a short period of time is Microsoft Corporation. This firm had the best operation system in the marketplace that allowed the on the highest market shares ever seen for a period of time of over decade. Their penetration on the operation system market share was over 90% constantly. Their own greediness was their demise since when other competitors tried to penetrate the market such as the people behind the Linux project and Apple Inc. the firm broke antitrust laws with subtle moves such as mandatory packaging of other software with their operation system such as internet explorer which gave them an illegal competitive advantage in the marketplace. Microsoft is still the market leader in the software business but their market share has gone down the more realistic plateau of around 80% dominance after the government intervened. There are good aspects of the potential of the creation of monopoly marketplace. Two of these positive variables are social benefits and innovation. Social benefits manifest themselves in natural monopolies such as the utilities industry since the people enjoy a great price that they would otherwise not receive if this industry operates in another market structure such as perfect competition. The possibility of obtaining a patent protection motivates lots of scientist to invent new things that benefit society in general when superior technological advances reach society. In the pharmaceutical industry the 17 year patent protection motivates firms to invest at times billion of dollars in research for new medicines to combat diseases since the implicit reward of having a de facto monopoly on a certain product allows them to get their investment back with a hefty profit in the latter years. Monopolies are a controversial market structure since most people think of them from a powerful business entity that destroys other competitors due to the absolute power the monopoly firms enjoys. This is pure fiction since in most instances there are many entrepreneurs that spend thousands of hours on research and development of a patent that does not make them a penny despite this individual or business entity having a monopoly business that never makes them any profit. References Colander, D. (2004). Economics (5th ed.). The McGraw-Hill Companies. Hirschey, M. (2006). Economics for Management (India Edition). India: Thompson South-Western. Businessdictionary.com (2008). Definition: Subsidy. Retrieved May 26, 2008 from http://www.businessdictionary.com/definition/subsidy.html Investorwords.com (2008). Definition: Barrier of Entry. Retrieved May 24, 2008 from http://www.investorwords.com/425/barriers_to_entry.html Kotler, P. (2003). Marketing Management (11th ed.). New Yersey: Prentice Hall. Papyrusaustralia.com (2008). Corporate website. Retrieved May 26, 2008 from http://www.papyrusaustralia.com.au/aspx/home.aspx Tutor2u.net (2008). Minimum efficient scale (MES). Retrieved May 26, 2008 from http://tutor2u.net/economics/content/topics/buseconomics/mes.htm Varian, H.R. (2003). Intermediate Microeconomics: A Modern Approach (6th ed.). New York: W.W. Norton & Company. Appendix A: Comparative graph of competitive vs. monopoly market structure (Varian, 2003, p.433). Legend: Left side = Competitive market Right side – Monopoly market Read More