Monopoly: what it is, how it works and main characteristics

What is a monopoly?

A monopoly exists when a particular company dominates the entire market or an industry in which it offers its products or services. This term comes from the Greek  monos  (single) and  polein  (to sell).

The existence of a monopoly can occur due to different factors. One type is the natural monopoly in which no other company has an interest in entering the market to offer a particular product.

In economics, monopoly is considered the opposite of perfect competition, when there are a maximum number of producers in a market and in competition.

The term monopoly is also widely used to describe a company that has all or most of the demand in the market. As an example, we can cite Google for being the most used search tool on the Internet.

Characteristics of monopolies.

Although monopoly markets have differences, they tend to have some similar characteristics that are causes of their appearance.

  • Barriers to entry for other companies.

Barriers are often one of the main causes of a monopoly. These barriers may exist legally or due to the cost structure required to enter.

The cost structure to produce a good can generate a natural monopoly, since having high entry costs makes a single company stay. An example of this comes from electricity supply companies or airlines in small countries.

  • The individual company sets its price.

Market demand is the demand of the only installed company, so you can define and control the market price.

By setting the price it will charge, the company ends up offering lower amounts than would be offered if there were more companies in the market.

The benefit is achieved with much less effort, as there is little technological innovation in this market. In a more competitive market, profits depend on the market price agreed by each company.

  • There are no close substitutes

The product or service offered by a monopoly does not have indirect competition through goods that can replace the utility offered.

This is a common scenario in smaller cities where there is only one telephone network or internet provider, for example.

There are situations in which the company with a monopoly is present in a more competitive market, different from the one it monopolizes. In this case, price discrimination is common and charges a lower and different price than the monopoly market.

  • Economy of scale

A monopoly can generally produce at a proportionally lower cost than other smaller companies.

In the company that has monopoly power, the average cost of production decreases as its production increases.

With a much lower cost, the organization can increase its actions with more investments, without compromising its income, and control the market.

How a monopoly works

In a market or industry, the existence of a monopoly is considered when there is no competition from the only company installed and supplier of a good.

The monopoly market is characterized by the existence of  several buyers who depend on a company that supplies the goods  . In addition, there are no other products that can replace the main good.

In this market, there may also be barriers that prevent the entry of other companies that would be competitors. When this happens, the monopolist has the ability to influence price and produce at a higher profit capacity.

Barriers can create a kind of natural monopoly, such as when a single company has a patent to produce a good or even an authorization to do so.

By operating with economies of scale, the monopolist can achieve a volume of production in which his marginal revenue equals his marginal cost. This is how you can charge high prices according to the demand in the monopoly market.

Difference between monopoly and perfect competition

In economics, perfect competition is a market model in which as many companies as possible compete with similar products.

It is considered the opposite of monopoly and exists only as a theoretical model, since in the real world companies compete by promoting the differentiation of their products or services.

Between the two extremes of perfect competition and monopoly, there is imperfect competition, which begins to consider the way most markets function in the economy.

One of the best examples of imperfect competition is oligopolies, in which a very small number of companies dominate the market. Both monopolies and oligopolies must be closely monitored by the authorities that monitor competition in the economy.