Econ 202 Principles of Contemporary Macroeconomics

1a) What is monopoly?

According to the American Heritage dictionary, �monopoly’ is described as:

i) a right granted by a government giving exclusive control over a specified commercial activity to a single party;

ii) a company or group having exclusive control over a commercial activity;

iii) a commodity or service so controlled.

A monopoly is a market with a single supplier of goods or services that has no close substitutes and in which natural or legal barriers to entry, prevents competition. Therefore, a monopoly exists when there is only one firm in the industry that has exclusive rights to manufacture and distribute its unique range of service or product.

Market for local telephone service, gas, electricity, and water are some examples of local monopoly. GlaxoSmithKline has a monopoly on AZT, a drug that is used to treat AIDS. DeBeers, a South African firm, controls 80 percent of the world’s production of raw diamonds-close to being a monopoly but not quite one.

However, it is not clear as to how an industry should or could be classified as a monopoly. There are many instances where an industry/ organization has monopoly over others, but there are replacement/ substitutes, which are similar in nature to the specific services, and products that make monopoly hard to achieve. It depends how narrowly the industry is defined. For example, a textile company may have a monopoly on certain types of fabric, but it does not have a monopoly on fabrics in general. The consumer can buy fabrics other than those supplied by the company. A rail company may have a monopoly over rail services between two cities, but it does not have a monopoly over public transport between these two cities. People can travel by coach or air. They could also use private transport.

To some extent, the boundaries of an industry are arbitrary. What is more important for a firm is the amount of monopoly power it has, and that depends on the closeness of substitutes produced by rival industries. The post office has a monopoly over the delivery of letters, but it faces competition in communications from telephone, faxes and e-mail.

In 1999, a landmark case in monopoly is revealed to the world when the U.S. government took on software giant, Microsoft Corporation for the use of its operating system widely. The majority of computers are pre-installed with Microsoft’s operating system called Microsoft Windows and has become a non-dispensable software operating system used in all Intel-compatible computers. The U.S. government has applied for a court order to stop Microsoft from monopolizing the Information Technology (IT) industry by imposing a heavy fine on its operations. This has prompted a U.S. federal judge, Thomas Penfield Jackson, who proclaims that “Microsoft holds a monopoly in computer operating systems, strongly criticizing the company in a decisive statement that could signal the outcome of the landmark antitrust case”, Wilcox (1999).

How can monopoly happen?

There are some circumstances in which monopoly can happen. Two instances where monopoly arises are:

i) No close substitutes;

ii) Barriers to entry.

i) No close substitutes

If a good has a close substitute, even though only one firm produces it, that firm effectively faces competition from the producers of substitutes. Water supplied by a local public utility is an example of a good that does not have close substitutes. Although it does have a close substitute for drinking-bottled spring water, it has no effective substitutes for doing the laundry, taking a shower, or washing a car.

Sometimes the arrival of a new product weakens a monopoly. For example, UPS, the fax machine, and e-mail have weakened the monopoly of the U.S. Postal service; broadband fiber-optic phone lines and the satellite dish have weakened the monopoly of cable television companies.

The arrival of a new product can also create a monopoly. For example, the IBM PC of the early 1980s created a monopoly in PC operating systems to Microsoft’s DOS (as in the earlier case of Microsoft’s monopoly).

ii) Barriers to entry

Anything that protects a firm from the arrival of new competitors is a barrier to entry. There are two types of barrier to entry:

a) Natural;

b) Legal.