Background
Suppose you want to purchase a specific type of mango that is only grown in a small region in Mexico. There are many mango farmers in this region, but only one company has the right to sell all these mangoes. They’re priced three times higher than any other mangoes, which is absurd, but there’s no other company selling these rare mangoes. Your only two choices are to pay for these overpriced mangoes or not buy any at all.
Explanation
The company that sells these mangoes is an example of a monopoly. It can choose whatever price it wants to sell the mangoes for because it doesn’t have to compete with another company that sells the same product. Therefore, it has the freedom to charge an unfair price for its mangoes.
Definition: Monopoly
A monopoly is the exclusive control of the supply of a good or service. It is typically characterized by a lack of economic competition to produce that good or service and has limited viable substitute goods.
How Are Monopolies Formed?
There are a few different ways that one company can come to control the market for a good or service. First, the government can grant a company exclusive rights through patents and copyrights. Second, a natural monopoly can form when it is more cost-effective to have one large producer rather than several smaller ones, which is often the case with infrastructure and utilities like water and electricity. Natural monopolies may also form when a company controls a scarce resource that competitors don’t have. However, not all monopolies that form this way are natural monopolies. For instance, if a mining company took advantage of their exclusive access to diamonds to create a monopoly of the diamond business, they are not a natural monopoly.
Other ways that monopolies form are through mergers, acquisitions, and vertical and horizontal integration. Vertical integration is when one company has control of all or most of its supply chain. For example, a company can be vertically integrated if they manufacture, distribute, and sell all their products without working with outside entities. Horizontal integration is when one company buys or merges with another company that produces a similar product. An example of this would be if one soda company purchased another soda company.
In order for a company to maintain monopoly power, there must be high barriers for other companies trying to enter the market. One of the most common ways monopoly power is maintained is through predatory pricing, which is when companies lower the price of their goods to pressure rival companies. Limit pricing is a type of predatory pricing where a company will lower the price of the good to the point that competitors will make no profit if they try to compete. Brand loyalty and exclusive contracts are other barriers to entry; when consumers are loyal to a particular brand or retailers are loyal to particular suppliers, it is difficult for rival companies to enter the market. Companies with large market share in a given industry also maintain monopoly power because it is difficult for other companies to compete. Lastly, new companies and small businesses will be unable to enter the market if the cost of entry is too high.
Generally, monopolies are criticized because they are the antithesis of free-market capitalism, which tends to value competition and choice. When little to no competition or substitutes exist, consumers are forced to purchase from the company, despite unfair prices. However, it’s important to note that monopolies can only exist when there isn’t sufficient regulation, so there is debate surrounding how much the economy should be regulated to prevent the creation of monopolies.
Regulation
The United States government has combated monopolies through antitrust laws, which aim to promote competition. For example, antitrust laws are in place that require government approval for mergers and acquisitions, which limits the possibility for companies to expand too much. Antitrust laws can also prevent companies from making exclusive deals with suppliers, which is a practice that limits competition. For example, if a sandwich shop made a deal with a bread company to only sell their bread to this particular sandwich shop, the government has the power to prevent this deal. Lastly, the government also has the freedom to deregulate, or break up, monopolies.
Why Care?
The United States still has companies that can exercise monopoly power, including industries such as search engines, technology, and retail. Furthermore, many of the utilities in the area you live in are likely controlled by one company.
Understanding how monopolies function in our economy is extremely important. They affect the prices of the goods and services we buy, the ability of small businesses to enter the market and succeed, and the number of choices we have available to us. Once a company gains monopoly status or reaches a point where it can exercise significant control over a particular market, it is possible for that company to abuse its power. So next time you see one company dominate a market or you are charged an unfair price for a product, think about certain monopolistic practices in place today and how they affect you.
