The simplest way for a monopoly to arise is for a single firm to own a key resource. For example, consider the market for water in a small town in the Old West. o But if there is only one well in town and it is impossible to get water from anywhere else, then the owner of the well has a monopoly on water. o Not surprisingly, the monopolist has much greater market power than any single firm in a competitive market. o In the case of a necessity like water, the monopolist could command quite a high price, even if the marginal cost of pumping an extra gallon is low. Although exclusive ownership of a key resource is a potential cause of monopoly, in practice monopolies rarely arise for this reason. Government-Created Monopolies In many cases, monopolies arise because the government has given one person or firm the exclusive right to sell some good or service. The patent and copyright laws are two important examples o When a pharmaceutical company discovers a new drug, it can apply to the government for a patent. If the government deems the drug to be truly original, it approves the patent, which gives the company the exclusive right to manufacture and sell the drug for twenty years. o Similarly, when a novelist finishes a book, she can copyright it. The copyright is a government guarantee that no one can print and sell the work without the author's permission. The copyright makes the novelist a monopolist in the sale of her novel. Because these laws give one producer a monopoly, they lead to higher prices than would occur under competition. But by allowing these monopoly producers to charge higher prices and earn higher profits, the laws also encourage some desirable behavior. o Drug companies are allowed to be monopolists in the drugs they discover to encourage research. o Authors are allowed to be monopolists in the sale of their books to encourage them to write more and better books. Natural Monopolies An industry is a natural monopoly when a single firm can supply a good or service to an entire market at a lower cost than could two or more firms. o A natural monopoly arises when there are economies of scale over the relevant range of output.
Figure 1 shows the average total costs of a firm with economies of scale. In this case, a single firm can produce any amount of output at least cost. That is, for any given amount of output, a larger number of firms leads to less output per firm and higher average total cost. o When a firm's average-total-cost curve continually declines, the firm has what is called a natural monopoly. In this case, when production is divided among more firms, each firm produces less, and average total cost rises. As a result, a single firm can produce any given amount at the smallest cost.