A monopoly is a market structure in which one company is the only supplier of a good or service for which there is no close substitute. The supplier is a monopolist. Unlike the market structure of perfect competition, in which individual suppliers have no ability to set prices, the monopolist is a price maker with a lot of market power. The monopolist's market structure has considerable barriers to entry, so potential competitors cannot easily enter the market. These barriers could be economies of scale, legal barriers, innovation, and a monopolist's control of key resources or a monopolist's ability to practice strategic pricing, which deters competitors from entering the market (or drives out new firms).
At A Glance
- Firms operate in a range of different market structures. Monopolies are characterized by markets with only one supplier of a good or service for which there are no close substitutes.
Barriers to entry prevent or obstruct the entry of new firms into a market and limit the amount of competition that existing firms must face.
Economies of scale, wherein products made in larger quantities become cheaper and products made in smaller quantities are more expensive, create barriers to entry when average fixed costs are high.
- Monopolists can use control of key resources to create barriers to entry for potential competitors.
- Economies of scale give monopolists lower break-even prices, allowing them to strategically set prices below those at which competitors can make a profit.
- Monopolies may stimulate or stifle innovation, and economists debate the extent to which they benefit or harm the economy as a result.
Legal barriers to entry, such as patents and copyrights, are intended to encourage innovation. These barriers create a temporary monopoly for inventors and patent holders.
- The monopolist has the ability to determine the price and/or the amount of the good or service that is available to consumers. Profit-maximizing firms produce where their marginal cost is equal to their marginal revenue.
- Compared to a perfectly competitive market, a monopoly has higher prices and a lower quantity of products available for purchase. There is both excess capacity in the market and deadweight loss to the economy as a whole.
Disadvantages of a monopoly include higher prices with lower output, higher costs from lack of innovation, and unequal distribution of income in the economy.
Advantages of a monopoly include economies of scale and lower costs over time because of innovation.