Sources of Monopoly Power

Sources of Monopoly Power

A monopoly is a market structure with a single seller. Unlike a competitive firm, a monopolist has market power—the ability to influence the price. Where does this power come from?

The Concept of Monopoly

Pure monopoly: a sole seller of a good without close substitutes.
Market power: ability to set the price above marginal cost.
The monopolist is a price maker, not a price taker.
Demand for the monopolist's product: coincides with market demand.
Downward-sloping curve—to sell more, must lower the price.

Sources of Monopoly Power

1. Control over a key resource:
   Historically: De Beers and diamonds
   Unique deposits, water rights
   Rarely creates an absolute monopoly
2. Legal barriers:
   Patents: temporary monopoly on an invention (usually 20 years)
   Copyrights: protection of intellectual property
   Licenses: government restriction of the number of participants
   Franchises: exclusive rights (postal service, utilities)
3. Natural monopoly:
   Economies of scale are so great that one producer is more efficient than several
   High fixed costs, low variable costs
   Examples: electric grids, water supply, railways
4. Network effects:
   Value of the product grows with the number of users
   Winner takes all
   Examples: operating systems, social networks, payment systems
5. Strategic barriers:
   Predatory pricing
   Exclusive contracts
   Excess capacity as a threat
   May be illegal under antitrust law

Natural Monopoly in More Detail

Condition: LRAC decreases over the entire relevant demand range.
One producer supplies the entire market cheaper than several.
Characteristics:
High FC (infrastructure), low MC
Cost subadditivity: $C(Q_1 + Q_2)$
Examples:
Utility networks (water, gas, electricity)
Transport infrastructure
Telecommunications (historically)
Problem: an unregulated natural monopoly will abuse its power.
Hence—regulation or public ownership.

Monopoly vs Market Power

Degrees of market power:

• Pure monopoly—one seller, no substitutes
• Dominant firm—one large player, small competitors
• Oligopoly—several large players
• Monopolistic competition—many sellers, differentiated products

In reality, pure monopoly is rare. But market power is a matter of degree, and monopoly analysis is relevant to any situation involving price power.

For the Investor

The source of monopoly power determines its sustainability:

• Patents—temporary (expire)
• Network effects—can be sustainable, but vulnerable to disruption
• Natural monopoly—sustainable, but often regulated
• Resource control—depends on alternatives

“Moat” analysis:

• What protects the company’s profit?
• How durable is the barrier?
• What threats (technology, regulation)?