How Monopolies Impact the Economy

Four Reasons Monopolies Are Bad, and One Time They're a Necessity

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Google's control of web search is a monopoly, but it isn't illegal.. Photo: Adam Berry/Getty Images

Definition: A monopoly is a business that's the only provider of a good or service. That gives it a tremendous competitive advantage over any other company that tries to provide a similar product. 

Some companies become monopolies through vertical integration. They control the entire supply chain, from production to retail. Others use horizontal integration, buying up competitors until they are the only ones left.

Still others, like utilities, benefit from government regulations that give them a particular market. Governments do this for electricity production and delivery because it's too important to tolerate the disruptions that come from free market forces.

4 Reasons Why They're Bad for an Economy

Monopolies restrict free trade, preventing the market from setting prices. That creates the following four negative effects.

1. Since monopolies are the only provider, they can set any price they choose. That's known as price-fixing. They can do this regardless of demand because they know the consumer has no choice. It's especially true for goods and services where there is inelastic demand. That's where people don't have a lot of flexibility. An example of this is gasoline. There are choices, such as mass transit or bicycles, but they aren't a natural substitute in many areas.

2. Not only can monopolies raise prices, but they can also supply inferior products.

That's happened in some urban neighborhoods. Grocery stores know that the poor urban dweller has fewer alternatives.

3. Monopolies eliminate the manufacturer's incentive to innovate and provide "new and improved" products. That used to be true of cable companies. It was expensive to lay new cable, so residents had to accept the cable company's service and prices.

Disruptive technology is the worst enemy of monopolies. Dish TV, iPads, and Netflix have created a new type of entertainment service that doesn't rely on cable to deliver movies and TV programming. The same thing happened with land-line telephones.

4. Monopolies create inflation. Since they can set any price they want, they will raise costs to consumers. It's called cost-push inflation. A good example of how this works is OPEC or the Organization of Petroleum Exporting Countries. The twelve oil exporting countries in OPEC now control the price of 46% of the oil produced in the world. It's not a true monopoly, but more of a cartel. First, most of the oil is produced by one country, Saudi Arabia. It has a far greater ability to affect the price by itself by raising or lowering output. Second, the price set by OPEC must be agreed to by all its members. Even if they agree to it, some may try to undercut the price to gain a little extra market share. Enforcing the OPEC price is not easy. Nevertheless, the countries within OPEC still make more per barrel of oil than they did before OPEC.

That power created the OPEC oil embargo in the 1970s.

Are Monopolies Ever Good?

Sometimes a monopoly is necessary to ensure consistent delivery of a product or service that has a very high up-front cost. That is true, for example, with electric and water utilities. Since it is so expensive to build new electric plants or dams, it made economic sense to allow a monopoly for a particular area.

The federal and local governments regulated these industries to protect the consumer. The companies were allowed to set prices to recoup their costs and a reasonable profit. In the 1990s, there was much talk of deregulation to allow competition. In some cases, this occurred.

PayPal co-founder Peter Thiel advocates the benefits of creative monopoly. This is a company that is "so good at what it does that no other firm can offer a close substitute." They give customers the benefits of more choices "by adding entirely new categories of abundance to the world." He goes on to say, "All happy companies are different: Each one earns a monopoly by solving a unique problem. All failed companies are the same: They failed to escape competition." He suggests entrepreneurs focus on "What valuable company is nobody building?" (Source: L. Gordon Crovitz, "Three Cheers for 'Creative Monopolies,'" The Wall Street Journal, October 13, 2014.)

Monopolies in the United States

Monopolies in the United States aren't illegal. However, thanks to the Sherman Anti-Trust Act, they cannot use their monopoly power to gain price or other advantages.  It was called Anti-Trust because that was the form that monopolies held in ​1890, when it was enacted. A group of companies formed a trust to fix prices low enough to drive competitors out of business. Once they had a monopoly on the market, these trusts would raise prices to regain their profit.

The most famous trust was Standard Oil Company. John D. Rockefeller owned all the oil refineries, which were in Ohio, in the 1890s. His monopoly allowed him to control the price of oil. He could also bully the railroad companies to charge him a lower price for transportation. When Ohio threatened legal action to put him out of business, he simply moved to New Jersey. He also set up the first trust. He bought up the majority share of former competitors' stock certificates of trust. (Source: "The Sherman Anti-Trust Act," archive.)

In 1998, the U.S. District Court ruled that Microsoft was an illegal monopoly. It had a controlling position as the operating system for personal computers. It used this to intimidate a supplier, chip-maker Intel. It also forced computer makers IBM and Apple Windows to withhold superior technology. Microsoft was ordered to share information about its operating system. That allowed competitors to develop innovative products using the Windows platform. But disruptive technologies have done more to erode Microsoft's monopoly than government action. People are switching to mobile devices, such as tablets, iPods, and smartphones. Microsoft does not have a good operating system on these devices. (Source: "Long Microsoft Anti-Trust Case Is Over," Seattle Times, May 11, 2011)

Google almost has a monopoly on the Internet search market. People use Google for 65% of all searches. Its closest competitors, Microsoft's Bing and Yahoo, only make up 34%, combined. But Google continuously works to make its search algorithms better. It also controls 80% of all search-related advertising. Furthermore, Google has developed the Android operating system for smartphones. (Source: "A Google Monopoly Isn't the Point," Businessweek, September 23, 2011.) 

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