Monopolies: Pros, Cons, and Effect on Economies
4 Reasons They're Bad—and the One Time They're a Necessity
A monopoly is a business that is the only provider of a good or service, giving it a tremendous competitive advantage over any other company that tries to provide a similar product or service.
Some companies become monopolies through vertical integration. They control the entire supply chain, from production to retail. Others use horizontal integration. They buy up competitors until they are the only ones left.
Some, like utilities, enjoy government regulations that award them a market. Governments do this to ensure electricity production and delivery because it cannot tolerate the disruptions that may come from free market forces.
4 Reasons Why They're Bad for an Economy
Monopolies restrict free trade and prevent the market from setting prices. That creates the following four adverse effects:
- Price fixing: Since monopolies are lone providers, they can set any price they choose. That's called price-fixing. They can do this regardless of demand because they know consumers have no choice. It's especially true when there is inelastic demand for goods and services. That's when people don't have a lot of flexibility. Gasoline is an example. Some drivers could switch to mass transit or bicycles, but most can't.
- Declining product quality: Not only can monopolies raise prices, but they also can supply inferior products. That's happened in some urban neighborhoods, where grocery stores know poor residents have few alternatives.
- Loss of innovation: Monopolies lose any incentive to innovate or provide "new and improved" products. A 2017 study by the National Bureau of Economic Research found that U.S. businesses have invested less than expected since 2000 due to a decline in competition. That was true of cable companies until satellite dishes and online streaming services disrupted their hold on the market.
- Inflation: Monopolies create inflation. Since they can set any prices they want, they will raise costs for consumers. It's called cost-push inflation. A good example of how this works is the Organization of Petroleum Exporting Countries (OPEC). The 13 oil-exporting countries in OPEC are home to nearly 80% of the world's proven oil reserves.
When Monopolies Are Good
Sometimes a monopoly is necessary. It ensures consistent delivery of a product or service that has a very high up-front cost. An example is electric and water utilities. It's very expensive to build new electric plants or dams, so it makes economic sense to allow monopolies to control prices to pay for these costs.
Federal and local governments regulate these industries to protect the consumer. Companies are allowed to set prices to recoup their costs and a reasonable profit.
PayPal co-founder Peter Thiel advocates the benefits of a creative monopoly. That's a company that is "so good at what it does that no other firm can offer a close substitute." He argues that they give customers 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 this question: "What valuable company is nobody building?"
Monopolies in the United States
Monopolies in the United States are not illegal, but the Sherman Anti-Trust Act prevents them from using their power to gain advantages. Congress enacted it in 1890 when monopolies were trusts. A group of companies would form a trust to fix prices low enough to drive competitors out of business. Once they had a monopoly on the market, they 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 bullied the railroad companies to charge him a lower price for transportation. When Ohio threatened legal action to put him out of business, he moved to New Jersey.
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 and used this to intimidate a supplier, chipmaker Intel. It also forced computer makers to withhold superior technology. The government ordered Microsoft to share information about its operating system, allowing 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 and smartphones, and Microsoft's operating system for those devices has not been popular in the market.
Today Google almost has a monopoly on the internet search market; people use it for 90% of all searches.
- When a company has sole rights to a product, its pricing, distribution, and market, it is a monopoly for that product.
- The existence of a monopoly relies on the nature of its business. It is often one that:
- Needs to operate under large economies of scale.
- Requires huge capital.
- Offers a product with no substitute.
- Prompts government mandate ensuring its sole existence.
- May possess, but not always, technological superiority and control resources.
- The advantage of monopolies is an ensured consistent supply of a commodity that is too expensive to provide in a competitive market. An electric company is a good example of a needed monopoly.
- The disadvantages of monopolies are:
- Price fixing privileges that allow them to dictate prices, regardless of demand.
- Supply of a low quality product.
- Low incentive for product innovation.
- Possible creation of cost-push inflation.