According to Koutsoyiannis, a Monopoly can be defined as: a market situation in which there is a single seller, there are no close substitutes for the commodity it produces, there are barriers to entry (Khanna & Jain, 2010). Hence, a monopolistic company will have absolute market share, or in other word, the company is an industry all by itself. According to Baumoi, a Pure Monopoly is defined as: the firm that is also an industry. It is the only supplier of some particular commodity for which there exists no close substitute (Khanna & Jain, 2010). There are also Legal Monopolies, where a firm hold monopolistic power by controlling over 25% of a given market. Monopolistic firms have the privilege of setting prices and can hence reap supernormal profits. In such a scenario, consumers will need to pay whatever price is fixed for a given product, whether it is reasonable or not. Hence, firms making supernormal profits could be acting against public interests. However, there have been arguments claiming that monopolistic firms are, in fact, not against public interest. This paper aims to evaluate both arguments, review relevant literature and finally draw conclusions based on the findings of the said research.
2 Features of a Monopoly
A company can gain monopoly in a market under the given situations:
a) The government itself may choose to grant monopolistic powers to a company, usually a government agency. For example, Oliver Cromwell gave the Royal Mail Group monopoly over the post in 1654, which it eventually lost on 2006 due to the opening up of markets (Blake, 2010).
b) Company’s may have patented products or copyrighted material that does not allow any other firm to produce similar products or services without the consent of the patent owner. For example, Microsoft owns the patent for the Windows Operating System which is the most commonly used operating system in the world having 95% of the market share (Hardware.com, 2010).
c) Two or more major market players merging to attain monopoly through cooperation. However, this is generally prevented by the government if the resulting firm would control over 25% of the market share.
A monopoly has the following main features:
a) One seller or manufacturing company catering to a vast number of consumers (Pride, Hughes & Kapoor, 2009).
b) As there is only one firm existing in the market, there is no difference between the firm and the industry.
c) Entry of new companies into the market is restricted through barriers such as patents, government laws and regulations, economies of scale and so on.
d) Competition is also eliminated as there is no close substitute for the product being sold or manufactured by the monopolistic company.
e) A monopolist company has the privilege of being a Price Maker. This is crucial to understanding the impact of monopolies on public interest. The price maker controls the supply of the product within the market and is the sole supplier. However, there is a greater magnitude of consumer demanding the product. Hence, the monopolist has full control on deciding the price of the commodity and the consumers have no choice but to buy it at the set price.
f) A monopolist can exercise price discrimination, i.e.: the company can set different prices for the same product when selling to different consumers (Khanna & Jain, 2010)
3 Supernormal Profits in Monopoly
When a firm more profits that are much higher than what is required to keep its operations running efficiently, it is known as supernormal profits. Supernormal profits can be made both in the short term as well as long term. When a firm makes supernormal profits, it alerts other supplier to the fact that the market can be tapped into to make money. This increases the level of competition. The laws of demand and supply come into play and the scope for supernatural profit is generally lost.
However, in a monopolistic market, there are far too many entry barriers to permit new entrants to compete. Hence, supernormal profit has a tendency to be long term in a monopolistic market. Figure 1 illustrates how monopolists can reap supernormal profits in the long run.
While it is true that most businesses always try to maximize their profits, monopolist companies have greater scope for earning supernormal profits. In Figure 1, at the point of maximized profit, MC = MR (Marginal Cost = Marginal Revenue), Q is the Output while P is price. When price (AR) is higher than ATC at Q, supernormal profits become feasible (the PABC area).
4 Impact of Monopoly & Supernormal Profit on Public Interest
The negative impact of a monopolistic market on public interest has been discussed for long. Several legislative steps have been taken in order to restrict monopolistic power and/or behaviour. The following are some of the negatives of a monopoly:
a) High prices reduce consumer wealth: As monopolists are more likely to sell products at a higher price than is reasonable, consumers are forced to spend more out of their wealth than they would in an oligopoly or under perfect competition. This will lead to the monopolist becoming richer while its consumers become poor, a trait that is mostly unacceptable as it affects the distribution of wealth.
b) Misallocation of resources: In order to maximize profits, monopolists are more likely to utilize the minimum amount of resources like raw materials and labour required to produce a product. The high pricing of products have a tendency to lower the demand for the product as consumers limit their purchases. In such a case, insufficient resources are used to produce high priced goods manufactured in quantities that do not adequately serve public interest. As a result, high priced products will witness underproduction where as the products of competitive industries will witness overproduction as resources from monopolists transfer. Hence, the overall output will be unbalanced that what would best suit public interest.
c) Lack of Innovation & Development: A monopolist company does not have any competition for its products and hence does not have the insecurity of losing customers to a competitor providing better products. This leaves little scope for any motivation towards research and development towards the improvement of the quality of the goods produced. As a result, consumers buy low quality goods at high prices, which is against public interest (Baumol & Blinder, )
5 The Case of Microsoft
Microsoft has held monopolistic power in the software industry for over a decade (Burrows, 2009). Its dominance of the operating system market by 95% allowed it to control the prices of not only its Windows OS but also using its monopoly in this segment to market its other products (US Department of Justice, 2007). The US Government sued the corporation on 18 May 1998 for attempting to use its market influence to crush competition. While Microsoft debated that its actions were aimed towards improving the quality of the Windows OS leading to enhanced consumer experience, it was ordered to share the technical specification of its windows OS in order to allow its competitor to create similar products. Further, it was restricted from using any strategies that could be viewed as restricting competition through unfair means (Sloman, 2008)
Monopolist companies pose several threats to public interest. Monopolists have absolute control over the pricing over their products and are unaffected by the demand within the market. As they do not face any competition, they also control supply. Further, they have no inclination to improve or even maintain the quality of products as the consumers do not have any substitutes to turn to. In order to earn supernormal profits, monopolists force consumers to purchase low quality goods at high prices. This is against public interest. By limiting competition, monopolists also limit the options available to consumers.
The fact that monopoly is not in favour of public interest is what has spurred government, especially in developed countries such as the US and the UK to modify regulation and legislation to prevent potentially monopolist companies, such as Microsoft, from controlling vital markets and killing competition. Such regulations are needed, should be encouraged as well as enforced in the interest of public interest and consumer welfare.
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Blake, H., 2010. The Royal Mail: a history of the British postal service. The Telegraph, [online] 10 June. Available At: http://www.telegraph.co.uk/news/uknews/royal-mail/7814591/The-Royal-Mail-a-history-of-the-British-postal-service.html [Accessed on 11 August 2011]
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Pride, W. M., Hughes, R. J. & Kapoor, J. R., 2009. Foundations of Business. Houghton Mifflim Harcourt Publishing: Boston. 26-27