Monopolistic Market

Monopolistic Market Structure

A monopolistic market structure is characterized by an individual firm that is the only provider of a good or service. In a monopolistic market structure, consumers do not have a variety of companies or businesses to buy from. Instead, it is a single firm that produces those products.

A firm that is part of the monopolistic market structure has an advantage since they are the only one making the product. This then enables the monopolistic firm to charge higher prices as it basically faces no competition.

The monopolist controls the number of products sold since they are the market.

However, this does not mean that the monopolist may charge whatever price it pleases, not if the monopolist's goal is to maximize profits.

When deciding to set a price, a monopoly should consider both the demand for the good and the cost. Although a firm in a monopolistic market does not have any competitors, it can't increase prices indefinitely.

Monopolistic Market Structure: Causes of Monopoly

The primary factor that causes monopoly is the existence of entry barriers.

Entry barriers result from three main factors: Monopoly resources, government regulations, and the production process.

1. Monopoly resources occur when one company has the rights to a crucial resource necessary for manufacturing. The exclusive ownership of a valuable resource by a single company is the most straightforward route to establishing a monopoly.
2. Government regulations create monopolies when the government grants a single company the exclusive right to manufacture a specific product or provide a particular service.
3. Production processes may also generate market barriers that lead to monopolies. When some companies can produce goods and services at a lower price than their competitors, they can acquire more market power, leading to a monopoly.

Monopolistic Market Examples

A real-life example of a monopoly is Standard Oil, which operated from 1870 to 1911. John D. Rockefeller established Standard Oil. It started in Cleveland, Ohio, and throughout the years, Standard bought other oil refineries. Shortly after the establishment of Standard Oil, most of the rival firms were shut down due to bankruptcy.

Before Standard Oil, several other oil businesses competed with one another throughout the United States. By the beginning of the 20th century, Standard Oil had cornered nearly 90 percent of the market for oil, which made John D. Rockefeller the first person ever to become a billionaire.

Due to its monopoly power, Standard Oil was able to charge higher prices and enjoy enormous profits.

Over time, public sentiment shifted against Standard Oil and Rockefeller, and in 1911, the government of the United States took action. The Supreme Court ruled that Standard Oil must be divided into 34 different businesses to reduce its monopoly power across the United States.

Monopolistic Market Demand Curve

A monopolistic market demand curve is a downward-sloping demand curve. That's because, in a monopolistic market, a firm can charge higher prices without losing its consumers. Think about it, as consumers have nowhere else to buy the product from, regardless of the price set by the company, consumers will still be buying the good.

Fig. 1 - Demand curve in a monopolistic market

Figure 1 shows the demand curve in a monopolistic market. Notice that as the price declines, the quantity demanded increases. On the other hand, as the price increases, the quantity demanded will drop. The price can increase up to a certain point which in the above figure is P*. That's because no one is willing to buy the product offered by the monopoly above a certain price.

The demand curve in a monopolistic market differs from a perfectly competitive market. In a perfectly competitive market, the demand curve is perfectly elastic. That means that demand for a firm's product or service when pricing at the equilibrium price is infinite. If the firm were to increase the price even by just a little, there would be no market demand.

On the other hand, the demand curve for an individual company in a monopolistic market slopes downward, meaning that the company can increase the price while still having consumers who demand their goods. That's because, in a monopolistic market, a firm has monopoly power.

• Monopoly power allows firms to increase their prices without losing all of their clients.
• Monopoly power results from not having a competitive firm that would charge less.
• This then results in a downward-sloping demand curve.

Monopolistic Market Graph

The monopolistic market graph shows how a firm with no competition sets its price to maximize profit. The firm in a monopolistic market has average revenue, marginal revenue, and marginal cost. To set the price, a firm must consider both these curves.

Fig 2. - Marginal Revenue and Average Revenue in a Monopolistic Market

Figure 2 shows two important curves a firm in a monopolistic market faces, the marginal revenue, and the average revenue.

Notice that the marginal revenue a firm faces is below the average revenue of the firm. That’s because a firm that belongs to a monopolistic market faces a downward-sloping demand curve. That means that to increase the number of products it sells, a firm has to lower the price, which reduces the quantity sold.

The average revenue of a monopolistic firm is equal to the demand of the monopolistic firm. That’s because the firm is the only supplier of the good, and the price paid for the good equals the average revenue for the firm.

Fig. 3 - Profit Maximization in a Monopolistic Market

Figure 3 shows the monopolistic market graph of a firm that maximizes its profit. Like in a perfectly competitive market, a firm in a monopolistic market maximizes the profit at the point where MC=MR.

Assuming that there is no fixed cost and marginal cost is constant, the firm will produce up to point 1, where MC=MR. The additional revenue it makes from producing another product is equal to the additional cost it takes to produce that product.

As the firm has monopoly power, the price it will charge is the corresponding point of the intersection between the MR and MC curves on the demand curve. That point in figure 3 is point 2.

Advantages and Disadvantages of Monopolistic Competition Market

Before we discuss the advantages and disadvantages of a monopolistic competition market, let's consider what a monopolistic competition market is.

Monopolistic competition is a market in which many firms sell similar but not identical products.

There are three main characteristics of monopolistic competition.

1. Many firms: Many firms sell a similar product.
2. Product differentiation. Every firm that is part of a monopolistic competition market produces a slightly different product from other firms.
3. Free entry and exit: Firms in a monopolistic competition market do not have entry barriers to the market or exit barriers out of the market.

A firm that is part of a monopolistic competition market gains monopoly power (the ability to set higher prices) by mainly producing better and differentiated products from its main competitors.

The main advantage of monopolistic competition is that firms constantly compete to bring new and differentiated products to market. This causes more innovation, bringing more valuable products to consumers.

On the other hand, the main disadvantage of monopolistic competition is that firms that gain monopoly power can abuse their products' pricing, which would harm the consumers.