What it means
The defining feature of a monopolistic market is a lack of effective competition. Customers have few or no alternatives, so the seller can set prices and terms more freely than it could in a competitive market.
High barriers to entry protect the position. These include patents, large start-up costs, control of essential inputs, regulation, network effects and strong brand loyalty, and the higher they are, the longer the seller can hold on to excess profits.
Economists measure how concentrated a market is with tools such as the Herfindahl-Hirschman Index (HHI), which adds up the squares of each firm's market share. Regulators use such measures to decide whether a merger might create too much market power.
The term is also confused with monopolistic competition, a different structure. In monopolistic competition there are many sellers, each offering a slightly different product, such as restaurants or clothing brands, and each has a little pricing power but faces plenty of rivals.
Profits there tend to be competed away over time as new entrants arrive. For businesses and customers the effects of a truly monopolistic market include higher prices, reduced choice and less pressure to improve quality.
They can also include benefits such as scale economies, which is why regulators examine each situation instead of assuming harm. Managers operating in such a market should expect regulatory attention.
Buyers should look for ways to create alternatives, such as second suppliers or long-term contracts with price protection.
In practice
Real-world examples.
Example
A town has one hospital and no other provider within 200 miles. Patients and insurers have little bargaining power, so a regulator reviews the prices the hospital charges. The hospital must justify any increase with cost data.
Example
A software company holds a 90% share of a specialised design tool market. Customers who want to switch face high costs because their files and training are tied to the tool. This lock-in is a typical sign of market power.
Example
A local authority grants a single company the exclusive right to operate a toll bridge. The contract limits the tolls it may charge and specifies maintenance standards. After a set number of years the right returns to the authority.
Formula
Calculation
HHI = (Share of firm 1)^2 + (Share of firm 2)^2 + ... , with shares expressed in per cent as whole numbers
Consider a market with four firms holding 40%, 30%, 20% and 10%. The HHI is 40 x 40 + 30 x 30 + 20 x 20 + 10 x 10 = 1,600 + 900 + 400 + 100 = 3,000. A pure monopoly with a 100% share has an HHI of 100 x 100 = 10,000, the maximum. Regulators often treat markets with an HHI above a set threshold as highly concentrated and look more closely at mergers there. A market with ten equal firms of 10% each has an HHI of 10 x 10 x 10 = 1,000, showing how the index rises as the market concentrates.Case study
Seen in the real world.
Kestrel Cement is an illustrative, fictional company that acquired the two rival plants in a remote region and became the only cement supplier within 300 miles. Construction firms had to buy from Kestrel or import cement at much higher cost.
Within a year Kestrel raised prices by 25% while its own costs rose by only 3%. Local builders complained, and the competition authority launched an inquiry into whether the acquisition had reduced competition.
In this fictional story the authority ordered Kestrel to sell one plant to a rival and to supply the new entrant with limestone at fair prices. Prices in the region fell by 15% over the following two years, and local construction activity recovered, which showed how quickly the discipline of competition could return. Builders passed part of the saving on to home buyers.
Watch out
Common mistakes.
- Treating monopolistic competition and a monopolistic market as the same thing, when the first has many sellers and the second has very few.
- Judging market power only by market share, when entry barriers, substitutes and the ability of customers to switch also matter.
- Assuming a monopolistic market always harms customers, when scale benefits can sometimes lower costs.
Questions
People also ask.
What causes a monopolistic market?
Barriers such as patents, high set-up costs, control of inputs, regulation or network effects keep rivals out. Mergers and aggressive tactics can also reduce competition.
How is it measured?
Economists use market share, concentration ratios and the Herfindahl-Hirschman Index. A higher HHI means a more concentrated market, and 10,000 is the maximum.
What can customers do?
They can look for substitutes, share demand across several suppliers or ask regulators to act. Keeping records of price changes helps if a complaint is needed. Long-term contracts with price caps can also provide protection, as can joining with other buyers to negotiate as a group.
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