The use of a product by other people can increase its value to a person. For example, cement production exhibits economies of scale, and the quantity of cement demanded in a local area may not be much larger than what a single plant can produce. Natural monopolies occur when a single firm can serve the entire market at a lower cost than a combination of two or more firms. One famous trade secret is the formula for Coca-Cola, which is not protected under copyright or patent law, but is simply kept secret by the company. In what sense is a natural monopoly “natural”? Economies of scale and network externalities discourage potential competitors from entering a market. Firms gain monopolistic power as a result of markets’ barriers to entry, which discourage potential competitors. If barriers to entry are very high then the market will invariably become a monopoly. Property rights may give a company exclusive control of the materials necessary to produce a good. What products we consider utilities depends, in part, on the available technology. There is also a body of law known as trade secrets. For many years, the Justice Department has tried to break up large firms like IBM, Microsoft, and most recently Google, on the grounds that their large market share made them essentially monopolies. Decreasing costs coupled with large initial costs give monopolies a cost advantage in production over would-be competitors. The cost of constructing a competing transmission network and delivering service will be so high that it effectively bars potential competitors from entering the monopolist’s market. Suppose the local electrical utility, a legal monopoly based on economies of scale, was split into four firms of equal size, with the idea that eliminating the monopoly would promote competitive pricing of electricity. Market entrants have not yet achieved economies of scale, so their output simply costs so much more than the incumbent firms that market entry is difficult. telephone companies provided local and long distance service over wires. Back in the 1930s, when ALCOA controlled most of the bauxite, other firms were simply unable to produce enough aluminum to compete. During the term of the patent, the patent holder has the right to exclude others from making, using, or selling the patented invention. Moreover, the costs of transporting cement over land are high, and so a cement plant in an area without access to water transportation may be a natural monopoly. A firm with high fixed costs requires a large number of customers in order to have a meaningful return on investment. In a government monopoly, an agency under the direct authority of the government itself holds the monopoly, and the monopoly is sustained by the enforcement of laws and regulations that ban competition or reserve exclusive control over factors of production to the government. Markets with a low exit barrier are stable and self-regulated, so the profit margins do not fluctuate much over time. One is legal monopoly, where laws prohibit (or severely limit) competition. The reverse is also true. The other is legal monopoly, where laws prohibit (or severely limit) competition. Barriers to entry and exit exist, and, in order to ensure profits, a monopoly will attempt to maintain them. Trademarks are enforced by government, and therefore are a barrier to entry. Small firm cannot enter the industry as small scale producer cannot achieve the lowest average total cost and resultantly cannot get profit necessary for s… In some cases, large advertising budgets can also act as a way of discouraging the competition. Each firm only has a tiny share of the market and changes in one firm wont affect the entire industry. The barriers to entry and exit into and out of the market are low In the short run the profits made by businesses competing in this type of market structure can be at any level - in our example above the business is making supernormal profits indicated by the shaded area. Additionally, the Dutch East India Company provides a historical example of a government-granted monopoly. The government can provide exclusive or special rights to companies that legally allow them to be monopolies. De Beers had a lot of market power in the world market for diamonds over the course of the 20th century, keeping the price of diamonds high. However this disadvantage can be offset if government has proper mechanism and tools to check that firms do not create monopoly like … De Beers is a classic example of a monopoly based on a natural resource. It did not make much sense to have many companies building multiple wiring systems across towns and the entire country. Approximately how much profit would each firm earn? It becomes most efficient for production to be concentrated in a single firm. What do you anticipate would happen to prices? Once an entrepreneur or firm has purchased the rights to all of them, no new competitors can enter the market. One is natural monopoly, where the barriers to entry are something other than legal prohibition. In practice, monopolies rarely arise because of control over natural resources. Monopolistic competition characterizes an industry in which many firms offer products or services that are similar, but not perfect substitutes. Copyright Office. In a government-granted monopoly, on the other hand, the monopoly is enforced through the law, but the holder of the monopoly is formally a private firm, which makes its own business decisions. The patent provides incentives (1) to invent in the first place, (2) to disclose the invention once it is made, (3) to make the necessary investments in research and development, production, and bringing the invention to market, and (4) to innovate by designing around or improving upon earlier patents. Typical Barriers to Entry. Barriers to entry are the legal, technological, or market forces that discourage or prevent potential … Intellectual property rights are an example of legal barriers that give rise to monopolies. In other cases, they may limit competition to a few firms. There are two types of monopoly, based on the types of barriers to entry they exploit. If there were no (or only low) barriers, other firms would enter such markets to participate in the monopoly profits. Predatory pricing is a violation of U.S. antitrust law, but it is difficult to prove. Around the world, government monopolies on public utilities, telecommunications systems, and railroads have historically been common. In a government monopoly, the holder of the monopoly is formally the government itself and the group of people who make business decisions is an agency under the government’s direct authority. When a patent expires and the invention enters the public domain, others can build on the invention. In the United States, exclusive patent rights last for 20 years. Intellectual property rights, such as patents and copyright, give the rights holder exclusive control over the production and sale of certain goods. Quite simply, if you are struggling to get the funds together to start the business, then this is a 'barrier' to you entering the market. Demonstrate an understanding of how a natural monopoly is created. Government-granted monopolies and government monopolies differ in the decision-making structure of the monopolist. usually, the company which is the pioneer in that market controls the resources. Key Terms • Monopoly (market) power • Deadweight social welfare loss • Antitrust law • Barriers to entry and exit • Natural monopoly • Regulatory capture theory In this world of near ubiquitous information, other companies could take the formula, produce the drug, and because they did not incur the costs of research and development (R&D), undercut the price of the company that discovered the drug. The granting of permits or professional licenses can also favor certain firms, while setting standards that are difficult for new firms to meet. Under U.S. law, no organization but the U.S. For example, in many countries, the postal system is run by the government with competition forbidden by law in some or all services. #2 Artificial (Strategic) Barriers to Entry. The laws that protect intellectual property include patents, copyrights, trademarks, and trade secrets. They discourage potential competitors from entering a market, and thus contribute to the monopolistic power of some firms. Innovation takes time and resources to achieve. Around the world, from Europe to Latin America to Africa and Asia, many governments continue to control and limit competition in what those governments perceive to be key industries, including airlines, banks, steel companies, oil companies, and telephone companies. In contrast, a natural monopoly will have a marginal cost that is constant or declining, and an average total cost that drops as the quantity of output increases. A natural monopoly ‘s cost structure is very different from that of most industries. Principles of Economics 2e by Rice University is licensed under a Creative Commons Attribution 4.0 International License, except where otherwise noted. These profits should attract vigorous competition as we described in Perfect Competition, and yet, because of one particular characteristic of monopoly, they do not. Define Economies of Scale., Explain why economies of scale are desirable for monopolies. Intellectual property refers to legally guaranteed ownership of an idea, rather than a physical item. Tuteja (Lecture Notes, IIFT) Business Economics MBA IB (2020-22) Introduction What are Barriers to Entry and Exit? As a consequence, the government allows producers to become regulated monopolies, to insure that customers have access to an appropriate amount of these products or services. At that case the economies of scale act as barrier to enter industry. For example, once a water company lays the main water pipes through a neighborhood, the marginal cost of providing water service to another home is fairly low. Monopolies exhibit decreasing costs as output increases. A copyright, according to the U.S. There are cases in which a government agency is the sole provider of a particular good or service and competition is prohibited by law. The price is determined by market forces of demand and supply. For example, there are a finite number of radio frequencies available for broadcasting. It is also possible that there is a monopoly because the government has granted a single company exclusive or special rights. The lower the barriers, the more likely the market will become perfect competition. Y2 10) Barriers to Entry and Exit (Sources of Monopoly Power). Additionally, legal monopolies are often subject to economies of scale, so it makes sense to allow only one provider. Unfair taxes (high taxes or tax-breaks for others) also frequently constitute barriers to competition. The intent behind copyright is to promote the creation of new works by providing creators the opportunity to profit from their works. 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