What is a Monopoly?
A monopoly is when there’s only one company selling a certain product or
service, and there are no other companies competing with it. So, if you want that
product or service, you have to buy it from that one company. This is bad for
customers because when there’s no competition, the company can raise prices
and limit choices for you.
For example, imagine there’s only one ice cream store in your town, and it’s the
only place you can buy ice cream. This store has a monopoly because no one else
can sell ice cream, and they can make the prices as high as they want.
Why Do Some Markets End Up with Monopolies?
Now, let’s talk about why some markets or industries get monopolized, or in other
words, why one company ends up being the only one selling something. There are a
few main reasons for this, and they all come down to things like costs,
government decisions, and business strategies.
1. Cost-Based Monopoly (Lower Costs = Monopoly)
One big reason monopolies happen is because one company can make things
cheaper than everyone else. When a company has lower costs, it can sell
products at lower prices, which forces other companies to lose money if they try to
compete.
Let’s use a real-life example:
Henry Ford and Cars: A long time ago, Henry Ford figured out a way to
make cars a lot cheaper by using a new way of building cars—he used
assembly lines. This method made cars way cheaper than how other
companies were making them. So, even though there were other companies
trying to sell cars, Ford was able to sell them at a lower price and get more
customers. Over time, Ford’s way of making cars became the main way, and
it was hard for other companies to compete. This helped Ford create a
monopoly in the car industry.
So, if a company has a much cheaper way to make something, they can
push out the other companies because those companies can’t sell their product at
the same low price.
Cost Advantages: Controlling Resources
Another way to create a monopoly is if a company controls something really
important that no one else can access. For example:
Gravel Quarry: Imagine there’s a company that owns the only gravel
quarry in a region. Gravel is needed for construction, and because this
company controls the only source of gravel, no other company can compete.
This company becomes the only one selling gravel and has a monopoly on
the market.
2. Natural Monopoly (One Company is Just Better for the Market)
Sometimes, there are industries where it just makes more sense for one
company to do all the work. This is called a natural monopoly.
Let’s imagine a water company:
Water Supply: To bring water to a whole town, a company needs to build
water pipes that go everywhere. This is very expensive to do. If there were
two or three companies building their own pipes, it would be a huge waste of
money. One company can build the pipes and provide water to everyone in
a cheaper way than multiple companies could. This is why water companies
are usually monopolies—they’re the only ones who can do it efficiently.
In other words, when one company can provide the product or service at a lower
cost than multiple companies could, it becomes a natural monopoly. It’s just
cheaper for everyone if there’s only one company providing the service.
3. Mergers and Buying Out Competitors
Sometimes, monopolies are created when several smaller companies combine
into one bigger company. This is called a merger. When companies merge, they
may end up being the only company in the market, which creates a monopoly.
For example, imagine there are three lemonade stands in your neighborhood, but
two of the stands decide to join forces and become one big stand. Now, there’s only
one lemonade stand left, and it becomes the monopoly in your neighborhood.
4. Strategies to Stop Competition (Barriers to Entry)
Sometimes, a company will do things to stop new companies from starting and
competing. These are called barriers to entry. Some of these strategies include:
Price Wars: One company might drop its prices so low that it loses money
just to push other companies out of the market. Once the other companies
are gone, the first company raises its prices again because it’s the only one
left.
Exclusive Contracts: A company might make deals with suppliers, so other
companies can’t get the materials they need to make their product. This
stops competitors from being able to start their own businesses.
5. Cartels: When Companies Work Together Like a Monopoly
Sometimes, even if there’s more than one company in a market, they might work
together to act like a monopoly. This is called a cartel.
Let’s say there are several ice cream shops in your town. If all the ice cream shop
owners secretly agree to set high prices together, then it doesn’t matter how
many ice cream shops there are—they all act like they’re one big monopoly. This is
illegal in many countries because it’s unfair to customers.
6. Government Policy and Natural Monopolies
Governments sometimes decide that certain industries should be monopolies
because they are essential to society. For example, things like water, electricity,
and gas are really important, and it might be a bad idea to have multiple
companies competing because it would be very expensive and inefficient.
So, in these cases, the government allows one company to control the market, but
they regulate the company to make sure they don’t take advantage of customers.
For example, the government might say, “You can’t charge too much for water,” or
“You must keep your prices affordable.”
In Summary:
Monopolies happen for a few main reasons:
1. Lower Costs: One company can make things cheaper than others, so they
push out competitors.
2. Natural Monopoly: Some industries work better with only one company, like
water or electricity.
3. Mergers: Companies combine to create one big company, which can
become a monopoly.
4. Stopping Competition: Companies use strategies to prevent others from
entering the market.
5. Cartels: Companies secretly agree to act like a monopoly.
6. Government Policy: Governments sometimes allow monopolies in
industries that are essential for everyone.
So, monopolies are created because it’s sometimes cheaper or more efficient for
one company to run the whole market. But when this happens, it’s important for the
government to make sure the company doesn’t take advantage of customers by
raising prices too much or limiting choices.
What is a "Natural Monopoly"?
Imagine you live in a neighborhood, and there’s only one company that supplies
water to all the homes. This company is what we call a "natural monopoly." That’s
because it’s cheaper for just one company to supply all the water rather than
having multiple companies doing it.
Why is One Firm Cheaper?
Let’s say we have a company that supplies water. The company has to spend a lot
of money to build a big water plant and lay pipes to all the houses. This is called a
"fixed cost" because it doesn’t change no matter how much water the company
supplies. Then, there’s the cost of actually supplying the water to the homes, which
is called the "marginal cost." In this case, let’s say that cost is the same every time
—no matter how much water is supplied, the company pays the same amount to
deliver each unit of water.
Now, if this company tries to supply 12 units of water (enough for 12 houses), it has
an average cost of $15 per unit, which is pretty cheap. But if there were two
companies, each trying to supply 6 units of water, the cost per unit actually goes up
to $20. That’s because both companies still have to pay to build their own water
plants and lay their own pipes, which creates extra costs.
So, one company is able to supply water to the whole neighborhood more
cheaply than if two companies split the job. This is why we call it a natural
monopoly.
Economies of Scale
Now, here’s the cool part: the reason why one company can do it cheaper is
because of something called economies of scale. This just means that the more
water the company produces (or the bigger the company gets), the cheaper it gets
for them to keep producing more water. So, if the company grows, it can spread out
its big costs (like the water plant) over more and more water, and each unit of water
costs less to deliver.
The Formula and Example
Here's the formula to explain it:
C(Q) is the cost for one company to produce all the water (where Q is the
total amount of water needed).
C(q1) + C(q2) + ... + C(qn) is the cost if there are n companies, each
producing part of the water (q1, q2, etc. are the amounts produced by each
company).
For a natural monopoly, the cost of one company supplying all the water is less
than the total cost if multiple companies try to do it.
In the example with the water company:
The company has a fixed cost of $60 to build the plant and supply water.
The marginal cost (cost to supply one more unit) is $10 per unit.
If the company produces 12 units, the average cost per unit is $15
(calculated as the cost to supply the water divided by how much is supplied).
If there were two companies each producing 6 units, the cost per unit goes up
to $20 because each company has to pay to build their own plant and supply
water.
So, in this case, one company is the cheapest option.
Conclusion
A natural monopoly happens when it’s more efficient for one company to do all
the work rather than having multiple companies compete. This is because it’s
cheaper to spread the costs of things like factories and pipes across more units of
production, and the more units a company makes, the cheaper it becomes to make
each one.
