Chapter 24, Problem 24.1LO

To determine

The situations that give rise to a monopoly.

Concept Introduction:

Monopoly refers to a market in which there is only a single seller of a commodity. The seller has complete control over the product price. The demand curve faced by a monopoly is downward sloping. This implies that the monopoly can sell more goods only by lowering its price.

Explanation of Solution

Monopoly is the market structure in which a single firm serves the entire market. The following factors, acting alone or in combination, give rise to a monopoly:

a. Control over key inputs:

Monopoly can arise due to the sole ownership or control of certain essential inputs needed in a particular industry. For example, DeBeers Company of South Africa controls about 80 per cent of the world’s production of diamonds. This has caused DeBeers to have substantial monopoly over Diamonds market.

b. Economies of scale:

Economies of scale exists when production costs fall as the scale of the business increases and output is produced in a greater volume. Thus, if there are economies of scale in production, then existing firms will be larger and have a cost advantage over potential entrants which deter new entrants.

c. Patents:

A patent refers to an exclusive right granted by the government to an inventor or assignee for a limited period of time. These patents act as a reward to private companies for engaging in research and development activities and come up with new products or new technologies. Thus, firms holding patents act as a monopoly.

d. Cartels:

Under cartels, firms agree among themselves to restrict their total output to the level that maximizes their joint profits. These firms retain their individual identities but coordinate their output and pricing policies in order to act as a monopoly.

e. Government licenses:

Licensing refers to the special permission needed from the government for entering a particular industry. Licensing is used to ensure minimum standards of competency. Thus the government can create a monopoly by not granting licenses to new firms.