Monopoly, Oligopoly and Cheese

The Economics of Monopoly Oligopoly and cheese!

A monopoly is a situation where one firm has control of a particular market. The firm may be the only supplier of a product or service, or it may have a dominating market share.

In many countries, a firm is said to have a monopoly of a market if it controls more than 25% of that market. Can you think of any monopoly within the UK at the moment?

The Economics of the Monopoly:

The notion that monopolies can cause the price of goods to be higher than they would be if many companies was supplying them has existed for some time!

A Greek philosopher warned about this problem around 350bc. The public taunted the philosopher on his theory, so to prove them wrong he bought up the local olives presses in the winter when they were cheap and then – using his monopoly power – sold them at very high prices in the summer when the presses were needed. In doing so he made himself rather rich.

Are monopolies always bad news?

Let’s explore! Some economists believe that some monopolies can be a good thing, In many markets, a monopoly would have lower costs of a set of smaller firms because a monopolist would spend less on advertising and make full use of economies of scale.

For these reasons they may enjoy higher profits even when they are selling products for a lower price to that of a rival.

In a similar fashion, large firms can attempt to gain monopoly by driving down the prices of their products in the short term. Economists call this ‘predatory pricing’.

US economist William Baumol claimed that it does not matter if there is a monopoly as long as there is no barriers to entering or exiting the market – the threat of competition means that the monopoly will set the price at a competitive level. (Try telling that to the former shop owners before Tesco came to town!)

This is because higher pricing will attract new entrants to the market which would take a share of the monopoly.

Usually the presence of several producers in a market drives production and keeps prices down, as each company competes to attract customers. If there is only a single supplier – a monopoly – it can choose to restrict its output and charge higher prices.

Between these two extremes sits an oligopoly, where a few suppliers dominate the market for a particular product. If the suppliers can agree terms to not undercut each other, they can act like a monopoly and dictate terms of the market to their own benefit. This arrangement would cause the parties to be referred to as ‘Cartels‘.

Cartels can act as a monopoly and regulate a market, let’s look to the diamond industry. In 2004 “De Beers” the worlds largest rough Diamond producer was ordered to pay a fine of $10 million after charges of fixing the supply of Diamonds.

By keeping the market constantly understocked, Cartels can sell their commodities much above a natural price. Remember our ‘Diamond vs Water’ debate? Diamonds price valuations are contingent on their scarcity.

British Airways was fined more than £300 million for collusion in 2007, after Virgin Atlantic admitted that the two companies had met six times to discuss proposed price rises.

There seems to be a particular pattern with these sorts of arrangements: The market HAS to have only a few suppliers, the suppliers collude, forming a cartel. Cartel members can set prices high ans production low whilst enjoying increased profits. The market is transformed into a virtual monopoly and competition disappears.