November 29, 2021 

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LIMIT PRICING: The strategic behavior process in which a firm with market control sets its price and output so that there is not enough demand left for another firm to enter the market and earn profits. The firm expands its output causing the price to fall, which discourages potential entrants to this market. This practice is most commonly undertaken by oligopoly firms seeking to expand their market shares and gain greater market control.

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Monopolies achieve their single-seller status for three interrelated reasons: (1) economies of scale, (2) government decree, and (3) resource ownership. While a monopoly can emerge and persist for any one of these reasons, most monopolies rely on more than one and often all three.
Monopoly is a market in which a single firm is the only supplier of the good. Anyone seeking to buy the good must buy from the monopoly seller. This single-seller status gives monopoly extensive market control. It is a price maker. The market demand for the good sold by a monopoly is the demand facing the monopoly.

A monopoly market structure emerges and continues to exist for three primary reasons. One is by taking advantage of economies of scale and decreasing average cost over the range of market demand. A second is through authorization that legally designates a single firm as the exclusive provider of a good. The third is through complete ownership of a resource or input that is essential to the production of a good.

Consider these three sources of monopoly market control.

Economies of Scale

Many real world monopolies emerge due to economies of scale and decreasing average cost. If average cost decreases over the entire range of demand, then a single seller can provide the good at lower per unit cost and more efficiently than multiple sellers. This often leads to what is termed a natural monopoly. The market might start with more than one seller, but it naturally ends up with a single seller that can best take advantage of decreasing average cost. Many public utilities (such as electricity distribution, natural gas distribution, garbage collection) have this natural monopoly inclination.

A monopoly naturally emerges in a market that experiences decreasing average cost. Suppose, for example, that two firms (4M and Clear Cable) provide cable television services to the local Shady Valley television market. Each firm has a vast network of underground cables, converter boxes, computers, satellite receivers, and other capital equipment. With this capital, average cost declines as the relative high fixed cost is spread over more subscribers.

If each firm has half of the market, then each has equal average cost and can charge comparable prices. However, what happens if 4M obtains a few additional customers? With lower average cost, 4M can profitably charge a lower price than Clear Cable. This is bound to induce some Clear Cable subscribers to switch. As 4M provides cable services to an increasing number of subscribers, its average cost and prices decline. And as Clear Cable loses subscribers, its average cost and price rise. Clear Cable is increasingly at a competitive disadvantage. It is forced to charge higher and higher prices and 4M charges lower and lower prices.

An avalanche of subscribers flock to 4M, forcing Clear Cable out of business. The end result, naturally, is a single seller of cable television--a monopoly.

Government Decree

The monopoly status of firm can be established by the mandate of government. Government simply gives one and only one firm the legal authority to supply a particular good. Such single seller legal status is usually justified on economic grounds, such as an electric company that would naturally tend to monopolize a market. However, it might also result from political forces, such as mandating monopoly status to a firm controlled by a campaign donor or close political associate.

Government often extends monopoly control to a single firm in markets characterized by decreasing average cost. Such government authority, however, is usually accompanied by government regulation. Because a monopoly market tends to be inefficient, government often steps into those markets that naturally tend toward monopoly, preemptively establishing the monopoly, then regulating the firm to address any inefficiency that might occur.

Government effectively says, "You can be a monopoly, but you must play by our rules."

Of course, government has the power to create monopoly where none would exist otherwise. Government patents provide an example. In the world of pharmaceuticals, government patents establish monopoly in the markets for assorted drugs. Although dozens of firms could, in principle, provide the same drug, government often restricts the market to a single firm.

This is generally done to encourage pharmaceutical firms to invest time and money in the research and development of new drugs. The exclusive patent allows the firm to recoup this investment. For example, in the hypothetical world of Feet-First Pharmaceutical, their patent on the drug Amblathan-Plus used to cure the deadly foot ailment known as amblathanitis, generates oodles of revenue and profit. However, this is a reward for the years of research and millions of dollars of investment spent developing the drug. Had they lacked the expectations of such reward, then they probably would not have undertaken the investment, and society's health would have suffered.

Resource Ownership

A monopoly is likely to arise if a firm has complete control over a key input or resource used in production. If the firm controls the input, then it controls the output. Monopolies have arisen over the years due to control over material resources (petroleum and bauxite ore), labor resources (talented entertainers and skilled athletes), or information resources (patents and copyrights).

Resource ownership is often a key source of monopoly control. The firm that controls the resource input is able to control the good produced. Because mineral deposits and fossil fuels tend to be geographically concentrated, they often emerge as monopoly-enabling resources. The petroleum market, in particular, has been perpetually prone toward monopoly from J. D. Rockefeller and the Standard Oil Trust in the late 1800s to the Organization of Petroleum Exporting Countries in more recent times.

Labor is another resource that is amenable to monopoly. The labor union movement of the late 1800s and early 1900s was designed to monopolize the supply of labor for a given industry or skill. Professional entertainers and athletes, to the extent that they possess unique talents and abilities, are also prone toward monopoly.


Recommended Citation:

MONOPOLY, SOURCES, AmosWEB Encyclonomic WEB*pedia,, AmosWEB LLC, 2000-2021. [Accessed: November 29, 2021].

Check Out These Related Terms...

     | barriers to entry | monopoly | monopoly characteristics | monopoly, demand | monopoly, efficiency | monopoly, realism | monopoly, problems | monopoly and perfect competition |

Or For A Little Background...

     | short-run production analysis | average cost | average total cost | average fixed cost | economies of scale | market control | demand curve | government functions | efficiency | market structures |

And For Further Study...

     | monopoly, short-run production analysis | price discrimination | perfect competition | oligopoly | monopolistic competition | monopoly, marginal revenue and demand elasticity |

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