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By the end of this section, you will be able to:

  • Distinguish between a natural monopoly and a legal monopoly.
  • Explain how economies of scale and the control of natural resources led to the necessary formation of legal monopolies
  • Analyze the importance of trademarks and patents in promoting innovation
  • Identify examples of predatory pricing

Because of the lack of competition, monopolies tend to earn significant economic profits. These profits should attract vigorous competition as described in Perfect Competition , and yet, because of one particular characteristic of monopoly, they do not. Barriers to entry are the legal, technological, or market forces that discourage or prevent potential competitors from entering a market. Barriers to entry can range from the simple and easily surmountable, such as the cost of renting retail space, to the extremely restrictive. For example, there are a finite number of radio frequencies available for broadcasting. Once the rights to all of them have been purchased, no new competitors can enter the market.

In some cases, barriers to entry may lead to monopoly. In other cases, they may limit competition to a few firms. Barriers may block entry even if the firm or firms currently in the market are earning profits. Thus, in markets with significant barriers to entry, it is not true that abnormally high profits will attract new firms, and that this entry of new firms will eventually cause the price to decline so that surviving firms earn only a normal level of profit in the long run.

There are two types of monopoly, based on the types of barriers to entry they exploit. One is natural monopoly    , where the barriers to entry are something other than legal prohibition. The other is legal monopoly    , where laws prohibit (or severely limit) competition.

Natural monopoly

Economies of scale can combine with the size of the market to limit competition. (This theme was introduced in Cost and Industry Structure ). [link] presents a long-run average cost curve for the airplane manufacturing industry. It shows economies of scale up to an output of 8,000 planes per year and a price of P 0 , then constant returns to scale from 8,000 to 20,000 planes per year, and diseconomies of scale at a quantity of production greater than 20,000 planes per year.

Now consider the market demand curve in the diagram, which intersects the long-run average cost (LRAC) curve at an output level of 6,000 planes per year and at a price P 1 , which is higher than P 0 . In this situation, the market has room for only one producer. If a second firm attempts to enter the market at a smaller size, say by producing a quantity of 4,000 planes, then its average costs will be higher than the existing firm, and it will be unable to compete. If the second firm attempts to enter the market at a larger size, like 8,000 planes per year, then it could produce at a lower average cost—but it could not sell all 8,000 planes that it produced because of insufficient demand in the market.

Economies of scale and natural monopoly

The graph represents a natural monopoly as evidenced by the demand curve intersecting with the downward-sloping part of the LRAC curve.
In this market, the demand curve intersects the long-run average cost (LRAC) curve at its downward-sloping part. A natural monopoly occurs when the quantity demanded is less than the minimum quantity it takes to be at the bottom of the long-run average cost curve.

Questions & Answers

what is demand
Prince Reply
what is market mechanism
thammy Reply
how do you find the marginal line given the input and output?
Greatson Reply
population density
Thompson Reply
what is monopoly
Thompson
what is elasticity of demand?
tunde Reply
Elasticity is a central concept in economic , and is applied in many situations. Elasticity can provide important information about the strength or weakness of such relationship. Elasticity refers to the responsiveness of one economic variable such as quantity demanded, to change in another variable
Lena
such as price. #Price elasticity of demand:which measure the responsiveness of the quantity demanded to a change in price. #cross elasticity of demand:which measure the responsiveness of quantity demanded of one good to a change in the price of another good.
Lena
what are variables
Lekan Reply
marginal cost
Seyi Reply
division of labour
Abdulmumeen Reply
explain Qd=601/3p
mahmud Reply
what is unemployment
Ernest Reply
what is the formula for average revenues
EMMANUEL Reply
please 7 implications of Lionel Robbins definition of economics
Amaka Reply
Problem of economics to the society
Gmzaeeyan Reply
Within 1 or 2 percentage points, what has the U.S. inflation rate been during the last 20 years? Draw a graph to show the data.
Daphne Reply
law of demand is explaining why the demand curve is downward sloping
Tan Reply
the graph would be x axis is quantity and y axis is price, as the price is expensive, there would be less demand therefore less quantity anf vice versa, thats why demand curve is downward sloping
Tan
and*
Tan

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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