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A monopoly is a market condition in which a single seller controls the entire output of a particular good or service. A firm is a monopoly if it is the sole seller of its product and if its product has no close substitutes. Close substitutes are those goods that could closely take the place of a particular good; for example, a Pepsi soft drink would be a close substitute for a Coke drink, but a juice drink would not. The fundamental cause of monopoly is barriers to entry; these are technological or economic conditions of a market that raise the cost for firms wanting to enter the market above the cost for firms already in the market or otherwise make new entry difficult. If the barriers to entry prevent others firms from entering the market, there is no competition and the monopoly remains the only seller in its market. The seller is then able to set the price and output of a particular good or service.

A monopoly, in its pure form, is actually quite rare. The majority of large firms operate in a market structure of oligopoly, which means that a few sellers divide the bulk of the market. People often have the impression that the goals of a monopolist are somehow evil and grasping while those of a competitor are wholesome and altruistic. The truth is that the same motives drive the monopolistic firm and the competitive firm: Both strive to maximize profits. A basic proposition in economics is that monopoly control over a good will result in too little of the good being produced at too high a price. Economists have often advocated antitrust policy, public enterprise, or regulation to control the abuse of monopoly power.

BARRIERS TO ENTRY

For a monopoly to persist in the long run, barriers to entry must exist. Although such barriers can take various forms, they have three main sources:

1. A key resource is owned by a single firm.
2. The government gives a single firm the exclusive right to produce a specific good.
3. The cost of production makes a single producer more efficient than a large number of producers.

Monopoly Resources. The first and simplest way for a monopoly to come about is for a single firm to own a key resource. For example, if a small town had many working wells owned by different firms, no firm would have a monopoly on water. If, however, there were only one working well in town, the firm owning that well would be considered a monopoly. Although exclusive ownership of a key resource is one way for a monopoly to arise, monopolies rarely come about for this reason.

Government-Created Monopolies. In many cases, monopolies have arisen because the government has given a firm the exclusive right to sell a particular good or service. For example, when a pharmaceutical company discovers a new drug, it can apply to the government for a patent. If the patent is granted, the firm has the exclusive right to produce and sell the drug for a set number of years. The effects of such a government created monopoly are easy to see. In the case of the pharmaceutical company, the firm is able to charge higher prices for its patented product and, in turn, earn higher profits. With these higher profits, the firm is able to complete further research in its quest for new and better drugs. The government can create a monopoly when, in doing so, it is in the interest of the public good.

Natural Monopolies. A natural monopoly occurs when a single firm can supply a good or service to an entire market at a lesser cost than could two or more firms. An example of a natural monopoly is the distribution of water in a community. To provide water to residents, a firm must first put into place a network of pipes throughout the community. If two or more firms were to compete in providing the water distribution, each would have to pay the fixed cost of building a network. In this case, the average total cost of water is lowest when one firm serves the entire market.

MONOPOLY VERSUS COMPETITION

The major difference between a monopoly and a competitive firm is the monopoly's ability to influence the price of its output. Because a competitive firm is small relative to the market, the price of its product is determined by market conditions. On the other hand, because a monopoly is the sole producer in its market, it can often alter the price of its product by adjusting the quantity it supplies to the market.

An example of a company that garnered monopoly power is the case of Microsoft. In 2000, in an antitrust lawsuit brought against Microsoft, a U.S. federal court judge ruled against the company. Microsoft, a computer company, had established first MS-DOS and later Windows as the dominating operating system for personal computers. Once it had achieved a position of strength in the market, would-be competitors faced insurmountable hurdles. Software developers face large costs for every additional operating system to which they adapt their applications. Because Microsoft had the dominant operating system, any rival personal computer operating system would have only a handful of applications, compared to tens of thousands of applications for Microsoft's Windows system. This applications barrier to entry gave Microsoft enduring monopoly power.

The judge's ruling in the case made it clear that, besides being illegal, Microsoft's monopoly was not in the public interest and legal measures would be put into place in order to break the monopoly that Microsoft had created.