MONOPOLY AND OLIGOPOLY

MONOPOLY AND OLIGOPOLY

The reality in many business contexts, however, is that a small
minority of giant firms dominate the market place such that small
producers feel relatively powerless. For almost any industry you
can think of, you can probably also think of the handful of famous
names that bestride it – from sophisticated, high tech. products like
passenger aircraft (Boeing, Airbus) to the mundane household
items like washing powder (Proctor and Gamble, Unilever); from
things you can hold in your hand (Nestle, Coca-Cola) to abstract
ideas and entertainment (AOL TimeWarner, Sony).
A monopoly is a single large firm that sells its product in a
market place with no effective rival. If such a development were
allowed in the supply of an essential good or service, the monopolist
would exercise great economic power – customers would have to pay
the price the monopolist wanted or go without, since there would be
no alternative supplier. Most countries therefore have legislation to
prevent the growth of private monopolies to anything greater than
25 per cent of market share, with the result – as mentioned earlier –
that industrial concentration stops short of single firm dominance
and thus competition occurs between a small number of very large
firms. This is a market structure known as OLIGOPOLY.
Industries dominated by a few big rivals still means that each business
wields an impressive economic influence, however. The European
Commission calculates that 0.2 per cent of the total number of businesses
on the continent control over 37 per cent of market sales
and these large firms, on average, employ over a thousand people
each. When it comes to multinational corporations – businesses
that own and control assets in more than one country – the top
© 2004 Tony Cleaver
200 multinationals across the globe jointly produce about one third
of the world’s total output. Not much evidence here of the forces of
competition preventing the accumulation of market power!
What accounts for the prevalence of such large corporate enterprises
and why has their growth to such dominance not been
constrained by follow-my-leader-competition as theorised earlier?
In some cases it can actually be the forces of competition, over
time, leading to the survival of the fittest. The more efficient firms
in an industry may be able to reduce costs and prices below those of
their rivals, drive them out of business or take them over and thus
convert what was a competitive market place into one dominated by
a few large corporations.
Modern banking has sometimes been described in these terms.
The nature of banking as a business lends itself to over-optimistic
expansion on the one hand, followed by financial crashes where the
weakest go to the wall. Where this process has worked its longest –
in Europe and the USA – a few very large enterprises have
emerged, each with considerable financial muscle that simultaneously
acts as a safeguard against crises that would destroy smaller
brethren and also provides a key competitive advantage. (Bigger,
safer banks are more likely to attract more custom.)
Note, however, that this process of industrial or commercial
evolution could not succeed in producing a dominant few – in
banking or anywhere else – if the businesses that remain could not
somehow retain a competitive edge: some advantage that inhibits
the entry of new, lean and hungry enterprises looking to capitalise
on the profits that the lead oligopolists feed off.
Barriers to Entry
Economies of scale provide one explanation for oligopolies being
able to resist dilution of their market power by the entry of new
businesses. Financial and risk-bearing economies are relevant in the
case of banking referred earlier (large financial enterprises can buy
and sell money in bulk and thus can offer lower price deals to
customers) but other economies of scale include technical factors.
For example, in aerospace, the oil industry and also in pharmaceuticals,
the capital threshold that new firms have to cross before they
can bring their costs down to a level commensurate with existing
© 2004 Tony Cleaver
suppliers is simply immense. Where technically complex production
processes are involved in bringing goods to markets, then the set-up
costs for new entrants are a natural barrier to the forces of competition.
In some sectors, only very big businesses can be efficient and
the market place – even world-wide – may not be large enough to
support more than two or three firms. (For example, just three
enterprises dominate world aero-engine supply: General Electric,
Rolls Royce and Pratt & Whitney.)
We can discriminate, however, between barriers of entry like
those described earlier, which are structural or due to real economic
forces and those which are behavioural, or due to the manipulation
of power by existing oligopolists. Massive advertising campaigns, for
example, may be resorted to by existing firms which inflate production
costs on the one hand and create a brand image, on the other,
which new producers find hard to overcome. The technology
involved in producing carbonated soft drinks, for example, is hardly
rocket science (quite the opposite, it is one of the first industries that
low-income countries can invest in to develop their own emerging
industrial sector and serve their own peoples). Nonetheless, the
powerful presence enjoyed by the duopoly of Coca-Cola and
PepsiCo greatly reduces the room for poor countries to promote
industrial expansion in this particular market place.
Product differentiation is a strategy pursued by large firms to
increase the range of items they sell. Varying superficial qualities of
the product – colour, packaging, logos, special offers and other
marketing gimmicks – helps create a different BRAND in the mind of
the consumer. Thus the many supermarket offerings of breakfast
cereals seem to the untutored eye to illustrate very active competition
between a large number of rival producers but, on closer
inspection, the scores of different brands on display are all produced
by two or three large oligopolists. (Even supermarket ‘own brand’
items are simply purchased from these same producers and retailed
in cheaper packaging.) Product differentiation is a ruse employed by
such enterprises to block out the market. Any genuine new entrant
to this industry therefore faces having to establish its identity
against a wealth of dazzling alternatives.
Vertical and horizontal INTEGRATION refer to directions of
industrial growth that large firms may indulge in to exercise
greater market control. In the late part of the nineteenth century,
© 2004 Tony Cleaver
Rockefeller’s original Standard Oil (SO) company accumulated vast
profits by buying up or building all the pipelines serving North
Eastern US markets with oil from the Southern producer states. This
was horizontal integration – monopolising all business at one stage of
the production process, in this case the transporting of oil. (In 1911,
SO was broken up by US anti-trust legislation as a result of this
abuse of its power. It was such a huge business, however, that the
several parts into which SO was cut up all evolved to become international
oil majors in their own right.) As a result of this experience,
many oil producers have since resorted to vertical integration to
ensure they always have some degree of control over supplies and
markets – buying up, building or signing exclusive long-term
contracts with upstream suppliers or downstream distributors in the
production chain. Modern day Exxon (which Esso became) therefore
owns and controls a stake in all the processes involved in the international
oil industry – from oilfields, to pipelines and oil tankers, to
refineries and gas stations that operate all around the world.
Finally, an important reason for industrial concentration, if not
actual monopoly, is government legislation or patronage. An innovating
firm may apply for a PATENT or sole licence to supply a
unique product or process. Drug companies, for example, may spend
fortunes developing a new medicine but such innovations, though
costly to develop, may be very cheap to imitate. Without patent
protection, therefore, such firms would be unlikely to invest in new
ideas. Monopoly status is thus conferred with an official patent that
sets a time limit to the innovation – guaranteeing the firm sufficient
time and thus reward to recoup the investment before other
imitators can enter the market.
State monopolies or nationalised industries are those enterprises
owned and controlled by public authority where the law actually
forbids competition. There has been a world-wide trend to privatise
much state enterprise therefore fewer examples remain today, but
nonetheless in many countries the post office remains a monopoly,
as are certain public utilities (the distribution of gas, electricity and
water). In defence industries and in the provision of nuclear energy
the state may or may not own the production process but via exclusive
government contracts it will determine outputs and restrict
competition in this area for security reasons.
© 2004 Tony Cleaver
In all these cases, where monopolists or oligopolists dominate a
market place they are able to exert greater control over prices and
thus their sales and profits. Industry supply in these circumstances
will differ from the perfectly competitive model described earlier in
a number of vital ways.
Monopoly Demand
There is an important distinction between the demand conditions
for monopoly and for oligopoly and this is examined in this section
and in further detail in the boxes that follow.
First, the more a large firm monopolises a market place the more
the demand for its particular product will come close to that for the
industry’s output as a whole. Oligopolists attempt to mimic this situation
which is why corporations invest large sums in product
differentiation. The objective is to create customer loyalty – that is,
the monopoly of a brand. (‘The one and only – accept no substitute!’)
The ideal situation for the firm is that demand for its product
thus becomes price-inelastic: consumers are so accustomed to
buying their favourite brand that sales do not fall appreciably even
if its relative price rises.
Profit-maximising enterprises operating in conditions of
monopoly will deliberately restrict production if this forces prices up
more than unit costs. We can predict that if margins between
average prices and costs can thus be widened, and barriers to entry
to the industry can be maintained to frustrate new competition, then
abnormal profits can be realised even in the long run (Box 3.2).
Box 3.2 Profit-maximising monopoly
In the case of a pure monopoly where there is only one producer
and no competition whatsoever, the demand curve for the
firm must be identical to that for the industry. Unlike a competitive
firm that must accept whatever price the free market
dictates – see Figures 3.3 and 3.4 – the monopolist in contrast is
© 2004 Tony Cleaver
a price maker. The firm dictates what price will rule simply by
deciding what level of supply to produce. Restricting production
will push prices up since consumers are forced to outbid each
other to secure their purchases; increasing supplies will cause
prices to fall.
Note the effect this has on MRs. For a normal, downwardsloping
demand curve, since the monopolist must reduce prices
if sales are to be increased, MR (earnings gained on the last
item sold) must always be less than the average.
Check the derivation of average and marginal revenues in
Table 3.4 and Figure 3.5.
TR is derived from multiplying the price (P) of the good, times
the quantity (Q) sold. Note, in reverse, that dividing TR by Q
gives you P which is the same as AR. This relationship shown
between P and Q is actually the demand curve of the firm – which
Table 3.4 Monopoly costs and revenues.
Q TC AC MC P/AR TR MR TP TR TC
1 100 100 135 135 35
50 105
2 150 75 120 240 90
30 75
3 180 60 105 315 135
20 45
4 200 50 90 360 160
30 15
5 230 46 75 375 145
40 15
6 270 45 60 360 90
52 45
7 322 46 45 315 7
78 75
8 400 50 30 240 160
95 105
9 495 55 15 135 360
105 135
10 600 60 0 0 600
Note
MCs and MRs are calculated on the difference between one level of output and
the next which is why they are recorded between the lines.
© 2004 Tony Cleaver
Figure 3.5 The profit-maximising monopolist.
in the case of a pure monopoly is the same as the demand curve
for the industry.
The MR curve shows the increase in TR brought about by the
sale of one extra unit and it falls faster than AR.
Remember that no profit-seeking enterprise will expand production
to the point where the last good sold nets less revenue than it
costs to produce. That is, the firm – whether it be operating in
conditions of competition or monopoly – will produce only up to
the point where MCs equal MR. In Table 3.4, check that the
monopolist will produce 4 units of output but not 5. In Figure 3.5,
the firm is at equilibrium at 4 units of output where Price/AR is
90 and AC is 50. Total (abnormal) profits (TP) thus will be
maximised at 90 50 4 160, confirmed by reference to the
table of data.
Note: The profit maximising equilibrium as illustrated is stable
only so long as new competitors are barred from entry to the
industry. If, in time, new suppliers gain access to the market then
the demand/AR curve for the existing monopolist will shift back
as sales are lost. This squeezes out some of the abnormal profits
as the distance between price (AR) and unit costs (AC) closes.