Monopolies versus competition in market economics

Monopolies vs. Competition

In a perfectly competitive market, price is determined by the true forces of market supply and demand; the seller can only control the quantity of goods it produces. In the long run, the firm maximizes profit or minimizes loss by producing the output where marginal revenue equals marginal cost. A competitive firm's marginal revenue is the given market price. However, barriers to entry (i.e. legal, sociological, natural, technology factors) prevent perfect competition and create alternative market structures, namely monopolies, oligopolies and monopolistic competition as summarized in Figure 1. Barriers to entry create the potential for long-run economic profit and prevent competitive pressures from pushing price down to average total cost. Many economists believe that a significant reduction in competition will lead to overall slower economic growth. Even so, government should not interfere with market structures; free market dynamics alter market structures to become more competitive in the long run.

Market structures vary in degrees of competition. At the extreme end of the market structure is a monopoly or a single supplier in the market. Facing a downward sloping demand curve, a monopolist will charge the maximum price that consumers are willing to pay for the quantity it produces. It produces where the marginal cost (MC) curve equals the marginal revenue curve, and not where MC equals price. Because price exceeds MC, people's choices aren't determined in the way they would be if the market was competitive; they choose to consume less of the monopolist's output and more of some other output. Thus, the MC of increasing output is lower than the marginal benefit of increasing output, creating a welfare loss. In an oligopoly, there are a few competing firms. An oligopolist's price will be somewhere between the competitive price and the monopolistic price. These types of firms face at prisoner's dilemma. If one firm lowers its prices, competitors are likely to follow and everyone will see less profits. Or, a competitor might hold its price to gain market share. They all stand to gain only by setting prices where everyone earns profits and has a stable market share. In the real world, most firms are monopolistic competitors. There are several competing firms who supply goods, but, unlike perfect competition, they face a downward-sloping demand curve for their differentiated products. The perfect competitor in long-run equilibrium produces at a point where MC - P - ATC. At that point, ATC is at its minimum. On the other hand, a monopolistic competitor produces at the point, MC - MR. Increasing output will lower average cost. Therefore, monopolistic competitors make great efforts to increase their market share.

Proponents of government regulation argue that it has a responsibility to ensure the market is competitive. They argue that monopolies cease innovation and force people to pay exorbitant prices. However, this isn't always true. In 1994, the government accused Microsoft of using its more than 70% share of personal operating systems to prevent competition. But, what the case revealed was that Microsoft dominated the industry because of its innovation, solid marketing and successful products offered to the market at very affordable prices, exactly those factors that monopolies are supposed to impede. In January of 1969, the United States Department of Justice filed an antitrust suit against IBM to break it up into smaller companies because it controlled almost 70% of the computer market at that time. In 1982, the case against IBM was ruled to be "without merit." Even so, IBM did not continue its market dominance as advocators of government regulation for this company had asserted it would. Instead, IBM began to falter after a series of product failures. As a result, many companies gained market share against IBM with some even over taking it; an efficient market took care of the issue.

Yet, another example of why government should not interfere with market structures is the airline industry. After 1978, the airline industry was quickly transformed into an oligopoly market structure where only a half dozen or so companies controlled 90% of U.S. travel. Airlines such as American mostly enjoyed high profits until 2000, taking advantage of limited competition and their ability to price discriminate to increase profit margins for those customers who were willing and able to pay higher prices. Beginning in 2000, everything came crashing down for the airlines (pardon the pun). American airlines lost money from 2000 until it finally reaped a small net profit in 2005. The oligopoly market structure that once fueled profits has been the undoing of legacy carriers such as American. Not fearing significant competition due to what it perceived as significant barriers to entry such as government regulations and licensing agreements with airports, it had become complacent about costs, with inefficient operations and expensive union labor. But, new competitors were able to enter the market as barriers to entry decreased over time. Most notably, Southwest and JetBlue entered the industry with more efficient business models and dramatically lower costs. Then, along came a recession that reduced demand and higher fuel costs. Ironically, the oligopoly has high barriers to exist because the government closely scrutinizes mergers and acquisitions. The lesson learned is that even oligopolies have to focus on being as operationally efficient as possible and must keep up with changing market dynamics. Barriers to entry may be high, but this can always change.