In strict economy definition, monopoly means the only seller in the market. Such a market structure is quite hard to be found in the real world. Hence, a big company or a firm which can control more than 25% of shares is considered a monopoly. A company can become a monopoly when there are barriers which prohibit others to enter the market. Those barriers are patents, licenses given by government and also the dominance position of monopoly. Due to the barriers, a monopoly seldom faces competition and hence it has a great market power.
Because of the great market power, many economists have argued that monopoly is actually an inefficient and undesirable market. Why the monopoly is said to be inefficient? This is because monopoly will never produce at the point price equal to marginal cost which the social welfare is maximized. Most of the firms will try to maximize their profit and hence they will produce at the point of marginal cost equal to marginal revenue. The marginal revenue curve is below the demand curve. Because of that, there is a deadweight loss in the society. The resources are not allocated in the most efficient way.
Allocative inefficiency occurs. The demand curve of monopoly is downward sloping and it is very steep. Because of a steep downward sloping demand curve, the demand curve is very inelastic. Hence, a monopoly could charge its product at a very high price. It can do this easily by restrict its output and the price will shoot up. Because the demand curve is inelastic, a monopoly will not lose many customers when it raises its price. For instance, Genting in Malaysia is a monopoly. The fee that it charges for the casino and the theme park is actually very high.
However, many people still go to Genting for trips because there are no substitutes for that. Besides that, a monopoly does not face any competition. As a result, it becomes productively inefficient. It will not have incentives to cut down the average cost. Why should it do so? It is the one in the market. No matter how high it charges, it still has a lot of customers. Its high average cost can easily be covered by exploiting our customers’ welfare. Moreover, the quality of the products or services provided by monopoly may not be satisfactory.
For instance, Astro in Malaysia is the only cable channel for a long time. However, the service given by Astro is quite poor. When there is a rain, the image will be blurred and cannot be seen. It still can be accepted if the rain is really heavy, yet sometime there is just a gentle rain. How can a consumer like us pays so much to Astro but getting such quality? In addition, Astro is smart and it tries to exploit the customers as much as it can. It has some packages and all the channels are bundled together. Not all of the channels are going to be watched by us.
It should let the customer has the choices to choose only the channels that he wants. Nevertheless, Astro will never do so because you can’t find another substitute. If you want to watch cable channels, the only way is to tolerate with Astro which is a monopoly. Furthermore, a monopoly does not have incentive to innovate. Many economists have argued that because monopoly has a large capital, it can spend a lot in R&D department and it is more innovative. However, no one can guarantee that a monopoly will spend much money it earns in the research.
It can just use it to pay the high salary of its employees and the management board. In fact, we couldn’t see that a monopoly is actually innovative. For example, Microsoft used to be a very innovative corporate. Because of Microsoft, Windows and Office which benefit most of us come out. Windows and Office have caused Microsoft to reach a monopoly status. However, after Microsoft becomes a monopoly, what can you see about its innovation? Windows and office have a lot of versions. Window 98, Window XP, Window Vista and now Window 7, can users like us differentiate them?
The Office also changes from years to years. Besides it changes the place of the features, is there really something benefits consumers compared to the old version? Yet, Microsoft still can take these kinds of innovation as its new products and sell them to most of us. Monopoly seems to be very evil. Then should we ban monopoly totally? Is there something good about monopoly? There is actually something good about monopoly and this kind of good monopoly is called natural monopoly. Utilities such as water, electricity and telephone line need monopoly.