MONOPOLY

Introduction

Market is an institution that runs the activity of buying and selling goods

and services. Market as a collection of individual buyers and sellers has certain

characteristics. These characteristics arise because each individual buyer and seller

has different individual behaviors. There are certain market characteristics where in

that market there is only one seller of one product (goods or service) that has no

alternative substitute product (substitution). Market with these characteristics is

called monopoly market. Given the monopoly market, there is only one seller of a

product (goods or services) that do not have a replacement product alternatives

(substitution), then there is no competition from other sellers on the monopoly

market.

In a factual economic life, it is rare to get sellers who do not face

competition from other sellers. Although in a market, for example there is only one

seller so there is no direct competition from another seller, but the sole seller will

face indirect competition from other vendors who produce products that can be an

perfect replacement product alternative. Monopoly market is often interpreted

negatively in some people who lack understanding of economics. While there are

also some monopolies that aims to avoid monopolistic practices that harm the

general public. As an example of a State Electricity Company (PLN) monopoly in

providing electricity in Indonesia, it greatly helps the poor to be able to enjoy

electricity at a low cost through subsidies provided by the government.

Literature Review
Wang and Tan on their “The Influence of Product Market Externality on

Dynamic Decisions of Monopoly” done some research about The externality of the

goods in the market affects the diffusion process of the product, and also affects the

price strategy and advertising strategy that manufacturer makes in the diffusion

process of the product. Positive externality can accelerate the speed of the product

diffusion, increase product sales, and save the cost of advertising in order to

increase enterprise’s profit; Strong negative externality reduces product sales,

increases enterprise’s advertising costs and makes losses. Under the market of the

monopoly structure, considering the effect of products’ externality, product price

and advertising investment on the product’s demand, builds the dynamic decision

model of the product and uses the control theory to get the manufacturer’s optimal

price strategy and optimal controlling strategy of the advertisement expenditure,

and relatively analysis the changing trend of optimal controlling strategy, the

product’s diffusion process and manufacturer’s profit on the different condition of

positive and negative externality, and obtains some conclusions which are provides

theory support for the decision enterprise makes. They made conclusion that The

manufacturer could use advertising to accelerate product diffusion and increase

product sales in the early stage of the product entering the market. When

consumers buy and use the products, products will have externality in the market

that affects product diffusion and firm decision. So it is much valuable to study the

effect of externality on dynamic decision making for monopoly. The dynamic

model is built including price, advertising level and externality in this paper, using

the control theory to calculate the optimal price, advertising level control strategy
and the actual product total demand, and also analyzes the change trend of relevant

parameters in different conditions. The main conclusions are: when the product has

different market externalities, the optimal advertising investment level and the

optimal price have different trends with the increasing of external strength;

especially, whether the product has positive market externality or negative market

externality, the ratio of the optimal advertising investment level to the optimal price

decreases with the increasing of external strength. Under different conditions, the

effect of market externality on product sales is different. Research on the influence

of product monopoly externality on dynamic decision can provide a theoretical

basis for monopoly that makes dynamic decision and control in different sales

periods. The monopoly should make full use of the products’ positive externality to

save costs and increase revenue.

Ágoston, KC on his “Pricing of a Risk Averse Monopoly in the Presence of

Stochastic Demand” investigated the pricing behavior of a risk averse monopoly. Since the

focus is on the risk averse attitude of the firm, he ignore cost in his model. Demand is

considered to be stochastic demand: as price decreases, the expected number of customers

increases, but it has a variation. Although demand is uncertain, it relates to the aggregation

method of individual demands and the individual demand has the usual form. In his

framework a risk neutral (or profit maximizer) monopoly does not change the product’s

price as the number of clients increases. On product markets the risk averse monopoly with

DARA utility function always increases the price as the number of clients grows, but in

insurance markets the implication can be the opposite: the price of insurance may decrease

as the number of clients increases. He also make a conclusion that he presented a

microeconomic framework, in which a risk averse monopoly’s behavior can be

investigated. He proved that in a product market a risk averse monopoly applies a lower

price than a risk neutral (profit maximizer). If the risk aversion decreases with wealth

(DARA), the market price will increase with the market size. In the insurance market the

price can decrease or increase with the market size even for utility function with DARA

property.

Hosoya, Y and Kaneko S on their “Welfare Improvement and the Extension of the

Income Gap under Monopoly” done a research which constructs a model of a monopoly

where investors are also actors, and shows that, in contrast to traditional models, this

model admits the welfare improvement caused by monopoly. This study also reveals that if

a huge income gap exists in the initial stage, then monopoly exacerbates the expansion of

the income gap caused by market trades. Moreover, we show that this exacerbation occurs

in general situations under some additional (but natural) assumptions. As a conclusion,

They constructed a model of a monopoly with investors, and showed that monopoly did

not necessarily decrease total welfare. Meanwhile, under mild assumptions monopoly

exacerbated the expansion of the income gap. Therefore, we revealed a new aspect of the

negative influence of monopoly.

Kirsanov S, Safonov E and Ramirez S on their “Natural Monopoly in Russia :

State Regulation Problems” made an article that has a purpose to reveal some aspects state

regulation of natural monopoly in Russia, which are of paramount importance in economic

and social life of the country. The optimal path to reforming the monopolized industries is

currently a very topical question for Russia. The Russian government requires studying the

foreign experience in this field and adapting it to the Russian conditions. Almost complete

lack of transparency in the pricing of natural monopolies is one of the most important

problems in Russia. In this connection, against the background of almost uncontrolled

corruption in the country, the decision to increase tariffs for practically all services
provided by monopolists, irrespective of the world prices for energy resources, causes

distrust and just censures. The inefficient management of the state corporation Gazprom, a

significant reduction in taxes transferred to the state budget, has not, until now, been the

subject of thorough audit and critical analysis by the relevant government agencies. The

Ministry of Energy does not attempt to reform the gas industry, for example, in the

likeness of Scandinavian countries, where surprising results have been achieved in the

operation of numerous energy suppliers. The increase of tax revenues to the country’s

budget and the improvement of the quality of life of the population depend on to the scope

of reforms of the industry the state will carry out based on a combination of administrative

and economic control measures. Methods of investigation used: analysis, synthesis,

comparative analysis. They conclude that Despite the image of a successful company,

PJSC Gazprom is losing its markets and revenues with adverse effects on the state

budget. The deficit of the state budget of Russia in 2017 amounted to about 3

trillion rubles. Nevertheless, the management of the state corporation continues to

pay huge dividends to itself, which, under the conditions of the economic crisis in

Russia, causes social tension. Many economists believe that a high degree of

integrity of the Russian gas industry is objectively necessary and that Gazprom

should stay a natural monopoly. In our opinion, this point of view is erroneous,

comprehensive reform of the gas industry is required, which should be aimed at

real competition. According to the world experience, gradual decentralization of

regulation, emergence of new energy suppliers will lead to the emergence of a

civilized market, increasing business efficiency and, as a result, revenues to the

country’s budget.
Definition

Monopoly (from Greek: monos, one + polein, sell) is a form of market in

which there is only one seller who dominates the market. The price determinant in

this market is a seller or often referred to as a "monopolist". As a price-maker, a

monopolist can increase or decrease prices by determining the quantity of goods to

be produced; the less goods produced, the more expensive the price of the goods,

and vice versa. However, the seller also has a limitation in pricing. If the pricing is

too expensive, then the person will delay the purchase or seek to make or substitute

the product.

Monopoly market arises from the existence of monopolistic practices,

namely the concentration of economic power by a business actor resulting in the

control of production and marketing of certain goods and services, resulting in

unfair business competition and can harm the public interest. Although in the

monopoly market the seller has no rivals, not necessarily they can get a big profit,

this may happen if the cost of production is above market price. So the demand

curve in monopoly equals the market demand curve. Where on the market demand

curve, the average revenue curve (AR) and the marginal revenue curve (MR) can

be determined. For a monopolist, the marginal revenue (MR) curve is lower than

the price, because the seller has to lower the price for the purpose of the goods

being sold.
Monopoly Characteristic

Monopoly on the market has characteristics such as,

 The number of sellers is only one, and the seller has a substantial market

share.

From the definition of monopoly it is known that there is only one company

in the industry. Thus the goods or services it produces cannot be purchased

from elsewhere. Buyers have no choice, if they want the goods they have to

buy from the monopolist. The terms of sale are entirely determined by the

monopolist, and the consumer cannot do anything in determining the terms

of the sale.

 Does not have similar replacement items.

The goods produced by the monopolist cannot be replaced by other goods

in the market. They are the only type of item and no similar items can be

replaced.

 There is an obstacle for other companies to enter into the monopoly market.
 This characteristic is the main cause of the company that has monopoly

power. The monopolist's profit will not cause other companies to enter the

monopoly market.

 May affect pricing.

Since the monopolist is the only seller in the market, the pricing can be

controlled. The monopolist is therefore regarded as the price determiner.

 Less ad promotion required.

Since a monopolist is the only company in the industry, they do not need to

promote their goods using advertising

Types of Monopoly

 Natural Monopoly
A natural monopoly is a type of monopoly that exists due to the high fixed

or start-up costs of conducting a business in a specific industry.

Additionally, natural monopolies can arise in industries that require unique

raw materials, technology or similar factors to operate. Since it is

economically sensible to have some monopolies like these, governments

allow them to exist, but provide regulation, ensuring consumers get a fair

deal.

 Monopoly by Law or Legal Monopoly

 A legal monopoly is a company that is operating as a monopoly under a

government mandate. A legal monopoly offers a specific product or service

at a regulated price and can either be independently run and government

regulated, or government run and regulated.

Sources of Monopoly Power

Monopoly power is influenced by the following factors:

 Barriers to entry

 Number of competitors

 Advertising

 Degree of product differentiation

 The larger and more expensive the barriers to entry the greater the

monopoly power

 The smaller the number of competitors in the market the greater the

monopoly power

 The greater the advertising spend and more recognizable the brand name the

greater the monopoly power

 The larger the degree of product differentiation the greater the extent of the

monopoly power

Economic Repercussions

Some argue that monopolies are beneficial because highly-profitable

companies tend to pump more funds into research and development. Because the

monopoly is in a dominant position, it can comfortably bear the risks associated

with innovation. However, a highly-profitable monopoly also may have little

incentive for improvement as long as consumers still demonstrate a need for their

current product or service. In comparison, businesses in a competitive market can

compete by making changes to existing products and services and lowering prices.

Monopolies ensure there are high barriers to entry and thus no free riding or

adaptations to their current patents. The labor force in a monopolized industry may

also be significantly less than that of a competitive industry.

Dismantling a Monopoly

One option for policy makers would be to dismantle the monopoly. This

can be accomplished by splitting the monopoly into two companies, divide their

bundled products or services, or separating services into smaller competing

regional services. The monopoly's separation will lower the barriers to entry for

new companies. The new competition will eventually provide a wider variety of

options and most likely lower prices for consumers. For example, in the 1980s the

US experienced nation-wide deregulation in the telecommunications industry.

While four of the seven "Baby Bells" are back under the AT&T umbrella, the

breakup is still considered a great success. Competition in the telecommunication

industry again is increasing as start-ups begin using mobile technology to disrupt

the cost structures of the telecom companies.

Lowering Prices

Another option for policy makers would be to focus on lowering prices

instead of breaking apart a monopoly. Regulators can set pricing controls called

price caps in order to prevent the company from setting unreasonable prices. Price
capping is a way to reduce the price benefit of being a monopoly as the price

lowers to that of a competitive market. Once competition increases in the industry,

policy makers can reduce or remove the price caps. According to The Energy

Journal, all US electricity independent system operators have price caps. Similarly,

setting rate-of-return price regulations can help reduce artificially high utility

prices. The government can also opt to nationalize natural monopolies to ensure

that utility prices are in the best interest of the public.

References

Ágoston, K.C. (2015) Pricing of a Risk Averse Monopoly in the Presence

of Stochastic Demand. Theoretical Economics Letters, 5, 217-224.

Hosoya, Y. and Kaneko, S. (2015) Welfare Improvement and the Extension

of the Income Gap under Monopoly. Theoretical Economics Letters, 5, 590-

597

Kirsanov S, Safonov E, Ramirez S (2017) Natural Monopoly in Russia :

State Regulation Problems. Baltic Journal of Real Estate Economics and

Construction Management, 137-145.

Wang, Y. and Tan, D.Q. (2017) The Influence of Product Market

Externality on Dynamic Decisions of Monopoly. Modern Economy, 8, 806-

815.