4.4. MONOPOLY - PART 2
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Sources of Monopoly
Monopolies can exist because of multiple reasons. These reasons include:
Monopolies can exist because of multiple reasons. These reasons include:
- Barriers to entry (more will be discussed at the end of this section).
- Barriers to exit. These are similar to barriers to entry. Some industries have very high sunk costs. Sunk costs are costs that cannot be recovered if a firm wants to leave an industry. For example, advertising expenditure. If I own a firm and decide to leave, I cannot recover these costs. An industry that has low barriers to exit will be one that has low sunk costs and very liquid assets.
- Government may grant one firm a monopoly status. For example, the mail market was opened up to competition in 2006. This meant that the Royal Mail Group lost its monopoly status.
- A firm that has a patent over a design or a copyright on an idea, image or name. This gives the owner exclusive right to sell that product or service. The creator of the material has a monopoly over it.
- A firm has exclusive access over a scarce resource and the degree of product differentiation. Microsoft operating systems were considerably better than any other operating system on the market. Because the computing market was very differentiated and copyrights and patents protected anyone from stealing Microsoft’s software, they were able to enjoy a monopoly for many years, if not decades.
- Mergers and acquisitions can lead to a monopoly. These mergers can reduce the competition in the market. This results in regulators stepping in to review whether the acquisitions and mergers are in the interest of society. If they believe that it is, the mergers will be passed. If they believe that the merger would result in a company becoming too powerful then the regulators will block the takeover.
Barriers to Entry
Barriers to entry are an example of monopoly power. A barrier to enter prevents new firms from entering a market profitable. If the industry prevents new firms from entering the market, then existing firms can maintain their high level of profit, both in the short run and the long run. Some barriers of entry that existing firms have are:
Barriers to entry are an example of monopoly power. A barrier to enter prevents new firms from entering a market profitable. If the industry prevents new firms from entering the market, then existing firms can maintain their high level of profit, both in the short run and the long run. Some barriers of entry that existing firms have are:
- Economies of large-scale production. It may be the case that the larger a firm is the lower their cost will be because of economies of scale. This means that existing firms have a cost advantage and new firms will not be able to enter the industry profitable. Also, if the starting costs are large this is a deterrent.
- Pricing structure. One example of a pricing structure is predatory pricing whereby a firm has a price to put pressure on existing or new firms. Another strategy is limit price. This is a specific type of predatory pricing which involves setting a price that is just below what the average cost of new entrants is; this means that new firms would make a loss.
- High sunk costs. A sunk cost is a cost that cannot be retrieved if the firm was to go out of business. An example is advertising. This is another deterrent for new firms trying to enter the industry
- Existing brand loyalty. Some customers may only buy from one company as they have brand loyalty.
- Vertical integration. This is where a firm owns either the production process before or after, such as a brewer owning a chain of pubs which makes it harder for new brewers to sell to these pubs.
Concentration Ratio
We can get an indication of how competitive a market is by looking at the concentration ratio. This looks at what percentage of the market the top ‘n’ firms have. We can measure the market share in various ways such as revenue, output, profit, employees etc. Usually ‘n’ is 3 or 5.
The table shows the concentration ratios for the grocery market sales. For the grocery industry its concentration ratio are as follows:
We can get an indication of how competitive a market is by looking at the concentration ratio. This looks at what percentage of the market the top ‘n’ firms have. We can measure the market share in various ways such as revenue, output, profit, employees etc. Usually ‘n’ is 3 or 5.
The table shows the concentration ratios for the grocery market sales. For the grocery industry its concentration ratio are as follows:
- 3 firm concentration ratio is 61.4%
- 5 firm concentration ratio is 78.6%
Herfindahl-Hirschman Index (HHI)
There is another measure of concentration which looks at the extent of the market share. It is called the Herfindahl-Hirschman Index (HHI). It is calculated by squaring the market shares of all firms in the market and summing these together. The reason for squaring is to emphasis the market share. The larger the market share, the larger the value for the HHI score will be. The maximum that this scale can give is for a pure monopoly (100% of the market), which is a score of 10,000 (1002). The closer the score is to 0 the nearer the market is to perfect competition. For example, if an industry has 10,000 each who had 0.01% of the market each then it HHI score would be 1 (10,000 x (0.01x0.01)).
There is another measure of concentration which looks at the extent of the market share. It is called the Herfindahl-Hirschman Index (HHI). It is calculated by squaring the market shares of all firms in the market and summing these together. The reason for squaring is to emphasis the market share. The larger the market share, the larger the value for the HHI score will be. The maximum that this scale can give is for a pure monopoly (100% of the market), which is a score of 10,000 (1002). The closer the score is to 0 the nearer the market is to perfect competition. For example, if an industry has 10,000 each who had 0.01% of the market each then it HHI score would be 1 (10,000 x (0.01x0.01)).