Monopoly and Competition

Monopoly and Competition

Nature hates monopolies and exceptions. The waves of the sea do not more speedily seek a level from their loftiest tossing, than the varieties of condition tend to equalize themselves. There is always some leveling circumstance that puts down the overbearing, the strong, the rich, the fortunate, substantially on the same ground with all others.

—Ralph Waldo Emerson[1]

The Role of Competition

Markets become efficient through competition. Buyers compete to get the goods and services they want at the lowest possible prices. Sellers compete to sell at the highest possible prices. In a monopoly, a single company controls a market; there is no competition. Imagine a bridge that crosses a body of water, with no alternative. If you want to cross, you must use the bridge.

When there is competition in a market, consumers are free to choose the best providers and firms compete to serve consumers. Monopolies are often considered harmful because they interfere with this process, letting monopolists set prices higher than they could if they had real competitors. That’s why many countries try to prevent monopolies.

Oligopolies and Winner-Takes-All Markets

What is more common is oligopolies—markets with only a small number of competitors and limited room for new entrants. Markets tend to favor unequal distribution of market share and profits, with a few leaders emerging in any industry—what’s known as a “winner-takes-all market.” Winner-takes-all markets are hard to disrupt, and they suppress the entry of new players by locking in market share for leading players. When we say a market is “winner-takes-all,” what we mean is that a single company receives most available profits. A few others have at best a modest share. The rest fight over a minuscule remnant and tend not to survive long.

Positive Aspects of Monopolies

Monopolies can be positive, though, when significant investment needs to be made to develop and supply a product in the first place.[2] One example is utility companies. It costs a lot to create the infrastructure needed to provide sewage treatment or electricity. Giving a company a monopoly for service to an entire city justifies the initial upfront investment required and increases the possibility the resulting infrastructure will have a certain longevity.

Natural Monopolies

This type of monopoly often develops into a natural monopoly, which occurs when an industry has steep barriers to entry. These barriers—such as significant physical infrastructure requirements—make it daunting for new competitors to take on established players that are already operating at a large scale. When natural monopolies of providers of essential goods or services occur, governments may intervene to ensure prices remain affordable. With restrictions on prices in place, a natural monopoly can continue to benefit consumers, especially with an undifferentiated product, by reducing the overall cost of required infrastructure.

Temporary Monopolies for Innovation

Sometimes, markets have mechanisms in place to deliberately create temporary monopolies, to incentivize desirable economic activity. Economist Joseph Schumpeter believed that “monopolies were especially important for bringing about innovation because they give entrepreneurs big rewards for the risky activity of trying to create new things.”[3] For example, pharmaceutical companies typically receive exclusive rights to sell newly developed drugs for a few years, allowing them to set high prices to recoup the costs of research and development. Although this may initially restrict access, in the long run, pharmaceutical patents are intended to incentivize the development of drugs that would otherwise be unprofitable to create.[4]

Applications Beyond Economics

We can use the mental model of market monopolies to help us understand many situations involving unequal distributions: Most of the books sold each year are written by a handful of authors. Most internet traffic goes to a few websites. The top 100 websites get more traffic than ranks 101 to 999 combined. Most citations in any field refer to the same few papers and researchers. Most clicks on Google searches are on the first result. Each of these is an instance of a winner-takes-all market.

Self-Reinforcing Monopolies

Monopolies can perpetuate themselves; sometimes things are famous for being famous or popular because they’re popular. Robert H. Frank writes of such things in Success and Luck: “Although we often try to explain their success by scrutinising their objective qualities, they are in fact often no more special than many of their less renowned counterparts…. Success often results from positive feedback loops that amplify tiny initial variations into enormous differences in final outcomes.”[5]

Monopolies interrupt evolution because of their lack of competition. In a monopoly, there is less room for trying new things, for diversity, and for overall resilience.