What Is a Monopolistic Market?
A monopolistic market is a market structure with the characteristics of a pure monopoly. A monopoly exists when one supplier provides a particular good or service to many consumers. In a monopolistic market, the monopoly, or the controlling company, has full control of the market, so it sets the price and supply of a good or service.
How a Monopolistic Market Works
The monopoly that sets the price and supply of a good or service is called the price maker. A monopoly is a profit maximizer because by changing the supply and price of the good or service it provides it can generate greater profits. By determining the point at which its marginal revenue equals its marginal cost, the monopoly can find the level of output that maximizes its profit.
With generally only one seller controlling the production and distribution of a good or service, other firms cannot enter the market. There are typically high barriers to entry, which are obstacles that prevent a company from entering into a market. Potential entrants to the market are at a disadvantage because the monopoly has first mover advantage and can lower prices to undercut a potential newcomer and prevent them from gaining market share.
Since there is only one supplier, and firms cannot easily enter or exit, there are no substitutes for the goods or services. Therefore, a monopoly also has absolute product differentiation because there are no other comparable goods or services.
Are Monopolistic Markets Inefficient?
Both historically and in modern times, economists have been divided on the theory of monopolistic competition. Economists agree that most monopolistic activity is the result of government privileges to certain firms; however, many also believe that a natural industry concentration, or a monopoly or oligopoly, does not result in market inefficiencies. Inefficiencies only arise when less of a good or service is provided at higher economic profits than the market-clearing level.
A natural monopoly is a type of monopoly that occurs in an indutry that has extremely high fixed costs of distribution. For example, electricity supply requires huge infrastructure built with cables and grids. For the company that pays for the infrastructure, the costs are considered sunk costs, or costs that, once incurred, cannot be recovered. Typically, there is one company that provides the service because if other entrants were encouraged to enter the market, it would cause inefficiencies and loss to society because the competitor would have to duplicate the heavy infrastructure.
Natural monopoly theory is challenged both theoretically and empirically. The theoretical challenges imply that methodological problems in general equilibrium microeconomics and that there are flaws in the perfect competition models. Other economists claim that natural monopoly theory is not born out by history, and unregulated industries that are controlled by large firms show increasing productivity, declining real costs, and plenty of new entrants to the market.
Example of a Monopoly Market
In a pure monopoly market structure, there is only one firm in a particular industry. However, where regulations are concerned, a market is considered monopolistic if one firm controls 25% or more of the market. For example, De Beers has a monopoly in the diamond industry. (For related reading, see "How Is Profit Maximized in a Monopolistic Market?")