How Monopolies Impact the Economy

Four Reasons Monopolies Are Bad, and One Time They're a Necessity

Google Opens New Berlin Office
Google's control of web search is a monopoly, but it isn't illegal. Photo: Adam Berry/Getty Images

Definition: A monopoly is a business that's the only provider of a good or service. That gives it a tremendous competitive advantage over any other company that tries to provide a similar product. 

Some companies become monopolies through vertical integration. They control the entire supply chain, from production to retail. Others use horizontal integration. They buy up competitors until they are the only ones left.

Some, like utilities, enjoy government regulations that award them a market. Governments do this to ensure electricity production and delivery. That's because it cannot tolerate the disruptions that come from free market forces.

Four Reasons Why They're Bad for an Economy

Monopolies restrict free trade, preventing the market from setting prices. That creates the following four adverse effects.

1. Since monopolies are the only provider, they can set any price they choose. That's known as price-fixing. They can do this regardless of demand because they know the consumer has no choice. It's especially true for goods and services where there is inelastic demand. That's where people don't have a lot of flexibility. An example of this is gasoline. Some drivers could switch to mass transit or bicycles, but most can't.

2. Not only can monopolies raise prices, but they can also supply inferior products.

That's happened in some urban neighborhoods. Grocery stores know that the poor urban dweller has few alternatives.

3. Monopolies lose any incentive to innovate. They have no need to provide "new and improved" products. A found that U.S. businesses have invested less than expected since 2000.

 

That used to be true of cable companies. It's expensive to lay new cable. That meant residents had to accept the cable company's service and prices. Disruptive technology is the worst enemy of monopolies. Dish TV, iPads, and Netflix have created a new type of entertainment service. It doesn't rely on cable to deliver movies and TV programming. The same thing happened with land-line telephones.

4. Monopolies create inflation. Since they can set any price they want, they will raise costs to consumers. It's called cost-push inflation. A good example of how this works is the Organization of Petroleum Exporting Countries. The 12 oil exporting countries in OPEC now control the price of 46 percent of the oil produced in the world.

OPEC is more of a cartel than a monopoly. First, most of the oil is produced by one country, Saudi Arabia. It has a far greater ability to affect the price by itself by raising or lowering output. Second, all members must agree to the price set by OPEC. Even then, some may try to undercut the price to gain a little extra market share. Enforcing the OPEC price is not easy. Still, OPEC countries make more per barrel of oil than they did before OPEC. That power created the OPEC oil embargo in the 1970s.

Are Monopolies Ever Good?

Sometimes a monopoly is necessary. It ensures consistent delivery of a product or service that has a very high up-front cost. An example is electric and water utilities. It's very expensive to build new electric plants or dams. It made economic sense to allow a monopoly to control prices to pay for these costs.

The federal and local governments regulated these industries to protect the consumer. The companies were allowed to set prices to recoup their costs and a reasonable profit. In the 1990s, there was much talk of deregulation to allow competition. This occurred in some cases.

PayPal co-founder Peter Thiel advocates the benefits of creative monopoly. That's a company that is "so good at what it does that no other firm can offer a close substitute." They give customers more choices "by adding entirely new categories of abundance to the world."

He goes on to say, "All happy companies are different: Each one earns a monopoly by solving a unique problem. All failed companies are the same: They failed to escape competition." He suggests entrepreneurs focus on "What valuable company is nobody building?" (Source: "Three Cheers for 'Creative Monopolies,'" The Wall Street Journal, October 13, 2014.)

Monopolies in the United States

Monopolies in the United States aren't illegal. But the Sherman Anti-Trust Act prevents them from using their power to gain advantages.  Congress enacted it in 1890 when the monopolies were Trusts. A group of companies formed a trust to fix prices low enough to drive competitors out of business. Once they had a monopoly on the market, they would raise prices to regain their profit.

The most famous trust was Standard Oil Company. John D. Rockefeller owned all the oil refineries, which were in Ohio, in the 1890s. His monopoly allowed him to control the price of oil. He bulliod the railroad companies to charge him a lower price for transportation. When Ohio threatened legal action to put him out of business, he moved to New Jersey. He also set up the first trust. He bought up the majority share of former competitors' stock certificates of trust. (Source: "The Sherman Anti-Trust Act," American.gov archive.)

In 1998, the U.S. District Court ruled that Microsoft was an illegal monopoly. It had a controlling position as the operating system for personal computers. It used this to intimidate a supplier, chipmaker Intel. It also forced computer makers IBM and Apple Windows to withhold superior technology. It ordered Microsoft to share information about its operating system. That allowed competitors to develop innovative products using the Windows platform.

But disruptive technologies have done more to erode Microsoft's monopoly than government action. People are switching to mobile devices, such as tablets, iPods, and smartphones. Microsoft does not have a good operating system on these devices. (Source: "," Seattle Times, May 11, 2011)

Google almost has a monopoly on the Internet search market. People use Google for 65 percent of all searches. Its closest competitors, Microsoft's Bing and Yahoo, only make up 34 percent, combined. But Google always improves its search algorithms. It also controls 80 percent of all search-related advertising. Furthermore, Google has developed the Android operating system for smartphones. (Source: "A Google Monopoly Isn't the Point," Businessweek, September 23, 2011.)