Monopoly (& Competition, Barriers to Entry)

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A monopoly is a firm that controls the market for an industry. To elaborate, a monopoly will be able to completely set the prices in that industry, whereas a perfectly competitive firm must accept whatever prices the industry determines through supply and demand. In a competitive market, when a firm raises its price it can cause buyers to switch to competing sellers. By contrast, when a monopoly raises its prices, the only choice that buyers have is whether to buy from monopoly or not buy at all. Market power refers to this control of the market.

Figure A

All firms fall somewhere between monopoly and perfectly competitive.

Economic analysis

In perfect competition, if some firms are making supernormal profit (profit taking into account opportunity cost), firms will enter the market which will eventually lower the amount of supernormal profit to zero. By contrast, an industry controlled by a single firm will experience the conditions graphed in Figure A. Marginal revenue and average revenue slope downwards because they are set by the single firm in the market. By increasing or decreasing the supply, they can influence the price. The PRSC rectangle represents economic "rent" (supernormal profit).

Peter Thiel's Analysis

Peter Thiel once wrote, “There are two kinds of businesses. Monopolies, and those that never make any money”. In an interview with Uncommon Knowledge, the interviewer asked him if he was exaggerating for affect. Thiel responded that he was not. According to Thiel, there are "shockingly" few firms that are in-between, and neither monopolies nor perfectly competitive.

Thiel emphasizes the importance of differentiating one's products in order to gain market power. He further explains that, in a competitive industry, "all of the profits are competed away." It is very unlikely that one will be able to get the top of a field with a huge number of fiercely competitive subjects, but it is much easier to be the best if you are doing something different than everyone else.

He is known for his statement that "competition is for losers," and that, in order to achieve high returns, one must stand out by doing something that no one else is doing (something where there are no other competitors).

He talks about how avoiding competitive fields is difficult because humans have an innate drive to mimic others and compete. He links this to mimetic theory.

Thiel admits that, while many types of monopolies are bad, the attempt to gain a monopoly position via proprietary technology can also be a tool of advancement.

Definition of the Market

Being that monopoly power is defined based on control of the market, how one defines the market influences whether you consider a firm to be a monopoly. A firm with market power can superficially appear like it does not if one defines the market inaccurately.

According to Thiel, firms will attempt to mislead about whether they are monopolies, and therefore about the size of the market. Monopolies will try to appear as if they are not monopolies, to avoid criticism and anti-trust, while on the other hand, firms that are not monopolies will try to represent themselves based on how they are difference, which can superficially make them appear as monopolies.

Barriers to Entry

A barrier to entry is something that makes it difficult for new firms entering the market to competing with incumbent firms. More generally, a barrier to entry is a mechanism by which an incumbent firm can maintain market power. Examples are:

  • Regulatory capture, or government-issued protection
  • Branding
  • Proprietary technology, especially differences in kind
  • Intellectual property protection
  • Economies of scale / complex coordination
  • Digital coordination (for example, compatibility issues surrounding software)

Other market power mechanisms

Monopsony: Monopsony is another situation where one firm has market power, but instead of being the single seller in the market, they are the single buyer of something in the market.

Collective bargain: In the case of unionization, it is an attempt for collections of workers to gain market power to combat the power of firms.

Further analysis/further reading

Monopoly power can enable someone to collect passive income, i.e., income that is not tied to the time that the person put in. In this way, the person can avoid being a "commodity." Monopoly power can also enable someone to achieve nonlinear returns.