“Patent monopoly creates a lot of problems. It allows the patentee to charge the maximum to consumers. This may not be a problem if the patented product is a luxury item, like parts that go into a smartphone, but can violate basic human rights if it involves things such as life-saving drugs.”—Ha-Joon Chang
So what is wrong with monopolies? In a free market, shouldn’t companies be rewarded for success in business? Should we even care about their impact?
The legal system in the U.S. is a hybrid of English common law and Roman civil law, though it is more fundamentally based in common law. As early as the 17th century English common law addressed restraint of trade as an offense against the King, with restraint of trade seen at the time as a contract between two parties which restricts the freedom of one party to engage in business activity (including selling your own labor). The Sherman Act is rooted in common law and deals specifically with restraint of trade. So the legal practice of addressing firms which harm other firms by preventing them from conducting business has a long history in both our legal system, and the roots of that system.
Then how does monopoly restrain trade? To answer that question, we must look to the study of economics, and more specifically to the understanding of different market structures. Introductory economics classes typically start with a discussion of supply and demand, then move to the discussion of markets and different forms they can take, typically starting with the ideal market in a free market system--perfect competition.
The Spectrum of Market Structures
Markets in a capitalist society have a range of structures with perfect competition on one end, and pure monopoly on the other. Perfect competition means many buyers and sellers in a market for a product or service, with no buyers or sellers having a large enough impact on the market that they can influence the price level. Perfectly competitive markets sell products that are very similar so that consumers have no reason to prefer the product of one firm over another. Since there is no significant difference in products between firms, prices do not vary much across sellers. Firms in competitive markets are seen as “price takers”, meaning they have no power to increase prices, or ability to gain additional profit in this industry. Economists consider competitive markets to be the ideal example of what an industry should be—they are efficient because no one seller or buyer exerts too much control over the market. Resources are used efficiently because firms must keep costs as low as possible to compete.
On the other end of the spectrum is pure monopoly. This means one seller exists in the industry, selling to many buyers. The monopolist is the supply side of the industry. Because there is no competition, the monopolist can charge prices that are higher than in a competitive market, which also means the volume sold will be lower than with competition. Monopolists can’t always charge any price they want, because some consumers will be priced out of the market. But if the monopolist is selling something that is necessary for people (e.g. insulin), they can extract a high price. This is the situation we have been seeing with many prescription medications in recent years. Monopolists are seen as being highly inefficient because they are able to capture excess profits through higher prices, and because of the higher prices, fewer goods and services are provided than society wants.
The graph below shows a comparison between the price and quantity in two hypothetical markets--one that is perfectly competitive and one that is a pure monopoly. The two hypothetical markets face the same demand. The point of this illustration is to show that in the competitive market the price paid and the quantity provided occurs where supply and demand meet. Competitive firms accept the price that is determined by the market, PCompetitiony, and produce the amount, QCompetitiony, that will enable them to cover their costs with a profit level that is reasonable for the industry.
However, the monopolist will charge a price that allows them to maximize profit. In order to do this, they determine the level of production first, by producing up to the point where the marginal cost of production is equal to the marginal revenue they will receive from the last unit sold. This is shown in the graph as QMonopoly. The monopolist determines the price which the market will bear at that output level. This will be at PMonopoly. The graph shows that in competition, prices will generally be lower, and output higher than if that industry was monopolized.
This is the major problem with monopoly. Even if a monopolist does not engage in predatory behavior, but instead is sanctioned by the government (as when a patent is active) monopolies reduce societal welfare because they result in higher prices, and lower production than is optimal.
Most industries have market structures that lie between these two extremes. Monopolistic competition occurs when there are many buyers and sellers, but the firms are able to promote their products as being unique in some way. If firms are successful in doing this, consumers will prefer this product enough to pay a slightly higher price, and perhaps refuse to buy from other sellers. Because there are numerous sellers in this type of market, this type of industry is not likely to see problems with firms acquiring excessive power, but these firms could engage in anticompetitive practices that are subject to regulation.
A fourth type of market structure that economists have identified is oligopoly. This industry is characterized by a few firms which compete in the market. This is a complex industry type, because the small number of firms means each firm is impacted by the actions of other firms in the industry. Price changes, new product introduction, and even innovative marketing strategies can significantly affect market shares.
Oligopolies pose particular concerns for regulators because mergers and acquisitions in these markets hold more potential for the creation of monopolies. The small number of competitors in oligopoly makes it easier for industry leaders to collude in some way if they choose to. The most well-known example of this is the Organization of Petroleum Exporting Countries (OPEC). OPEC is an organization of firms, called a cartel, which colludes to determine how much oil will be produced. Output level changes cause prices to respond, so the OPEC cartel has the power to affect the price of oil and its derivative products around the world. In the U.S. cartels are illegal.
Type of MarketNumber of FirmsNature of ProductEase of EntryPricingExamplesPerfect Competition
How to Make a Monopoly
Different market structures are the result of various factors, including ease and cost of entering and exiting the industry, production costs, availability of inputs used by the industry, government regulations and technology. Industries with low costs of entry and production, ready access to inputs, technology that is not expensive and/or highly complex, and limited regulations are likely to be competitive, while industries that require a large upfront capital investment, inputs with limited access, advanced technology or processes that are not widely available, or have an exclusive ability to produce through a sanction of some type, like a patent or copyright are likely to be oligopolies or monopolies.
Patents and copyrights assign sole ownership rights to use and profit from the holders for a given period of time. This right was intended to serve as an incentive for innovation. So any company holding a patent or copyright that is not expired, has a monopoly on that item.
Some industries require such large costs of entry that they can only be profitable through large scale production. Electric utilities are one example. These industries are referred to as natural monopolies. They can be granted the ability to operate as a monopoly, but regulated, or they may become publicly owned.
A more recent development that has arisen with the growth of the technology sector, is the issue of network monopolies. Facebook, Amazon, Google and others were able to gain market power because as the number of users increased, their use became more and more important in everyday life and business. At some point, they become almost impossible to avoid. They are private companies, but they function like a public entity. How we deal with the problems that arise from this situation, such as privacy and freedom of speech, is the issue we are currently facing with these companies.
But monopolies also are formed by what was called in John Sherman’s day as combination—mergers. Mergers can be made between firms in the same industry, or across industries. If two firms in the same industry and the same market are merged (competitors or near competitors) are merged, it is called a horizontal merger. A horizontal merger means that after the merger, the company will have a greater share of the market, and consumers will have fewer choices.
Another type of merger is the vertical merger. This is a combination of two firms in the same industry, but at different points in the supply chain. An example might be if a tomato canning company bought a tomato farming operation.
The danger of horizontal mergers is that one firm can gain control of the market, and the danger with vertical integration, is that a firm may control access to a key resource, or control of some point in the supply chain. Antitrust policy requires that mergers and acquisitions between firms must be reported beforehand to the DOJ or the FTC. These agencies have the authority to review the proposed mergers, and either block them, or make requirements that must be met before approval. A common requirement is the sale (divestiture) of some part of the company prior to the merger.
Companies Behaving Badly
So what are the kind of antitrust practices that monopolies and monopoly wannabes engage in? Exactly what tactic they might use depends on whether or not they are engaging with an actual or potential rival firm, a customer, or a supplier of inputs.
Ida Tarbell’s “The History of the Standard Oil Company” exposed some classic anticompetitive behavior by John D. Rockefeller, including forcing competitors to sell out by threatening them with corporate warfare tactics to bankrupt them (blackmail). He also colluded with railroad companies (collusion) to get favorable pricing for Standard Oil while other shippers were charged higher rates (price discrimination). Rockefeller also used vertical integration to his advantage by denying oil producers access to the oil refineries he acquired.
Anticompetitive tactics used against consumers include price fixing, where two or more firms make an agreement to set prices at a certain level, preventing consumers from having access to competitive pricing. Colluding firms may also agree to divide the market, so for example they could agree not to compete within certain geographic regions, or different customer bases. Again, consumers are deprived of competition. Tying (or bundling) is the strategy of requiring consumers to buy another product or service they may not want, in order to get the item they do want. A very well-known example is getting 200 or more channels with a cable service, when you might only want four or five. Until recently, cable monopolies used the excuse that they had no control over these bundles themselves. Technological innovations are now giving consumers more choices.
In cases where firms are required to provide bids, typically done by government or other institutions, some form of bid rigging may be found. Firms might take turns on bidding so that they don’t compete with each other. They might intentionally bid high or make unacceptable requirements so that one particular company wins the bid. Another variation is to have a subcontracting agreement between the bidders so that the winner will hire the competitors to fulfill some portion of the contract.
The Clayton Antitrust Act strengthened the Sherman Act by describing specific practices that were considered anticompetitive and illegal. In so doing, the Department of Justice was given authority to investigate and prosecute these practices.
What’s Good for the Seller…
One final point to make is that market dominance does not exist only on the supply side. Monopsony is the case of one buyer, and oligopsony is the case of just a few buyers. This has long been an issue in labor markets, with the example of the coal mining town with no other employer. As industry concentration has increased across the economy, problems with monopsony and oligopsony have arise frequently. WalMart has become an economic powerhouse by using monopsony power to force price concessions on manufacturers and other suppliers.
The agriculture industry has also been affected by concentration, with farmers having fewer meat packers and grain processors to sell to than forty years ago. Some industries, such as the poultry industry, have become completely vertically integrated, so that there essentially exists no cash market for poultry farmers. Instead, farmers raise chickens that are owned by the processor they have contracted with, according to processor specifications, and are paid according to the terms set by the processor in the contract. Zephyr Teachout does oa nice job of explaining what has happened to the industry in her recent book “Break ‘Em Up”.
In 2017, authors Azar, Marinescu and Steinbaum published a paper titled “Labor Market Concentration” (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3088767 ) which showed that the vast majority of counties in the United States have few alternatives for job seekers, and are essentially labor monopsonies or oligopsonies. The study also found evidence that this employer market power led to reduced wages. The figure below is a map of the U.S. by county from the study showing the level of labor market concentration.
Source: https://boingboing.net/2017/12/21/no-bid-contracts.html