Market Power Part 3: Monopoly – The One-Firm Show

Market Power Part 3: Monopoly – The One-Firm Show

Let’s say you're the only pizza shop in a town of 10,000 people. You can set the price however you like. Pineapple surcharge? £4 extra. Delivery? £10. People complain - but they still order.

Welcome to the world of monopoly, where one firm holds the reins and no one else even has a horse.

What Is a Monopoly?

A monopoly is a market structure with either:

• A single firm dominating supply

• Or a dominant firm with significant market power (enough to influence prices and output)

The monopolist is a price maker - they set prices rather than accept them. But here’s a key point: they don’t have unlimited pricing power.

Monopoly Myths: “They Can Charge Whatever They Want!”

Not quite.

Yes, monopolists control supply, but they can’t control demand. If they raise prices too high, consumers will cut back - or eventually find alternatives. That’s where price elasticity of demand (PED) kicks in.

So no, a monopoly isn’t a blank cheque. It’s more like a blank cheque that can bounce if consumers get clever.

Key Characteristics of Monopoly

• Single or dominant firm – One firm runs the show. In pure monopoly, it’s the only firm.

• High barriers to entry – Massive costs, regulations, or patents block new rivals.

• No close substitutes – The firm faces little or no competition, so demand is relatively inelastic.

Think of:

• Google’s search engine dominance (90%+ market share in many countries)

• De Beers and diamonds (historically a textbook monopoly)

• Utilities like electricity or water supply (which often lean into the next topic: natural monopolies)

• Luxottica and their glasses - control and production of about 80% of the eye-glass market

How Do Monopolists Set Prices?

Monopolists face a downward-sloping demand curve - so to sell more, they have to lower the price. They can't just raise prices and assume people will pay.

That’s why they maximise profit at the output level where MR = MC (marginal revenue = marginal cost). This is the condition for rational, profit-maximising behaviour.

In a monopoly:

• Price (P) is greater than marginal cost (MC) → allocative inefficiency

• The firm can earn abnormal profit in the short and long run

Real-World Examples of Monopoly Power

• Microsoft (in its early Windows era)

• Facebook/Meta (dominates social media advertising)

• Google (search + ad space combo = serious power)

Even if they’re not pure monopolies, their dominant market position gives them serious pricing and strategic power.

Enter: The Natural Monopoly

Now let’s crank up the complexity (and realism): the natural monopoly.

This is when having just one provider in a market is actually more efficient than having several.

What Makes a Monopoly “Natural”?

• Enormous fixed costs – infrastructure like railways, water pipes, power grids

• Low marginal costs – once the system is built, serving more customers is cheap

• High barriers to entry – competitors can’t afford to replicate the system

• No sense duplicating services – having three companies lay water pipes in the same street is just… daft

Examples:

• Electricity providers (power stations + national grid = huge investment)

• Water supply companies (network of pipes, reservoirs, treatment plants)

• Broadband Internet in rural areas (infrastructure too costly for competitors)

Natural Monopolies and the Government

Because natural monopolies are so powerful (and so unchallenged), they’re often regulated or even nationalised.

Governments may:

• Cap prices

• Monitor service quality

• Control profits

• Or in some cases, take ownership (e.g. British Rail in the past)

This protects consumers from excessive prices and ensures minimum service standards.

Natural Monopoly = Innovation Fund?

Since natural monopolies can earn abnormal profits (and don’t spend much on competition), they’re often in a strong position to invest in research and development (R&D).

This can lead to:

• New technologies

• Improved infrastructure

• Greater international competitiveness

So while monopolies can feel inefficient, they might also be the ones funding the next generation of ideas.

Monopoly & Profit Recap:

• Monopolists set output where MC = MR

• They typically charge P > MC, leading to abnormal profit

• In the long run, they can maintain profit due to entry barriers

• Natural monopolies are efficient in some cases, but need regulation

Are Monopolies All Bad?

Not necessarily. It depends on:

• The market

• The level of innovation

• The presence (or absence) of regulation

A monopoly that reinvests in R&D and improves services might be better than five inefficient competitors duplicating efforts. But an unregulated monopoly with poor service and high prices? That’s a different story.

Coming Up in Part 4: Oligopoly Power Plays

In the next entry, we dive into oligopolies - where a few big firms dominate, eye each other like chess masters, and battle not just with prices, but with branding, loyalty schemes, and TikTok ads.

Stay well