In 2015, the price of a drug called Daraprim by Turing Pharmaceuticals went from USD$13.50 to $750 overnight.1 The drug was instrumental in treating many parasite infections of the body. Why did the company increase the price by 5000%? How was the company able to increase the price by this much? Isn't that supposed to be illegal? The monopolistic market gives all the answers to these questions.
A monopolistic market is a market with only one firm selling a product. The firm in a monopolistic market can increase the price as much as it wants as it doesn't have any competitors. Why don't you read on and find out all there is to know about the monopolistic market structure?
Monopolistic Market Structure
A monopolistic market structure is characterized by an individual firm that is the only provider of a good or service. In a monopolistic market structure, consumers do not have a variety of companies or businesses to buy from. Instead, it is a single firm that produces those products.
A monopolistic market is a market that consists only of one seller.
A firm that is part of the monopolistic market structure has an advantage since they are the only one making the product. This then enables the monopolistic firm to charge higher prices as it basically faces no competition.
Suppose the monopolist chooses to increase the price of the product. In that case, it will not be necessary to worry about rivals who, by charging lower rates, will be able to grab a more considerable proportion of the market at the monopolist's cost.
The monopolist controls the number of products sold since they are the market.
However, this does not mean that the monopolist may charge whatever price it pleases, not if the monopolist's goal is to maximize profits.
Let's consider, for example, Apple. Let's assume that Apple is the only provider of smartphones; as such, Apple is capable of charging a much higher price for the new iPhone 14 Pro it has just released.
Apple could be charging $10,000 for the new iPhone; however, the number of new iPhones Apple would be able to sell would drop. That's because not many individuals will be able to afford it.
When deciding to set a price, a monopoly should consider both the demand for the good and the cost. Although a firm in a monopolistic market does not have any competitors, it can't increase prices indefinitely.
Monopolistic Market Structure: Causes of Monopoly
The primary factor that causes monopoly is the existence of entry barriers.
Entry barriers refer to the inability of other businesses to join a market and compete with a monopoly, ensuring that the monopoly will continue to be the sole vendor in that market.
Entry barriers result from three main factors: Monopoly resources, government regulations, and the production process.
- Monopoly resources occur when one company has the rights to a crucial resource necessary for manufacturing. The exclusive ownership of a valuable resource by a single company is the most straightforward route to establishing a monopoly.
- Government regulations create monopolies when the government grants a single company the exclusive right to manufacture a specific product or provide a particular service.
- Production processes may also generate market barriers that lead to monopolies. When some companies can produce goods and services at a lower price than their competitors, they can acquire more market power, leading to a monopoly.
Monopolistic Market Examples
A real-life example of a monopoly is Standard Oil, which operated from 1870 to 1911. John D. Rockefeller established Standard Oil. It started in Cleveland, Ohio, and throughout the years, Standard bought other oil refineries. Shortly after the establishment of Standard Oil, most of the rival firms were shut down due to bankruptcy.
Before Standard Oil, several other oil businesses competed with one another throughout the United States. By the beginning of the 20th century, Standard Oil had cornered nearly 90 percent of the market for oil, which made John D. Rockefeller the first person ever to become a billionaire.
Due to its monopoly power, Standard Oil was able to charge higher prices and enjoy enormous profits.
Over time, public sentiment shifted against Standard Oil and Rockefeller, and in 1911, the government of the United States took action. The Supreme Court ruled that Standard Oil must be divided into 34 different businesses to reduce its monopoly power across the United States.
Monopolistic Market Demand Curve
A monopolistic market demand curve is a downward-sloping demand curve. That's because, in a monopolistic market, a firm can charge higher prices without losing its consumers. Think about it, as consumers have nowhere else to buy the product from, regardless of the price set by the company, consumers will still be buying the good.
The monopolistic market demand curve is a downward-sloping demand curve, which indicates that when the product price decreases, the quantity demanded will increase.
Fig. 1 - Demand curve in a monopolistic market
Figure 1 shows the demand curve in a monopolistic market. Notice that as the price declines, the quantity demanded increases. On the other hand, as the price increases, the quantity demanded will drop. The price can increase up to a certain point which in the above figure is P*. That's because no one is willing to buy the product offered by the monopoly above a certain price.
The demand curve in a monopolistic market differs from a perfectly competitive market. In a perfectly competitive market, the demand curve is perfectly elastic. That means that demand for a firm's product or service when pricing at the equilibrium price is infinite. If the firm were to increase the price even by just a little, there would be no market demand.
We have explained the perfectly competitive market in great detail in another article. Feel free to check it out.
On the other hand, the demand curve for an individual company in a monopolistic market slopes downward, meaning that the company can increase the price while still having consumers who demand their goods. That's because, in a monopolistic market, a firm has monopoly power.
Monopoly power refers to the capability of a company to control prices or limit production due to its dominant position in the market.
It is hard to find a company with complete monopoly power in the real world. Instead, companies have some degree of monopoly power. The higher the degree of monopoly power, the higher the price a firm can charge.
Check out our detailed explanation of Monopoly Power.
- Monopoly power allows firms to increase their prices without losing all of their clients.
- Monopoly power results from not having a competitive firm that would charge less.
- This then results in a downward-sloping demand curve.
Monopolistic Market Graph
The monopolistic market graph shows how a firm with no competition sets its price to maximize profit. The firm in a monopolistic market has average revenue, marginal revenue, and marginal cost. To set the price, a firm must consider both these curves.
Fig 2. - Marginal Revenue and Average Revenue in a Monopolistic Market
Figure 2 shows two important curves a firm in a monopolistic market faces, the marginal revenue, and the average revenue.
Notice that the marginal revenue a firm faces is below the average revenue of the firm. That’s because a firm that belongs to a monopolistic market faces a downward-sloping demand curve. That means that to increase the number of products it sells, a firm has to lower the price, which reduces the quantity sold.
Let’s consider an example of a software monopoly company. To increase the number of software, it sells from 1 to 2; the firm must decrease the price from $500 to $450. The price decrease increases total revenue from 500 to 900 while reducing the marginal revenue from 500 to 400.
| A software monopoly |
|---|
| Price ($) | Quantity | Total Revenue ($) | Marginal Revenue ($) |
| 500 | 1 | 500 | 500 |
| 450 | 2 | 900 | 400 |
| 400 | 3 | 1200 | 300 |
| 350 | 4 | 1400 | 200 |
| 300 | 5 | 1500 | 100 |
| 250 | 6 | 1500 | 0 |
| 200 | 7 | 1400 | -100 |
Table 1. A software monopoly example
In order to increase the quantity sold, the monopoly has to give up some of its marginal revenue.
When deciding to increase the quantity it sells, the monopoly experiences an increase in total revenue due to the rise in quantity but eventually experiences a drop in total revenue due to the price decrease.
The increase in total revenue due to selling more units of a good is known as the quantity effect.
The decrease in total revenue due to charging a lower price is known as the price effect.
The average revenue of a monopolistic firm is equal to the demand of the monopolistic firm. That’s because the firm is the only supplier of the good, and the price paid for the good equals the average revenue for the firm.
Fig. 3 - Profit Maximization in a Monopolistic Market
Figure 3 shows the monopolistic market graph of a firm that maximizes its profit. Like in a perfectly competitive market, a firm in a monopolistic market maximizes the profit at the point where MC=MR.
Assuming that there is no fixed cost and marginal cost is constant, the firm will produce up to point 1, where MC=MR. The additional revenue it makes from producing another product is equal to the additional cost it takes to produce that product.
As the firm has monopoly power, the price it will charge is the corresponding point of the intersection between the MR and MC curves on the demand curve. That point in figure 3 is point 2.
Advantages and Disadvantages of Monopolistic Competition Market
Before we discuss the advantages and disadvantages of a monopolistic competition market, let's consider what a monopolistic competition market is.
Monopolistic competition is a market in which many firms sell similar but not identical products.
There are three main characteristics of monopolistic competition.
- Many firms: Many firms sell a similar product.
- Product differentiation. Every firm that is part of a monopolistic competition market produces a slightly different product from other firms.
- Free entry and exit: Firms in a monopolistic competition market do not have entry barriers to the market or exit barriers out of the market.
A firm that is part of a monopolistic competition market gains monopoly power (the ability to set higher prices) by mainly producing better and differentiated products from its main competitors.
The main advantage of monopolistic competition is that firms constantly compete to bring new and differentiated products to market. This causes more innovation, bringing more valuable products to consumers.
On the other hand, the main disadvantage of monopolistic competition is that firms that gain monopoly power can abuse their products' pricing, which would harm the consumers.
Monopolistic Market - Key takeaways
- A monopolistic market is a market that consists of only one seller.
- Entry barriers result from three main factors: Monopoly resources, government regulations, and the production process.
- Monopoly power refers to the capability of a company to control prices or limit production due to its dominant position in the market.
- Monopolistic market demand is a downward-sloping demand curve, which indicates that when the product price decreases, the quantity demanded will increase.
References
- New York Times,Drug Goes From $13.50 a Tablet to $750, Overnight ,https://www.nytimes.com/2015/09/21/business/a-huge-overnight-increase-in-a-drugs-price-raises-protests.html
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