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Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Monopoly

What it is:

A monopoly is a market environment where there is only one provider of a certain economic good or service.

How it works (Example):

For a true monopoly to be in effect, each of the following characteristics would typically be evident:

  • A sole provider of a viable product or service.

  • A lack of any close substitutes for consumers to choose from.

  • High barriers to dissuade the entry of any potential competitors.

Why it Matters:

In a free enterprise system, prices are largely determined by the competing market forces of supply and demand. Buyers and sellers both exert an influence over prices, and this eventually results in a state of equilibrium.

However, in a monopolistic environment, a single company or provider has absolute control over the supply that is released into the market, giving that particular provider the ability to dictate prices. In the absence of any competition, the lone seller is free to keep prices artificially high, without fear of being undercut by another provider. Obviously, such a scenario is usually highly unfavorable for consumers, as it gives them no recourse to seek alternatives that might force prices lower.

Though some markets are much less competitive than others, true monopolies are rare. Regulatory bodies such as The Federal Trade Commission (FTC) and the Department of Justice (DOJ) are in charge of enforcing federal antitrust laws and help promote free trade. Any proposed corporate merger must first meet their approval, and those that would stifle competition and create an unfair market environment will likely be rejected. The Herfindahl-Hirschman Index -- a calculation that measures the degree of concentration in a given market -- is one tool that regulators use to assist in this decision making process.

Even with these safeguards in place, there are situations where Ev-like conditions can appear. A pharmaceutical The definition of monopoly on InvestingAnswerscompany might receive a patent on an effective drug for which there is no other substitute. An electronics company might develop a popular new technology that no other firms are able to duplicate initially. Such examples, though, are rarely long-lived -- as success always invites competition. Still, a company's innovation can occasionally have lasting effects. Microsoft, for example, has been accused of employing business practices that restrict free trade.

While monopolistic business practices tend to have an adverse effect on consumers, they can be investor friendly. Obviously, from a shareholder's standpoint, competitive pressures can crimp profits, and companies that have a wide economic moat or high barriers to entry are somewhat insulated from the encroachments of would-be rivals.

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