What is a Monopoly?
A monopoly occurs when a firm is controlling a substantial market share in any given market. The threshold to deem a business a monopoly rests with the laws of any jurisdiction.
Simply, it refers to a market situation where a firm has a dominating position in an industry.
Monopolists are crafted through various modes, including scarce resource, intellectual property, exclusive rights, Government granted monopoly, merger of two large players.
The owner can also sell exclusive rights to other parties like songwriters have rights over their songs.
Historically, the Governments across jurisdictions-built monopolies across goods and services destined for the public good and social cause such as postal mail, railways, but not limited to industries like power, mining, banking.
The ramifications of free markets have uprooted monopolies in the private world, and firms have gone on to capture large market share driven by numerous factors, including product utility, innovation, intellectual property systems and more liberal laws.
Perhaps investors love monopolies. Firms that construct a superior level of barriers to entry carry the arsenal to thrive in markets as the potential of new competition is bleak.
It is the competition that sets monopolies apart from other businesses. Since competition is limited, a monopolist can sustain supernormal profits in the long run.
Competition in any monopoly is suppressed along with its potential benefits, therefore growing monopolies become a problem in an economy. Consequently, it raises prospects of more stringent competition and antitrust laws.
How enterprises become Monopolists?
Barriers to entry: It literally means the restrictions, inability or incompetence of new players to enter an established market where the existing player commands higher barriers to entry.
Firms develop processes, products or services that are very hard to replicate, keeping new market players out of the competition. Companies that naturally acquire such status are said to have a moat around them. Term made famous in the investing world by Warren Buffett.
Read more on Moats: Economic Moats versus Stock Valuation
Intellectual property (IP): Secrets to supremacy are critical for thriving in an industry. Proprietary technologies and exclusive rights of those technologies rest with a firm that has developed such intellectual property.
But it is perennial for proprietary technology and IP to be far more superior than the next available substitutes in the market to gain a monopoly.
A meaningful gap between the next best alternatives will likely provide an advantage. IP rights allow a firm to construct barriers to entry in its market.
Interesting read: COVID-19 Vaccine: Battle of Intellectual Property
Economies of scale: It is perhaps the intention of almost all companies to achieve economies of scale. A large scale production enables firms to sell products in large volumes and lower margin.
Under economies of scale, firms have centralised purchasing, which improves the scale of business and average cost per unit.
Branding: Developing a brand will enable a firm to have a differentiated product which may provide different levels of utility to customers. It is a brand which creates perceptual value for its customers to attain a better position in the market.
A firm has a monopoly over its brand, therefore developing a powerful brand is a way to achieve a monopoly. Firms are inclined to develop brand loyalty and brand awareness.
Networking: When all your surrounding is using the same product or service, you might be inclined to use it as well. Twitter, Facebook, Instagram, LinkedIn are some examples of services that thrive on network effects.
What are the types of competition?
Perfect competition: It is a market in which there are large number of buyers and sellers. As a hypothetical market, the competition is assumed at its greatest possible level. Buyers and sellers have all the possible knowledge of products or services.
Pricing is derived from the prevailing demand and supply in the market. There are no barriers to entry, and firms sell similar products.
Monopolistic competition: Under this type, the market has many players similar to perfect competition. Customers perceive that products sold by sellers are differentiated even though products serve a similar purpose.
A perception of differentiated products is developed by various factors, including brand name, style, quality, networking effects. People may prefer Coke over Pepsi, despite both products being almost same. Behavioural economics has been a popular study these days to understand the human mind and make products more targeted to its audience.
Pricing is quite active in monopolistic markets because a meaningful divergence in prices of two similar products can force customers to choose lower-priced products. As a result, sellers would try to match the price.
The location also impacts consumer preferences many times like a barbershop will attract customers who live nearby. A gas station is another example where a nearby customer will have a preference. Advertising can also impact consumer preference.
Oligopoly: In an oligopoly, the market is concentrated with few sellers of a product. Sellers also control a substantial part of the market because of a few numbers of competitors.
Oligopolistic market requires larger investment for entry, and the cost of starting a business is usually high, keeping new entrants detracted.
Since oligopoly requires large scale investments, the industry under this competition generally includes industries like airlines, telecom, space travel, automobiles, defence equipment, shipbuilders.
Since products or services are similar, the pricing remains active in an oligopoly. A promotional offer by a firm will force others to replicate or at least a lower price of the product or service.
Joseph Schumpeter introduced the concept of creative destruction. He was of the belief that business cycles under capitalism could derail large scale players in a market by way of smaller new entries in a market.
It is important to evolve with changing technologies since smaller new entrants with disruptive technology and innovation could build competitive advantages over existing large firms in a market.
What is imperfect competition? Imperfect competition is a competitive market setup that includes multiple sellers engaged in selling heterogenous goods. Imperfectly competitive markets are a more accurate depiction of the markets in the real world than a perfectly competitive setup. The sellers in an imperfect market have the liberty to influence prices and are thus price makers. The sellers in this market are often protected by barriers to entry. What are the types of imperfect markets? Imperfect competition can be observed in various forms, including: Monopoly: Monopoly is a single producer market, wherein the producer has entire power as it is a price maker. The producer has control over the output, price, and the quality of the product in the market. There are no substitutes in the market, leaving the consumers with only one choice. Besides, there are many barriers to entry of new firms. Thus, the firm continues to hold its monopoly position. Public utilities are generally a monopoly set up as they have a single provider with no substitutes. Since these are government regulated, the prices are not too high to crowd out certain sections of individuals. Oligopoly: The number of players in this set up is more than one, however it is less than the number of sellers in a monopolistic competition. Here there are few barriers to entry and exit. A few producers have control over the market while other firms are small and are price takers. Thus, there exists a high level of interdependency between firms. This can also lead to firms coordinating in some instances to obtain higher profits. This is most frequently seen in the form of cartels. Monopolistic competition: Just like perfect competition, monopolistic competition also comprises of many buyers and sellers. However, both lie on the opposite end of the competitive market spectrum. Products are heterogenous and producers have greater control over the prices of their products as compared to perfect competition. Monopsony: In monopsony there are many sellers but a single buyer. Thus, buyer has greater bargaining power as compared to other market setups. Thus, buyers may ask for lower prices than what sellers want to sell for. Oligopsony: In oligopsony, many sellers serve a few buyers. Thus, buyers have slightly more bargaining power than in other market setups excluding monopsony. What are the characteristics of imperfect competition? The following characteristics define a market with imperfect competition: Number of buyers and sellers: The number of buyers and sellers vary largely, depending on the type of imperfect markets. Under monopolistic competition, firms are usually small in size and each firm is insignificant with respect to any changes in the entire market. Thus, no single firm can affect the sales of another firm. Each firm functions independently of the other. However, in a monopoly there is only one firm and, in an oligopoly, firms are highly interdependent. Heterogeneous Products: Products provided by different sellers may be similar. However, they are differentiated. This means that there are different variations offered in the same type of product across the market. This allows customers to have a variety of goods to choose from, even when the goods perform similar tasks. These variations in the products may come because of the differences in the quality of the product across sellers. For instance, ice creams are offered by different companies selling dairy. Thus, consumers may prefer one brand over the other for their quality or for their range of flavours. However, the product itself serves the same purpose irrespective of which company it belongs to. Free Entry and Exit of Firms: The free entry and exist exists in monopolistic competition under the imperfect market set up. Free entry and exit of firms allow them to produce close substitutes and consequently leads to a greater supply of goods in the market. However, this is not the same for all types of imperfect markets. For instance, in monopoly there are barriers to entry and exit. Imperfect Knowledge About the Market: Both sellers and buyers do not possess perfect knowledge about the market. Under monopolistic competition firms use advertisement to make consumers aware about their products. Thus, advertisements play an important role. However, same is not true for monopoly. Price Makers: Firm in imperfect markets are price makers. Each firm can decide the price for their products. Thus, producers may charge a price that is higher than the marginal price. This is especially true for a monopoly. Kalkine Group Image How did the theory of imperfect vs perfect competition come to light? The theory of perfect competition was given by French mathematician Augustin Cournot in 1838. The theory helped theorise the economic relationships that existed in the market. The theory, however, was too ideal a representation to fit into the real-world scenario. This model of perfect competition was a hypothetical one and was an oversimplification of real-world scenarios. It did not include other aspects like barriers to entry, imperfect knowledge in markets and heterogeneity of products. Despite these shortcomings, the model of perfect competition was widely accepted and is still popular in theory. Theoretical economics still includes the topic of perfect competition as an integral part. Markets like oligopoly, monopolistic competition, monopsony, monopoly, etc are all extensions and variations to the model of perfect competition. Importantly, the theory of imperfect competition was most prominently popularised by Joan Robinson in 1983 in her book “The Economics of Imperfect Competition”. In this book, Robinson gave the model where each firm enjoyed some monopoly power. This was later extended into the idea of monopolistic competition.
What is an oligopoly? Industries evolve over time and pass through several competition patterns. Competition in an industry is the effect of behaviour of firms. Fiscal policies also have an influence on the competition with industries. Policy intervention is implemented through a competition commission/regulator. Oligopoly is a term used to define an industry, a specific market, or a company. It is a market dominated by a few players and can have many small players. This type of competition in a market is known as oligopolistic competition. A few enterprises dominate the market, often selling similar goods and services. Since only a few firms dominate an oligopoly market, competition is muted from smaller payers. Firms in oligopoly gain significant market power, thus preventing other small players from flourishing or entering the market. Firms often replicate the behaviour of each other, and also recognise that action will likely provoke a similar response from other firms. In this way, firms also understand interdependence among each other in the oligopoly market. What are the characteristics of an oligopoly? Entry Barriers It is an important source of oligopoly. Barriers to entry make it difficult for firms to enter the market. It essentially refers to hindrances and restrictions an aspiring firm faces when entering new markets. Some markets have high barriers to entry, like an oligopoly, while some have very low barriers. Firms can have barriers in the form of licences, patents, intellectual property, or established economies of scale. Oligopoly could also exist in professions, which require licensing and specific educational qualifications. Since there are a few firms in oligopolistic competition with significant market share, oligopolies must realise economies of scale, which is an important barrier to entry. With economies of scale, firms realise cost benefits over competing and small players. Further, barriers could be in the form of the capability of firms with respect to developing intellectual property, patents, access to complex technology and capital. Government policies could be a source of barriers, especially when licenses for operating in a market are granted to a limited number of players. In many economies, entry barriers have given birth to oligopolies in many markets and industries. In the past 50 years, the increasing level of globalisation has also intensified competition across the industries. Price leadership Firms in an oligopoly market are also dependent on each other, and this interdependency is also defined as an oligopoly. The competition remains so intense that changes in price level and output are replicated by firms in the market. Collusion is a term used in competition and occurs when two competing firms join hands. This could result in restrictive trade practices, voluntary cut in volumes and price hikes. It remains illegal across most of the economies, and competition commissions keep a check on such practices. Price leadership may lead to tacit collusion in an oligopoly market, but it could be difficult to identify. The leader firms choose the prices, and other firms follow by raising or lowering prices to match. When other firms respond to price changes, it does not necessarily mean tacit collusion. Competition laws direct to firms to not explicitly communicate prices, therefore making it illegal. In an oligopoly, firms may agree tacitly and respond to the price or output changes by the price leader. Product differentiation Product differentiation is a procedure of developing goods or services that are distinguished from others available in the market. It is a source of higher demand for the product from the target market and includes differentiating products from substitutes as well as their own products. Although the differentiation may be small from a producer’s perspective, the buyers in the target market could have different perceptions for available products. This distinguishing feature may allow the producer firm to charge a premium price. Differences in goods and services can exist through differences in quality, functional features or designs, sales promotion activity, or availability. The motive of achieving product differentiation is to develop a position, which customers perceive as unique. As a result, the goods or services offered with differentiation have the ability to lower competition. A growing level of differentiation leads to fewer comparison and competition. In an oligopoly, firms make standardised products or differentiated products with similar attributes such as toothpaste, steel pipes, copper, gold. A firm in an oligopoly market is not necessarily needed to achieve product differentiation. However, when a firm successfully implements product differentiation strategy, it allows to gain further market power and dominate some parts of the industry. Increasing returns to scale In an oligopoly market, firms should have a significant market power, which would deter other firms from entering the market. Increasing returns to scale is a stage of business in which the rate of increase in output is higher than the rate of increase in input. Put another way, when a firm is operating at increasing returns to scale, doubling the input levels would result in more than doubling output levels. This simply implies that larger firms have lower average costs compared to smaller firms. In this way, larger firms can benefit from efficiency gains at a higher level of production. Oligopolies and monopolies typically exist in industries where increasing returns to scale are achieved at higher output levels. When a new firm seeks to enter the oligopoly market, the market penetration would be smaller, and it would have high average costs of production. It is because most of the market share is dominated by a few firms operating large outputs, thus more cost-efficient production. What are the disadvantages of oligopoly? Since there are few firms dominating a market, the choice with consumers is relatively less. By tacitly responding to each other’s move, a firm may act as a cartel, and reduce outputs to raise prices. Competition lacks in an oligopoly market, and firms could make consumer decision making a complex process. When consumers are manipulated at a large scale, there could be a loss of economic welfare. Since there are high levels of barriers to entry, aspiring firms may not enter markets, thus lower competition and lower consumer benefits.
What is Trade War? The term trade war is applied when two nations proceed at war with each other, not through military operations but by imposing tariffs and quotas on imports from a trading partner. The term is commonly used worldwide as many nations are continually competing with each other over the supremacy of the economy. These restrictions are implemented to harm the rival country financially. The foreign country retaliates with similar types of trade sanctions which is referred to as trade protectionism. Under the protectionist policies, the government encourages the consumption of domestic products over imported goods. The trade barrier imposition damages trading partners' economies and devalue its domestic currency. Image Source - ©Kalkine Group 2020 What happens when countries indulge in the trade war? Trade war begins when a nation wants to protect their jobs and domestic industries. They may do this by an increase in import tariffs or imposing restrictions in trade. This may lead to a boost in domestic economy and reduction of dependence on the foreign country for goods and materials. As the products from the foreign country stop penetrating the market or its demand are lowered because of higher prices, the local products see a growing request from domestic customers. If the local business grows because of such policies, it results in the ever-increasing need for jobs as well; however, in the long run, trade war bequeaths its impacts on both the countries. The consequences of a trade war can be as severe as depressing economic growth and triggering inflation as the prices of imports increased because of the tariffs. A phrase Beggar-thy-neighbor policy refers to this situation when an economic policy is implemented to benefit the country while harming the country's neighbours or trading partners in international trade. Such policies are ideated to protect the domestic economy while reducing the dependency on imports and increasing exports. Adam Smith, a Scottish philosopher who is considered to be a founder of modern economics, referred to the beggar-thy-neighbour implementation in the trade war. He criticised mercantilism; a dominant economic system prevailed in Europe from the 16th to the 18th century. Economists soon concluded that such policies could trigger trade wars and push countries involved in autarky - a system of economic self-sufficiency and limited trade. A state like this is hugely detrimental for a country's economic growth. Image Source: Kalkine Group Image What are the advantages and disadvantages of the trade war? Advantages: Bolsters Domestic Business: The most important advantage a trade war offers is that the policies aid companies to flourish. When the government enforces tariffs on imports, these products become expensive. The similar domestic product in the market is, however, available at a competitive price. The buyers would prefer to obtain local goods compared to the imported product, which leads the domestic companies to grow and prosper. Once the company becomes a prominent player in the local region, it has a higher possibility to expand internationally and build a more influential company. Diplomatic Stand: Another benefit trade war provides is that if one country is imposing tariffs and restrictions policies on another country and the country in return is not offering any retaliation then in the international arena, the government will be considered weak. Diplomatically its reputation will be a vulnerable nation who does not retaliate to such grave threats. Countries usually retaliate if such a situation arises in order to safeguard its international status. Checks Wrong Trade Practices: Not all countries trade in an honest manner. Some dominating countries dump their inferior products to other countries. The consumers of the nation stand at risk by buying low-quality goods. So, when the trade war occurs, it ensures that such ill practices are restrained and kept in check. Disadvantages: Increases Inflation A biggest disadvantage trade war has is that it increases inflation exponentially. This tariff war tends to create an artificial shortage of goods, which leads to the surge price of goods—ultimately causing inflation which then lowers the standard of living for both countries involved in the trade war. Creates Strains between Countries: Once the trade war is started, it has a tendency to continue longer. It does not just damage the economic backbone of the countries involved, but diplomatically weaken the relationships. So instead of reasonably talking terms, the countries indulge in tariff and restrictions wars. Such consequential situations hurt the cultural connections as well, which the countries could be nurturing for many years. In the long run, trade war shows its repercussions by incapacitating both countries, if not equally but on similar levels. Increases Domestic Monopoly: Because trade war provides a suitable environment for the local companies to flourish, in the long run, both involved countries can eventually become big and act dominant. The lack of competition from the international market renders a safe haven to create a monopoly. With both country's companies behaving influential in their space, the customers have greater chances to suffer from higher prices and no alternative. Because of multinational companies, domestic companies always feel threatened by healthy competition and provide the customer with good quality goods at competitive rates.
What is OPEC? OPEC stands for Organization of the Petroleum Exporting Countries. It is an intergovernmental organisation formed in September 1960 at the Baghdad Conference held from 10-14 September 1960. The headquarters of OPEC is located in Vienna since 1965. Before 1965 it had its headquarters in Geneva, Switzerland. At the initial stage, the organisation was formed by five founding member countries, later joined by eleven more members. At present, there are 13 member countries as of January 2021. Data as on January 2021, Image Data Source: OPEC As per the statute of OPEC any country can opt for the membership, the primary condition being the nation must be a net exporter of oil and the thoughts of the nation ought to be like OPEC. As per the OPEC website, Member countries houses around 79.4% of the world proven oil reserves, with around 64.5% located in the Middle East. The net addition in cumulative production during 2009-2018 by Non-OPEC countries was 24.6 billion barrels. In contrast, it was 186.2 billion barrels for OPEC countries, far ahead than Non-OPEC countries. Why was OPEC formed? OPEC was formed during the international economic transition phase when extensive decolonisation was taking place. The international oil market was monopolised by certain big players present in the market till 1970. The syndicate's objective is to coordinate and standardise the petroleum policies in member countries for stabilising oil prices in the international market, safeguarding the smooth supply of oil to petroleum consumers and appropriate returns for suppliers in the global market. Who are the decision-makers in OPEC? OPEC Secretariat is the apex body which regulates the organisation. It is also responsible for executing all resolutions and decision making related to oil prices, production and related issues. The organs of the organisation pass the decision. The three organs are The Conference, The Board of Governors and The Secretariat. Image Data Source: OPEC The Conference is the supreme authority of the organisation, which consists of representative delegations from member countries. Each member has one vote, and a quorum of a three-quarter member is necessary for holding a conference. The Board of Governors consists of governors nominated by Member Countries and confirmed by the Conference. It is responsible for managing the organisation, convening the Conference and drawing up the annual budget. The Secretariat carries outs the executive functions of the syndicate following the directions of Board of Governors and provisions of the statute. The Secretariat consists of a Secretary-General, who is appointed as the Organization's Chief Executive Officer by the Conference for three years. It further comprises the Office of the Secretary-General, the Legal Officer, the Research Division and the Support Services Division.