Given that, whether price takers or price setters, firms seek to maximize profits.
In the real world, there are many different behavior patterns by producers across different market structures. Some of them are extremely competitive, such as perfect competition which there are many firms offering essentially identical products and has little influence over the price it receives; in others, like monopoly which the firm and the industry are one and same, seems no competition at all. By contrast, a monopoly is the only supplier of a unique good or service for which there is no close substitute, therefore, has the market power which is the ability that a firm can raise the price without losing all its sales to influence the market and being a price setter while a competitive firm is a price taker. (Mankiw)
The key difference between a competitive firm and a monopoly is the former can only takes the price as given by market conditions, but the latter can alter the price by adjusting the quantity it supplied to the market.Whereas the perfectly competitive firm faces a perfect elastic demand curve for its product, the monopoly faces a downward-sloping demand curve. (McDowell at el) Particularly worth mentioning is although monopolist have to make output decision, but it is has no supply curve for monopoly market. It is only meaningful under competitive market which have shifted demand curve, and then may observing the supply curve that was traced out by the series of equilibrium price-quantity combinations. With the fixed demand curve, the supply curve for monopoly is only one point, in this sense, a monopoly market has no well-defined supply curve. (Nicholson, 2004)
The perfect competitor in effect face a horizontal demand curve, allowing it to sell as much as it wants at the market price in panel (a), Dc. The demand curve, Dm which slops downward confronting an imperfectly monopolist in panel (b), faces the entire industry, as the results, the monopoly is constrained by its demand, has to accept a low price if it wants to sell more. (Krugman & Wells, 2013) diagram p382
It is generally believed that the basic reason of the existence of monopoly is barriers to entry, that is, monopolist seller can maintain its sole position in the market by reason that other companies cannot enter the market and compete with it. There are six types of it.
To begin with the ownership of essential naturel resource without close substitutes. Preventing a new firm from entering an industry is often difficult without government support unless the monopoly has had the exclusive control over some important inputs. This is the simplest way for a monopoly to arise, consider the greater market power it has in the market, not surprisingly, the monopolist cannot easily be duplicated. A good example is Aluminum Company of America (Alcoa), a firm that prior to World War II who constituted a monopoly by virtue of its control over 90 percent of virgin aluminum output, which is the essential raw material produced from bauxite. (Swan, 1980) Such a situation is rare and sometimes even illegal and is ordinarily temporary. Although this ownership of a key resource is a potential cause of monopoly, in practice monopolies rarely arise for this reason, because of economics are large and resources are owned by many people. Indeed, goods are tend to traded internationally, the natural scope of their market is often worldwide, therefore, there are few of its kind. Also, a similar example of such monopoly situation is a diamond company DeBeers of South Africa was created in the 1880s by Cecil Rhodes, a British businessman which controlled most of the world’s diamond mine, people who wants real diamond , DeBeers is where has them. As synthetic diamond has now risen in quality to the point where they can occasionally fool even an experienced professional jeweller, the preference for having a real diamond of people will cease to confer monopoly power. And as the result, the exclusive input that generates by monopoly today is likely to become obsolete tomorrow. (Frank & Cartwright, 2013)
Next reason is the natural monopoly which created and sustained by economies of scale. When a firm double all its factors of productions, if the output more than doubles, the production process it said to exhibit increasing return to scale. If they continue to accrue up to the level of output which will satisfy the entire market demand for the industry’s output, are incompatible with competition. In such case, one firm can always produce the entire output of industry more cheaply than two or more firms, and hence is in a situation of natural monopoly. In figure 1 below, when the long-run average cost curve (given fixed input prices) is downward sloping, the lease costly way to serve the market is to concentrate production in the hand of a single firm. Note that when the LAC curve is declining throughout, the long-run marginal cost curve (LMC) will be always below the LAC as when average costs are falling, marginal costa are less than average costs. (Miller) diagram p534
A frequently cited example that recognized as natural monopoles is the provision of local utility companies, like water, gas and electricity.
In American, many people have natural gas piped into their homes for cooking and heating. Imagine that this was a competitive market, if there was to be competition between different natural gas suppliers, then there would have to be two sets of distribution pipes. Each firm would have to spend a lot of money in equal amount to compete for the same size of customer base, but only have half of the size of market to try to recover their costs from. Therefore, it makes sense for there to only be one firm in each city – it would be economically inefficient to have two competing natural gas distribution grids. (The Pennsylvania State University, 2014)
However, along with the population grow, satisfying the entire demand may require two or more producer, thus, as a market expends, a natural monopoly can evolve into a competitive market.
Moreover, some barriers to entry may be independent of the monopolist’s own activities, other barriers may result directly from those activities, like creation of barriers to entry which is to use technological superiority establish itself as a monopolist. Firms may develop unique products or technologies to maintain a consistent advantage over potential competitors and take extraordinary steps keep these from being copied by them as well; or firm may buy up unique resources to prevent potential entry.
For instance, Intel is a company specializes in the manufacturing of multinational semiconductor computer chips, considered to be the world’s largest and highest valued semiconductor chip maker based solely on their revenue. They launches the world's first microprocessor in 1971 and worked its way up to having and sustaining a monopoly power in the industry through their advanced chip design and innovative manufacturing capability. Since then, Intel processors account for more than 80 percent of the computers running their chips, it’s clearly separates themselves from the other competitors, hence hold on to a dominant position. But technological superiority is typically not a barrier to entry over the longer time, as IBM already demanded a contract with a company Advanced Micro Devices (AMD) as a second source while it signed with Intel to develop microprocessor chip. (Piller, 1999)
It is noteworthy that the attempt by a monopolist to erect barriers to entry may also involve real resource costs – maintaining secrecy, buying unique resources and engaging in political lobbing are all costly activities.
In addition, in certain high-tech industries, technological superiority is not a guarantee of success against competitors because of network externalities which sometimes described as demand-side scale economies. This creates what is also known as network effects where utility that an individual user derives from consumption of the good or service increases with the number of other agents consuming the good. (Katz & Shapiro, 1994) When a network externalities exists, the firm which being connected the largest network of customers using its product is able to attract more new customers to make itself monopolist, thus, charge a higher price in order to earn more profit than competitors.
Take Microsoft as an example, its Windows operating system currently installed in more than 90 per cent of all personal computers worldwide, achieved its dominant market position on the strength of powerful network economies. The inventory of available software in the Windows format is now vastly larger than any other competing operating system by taking the advantage of its initial sales of giving software developers a strong incentive to write for the Windows format and attracted more technical support. Although general-purpose software continues to be available for multiple operating system, but specialized professional software usually appear first in the Windows format and often only in that format. This gap has given people a good reason to choosing Windows even if many believe that Apple has superior operating system. (McDowell at el)
Furthermore, many monopoly are created as a matter of law rather as a matter of economic conditions. One important example of a government-granted monopoly position is in the legal protection of a product by a patent or copyright that is issued to inventor. A patent includes the grant of the right to exclude others from making, using or selling the invention for a period of 20 years, the law of copyright provides for the exclusive right to print, publish, copy and vend the copyrighted work and, subject to limitation, to perform the work, deliver the same or make mechanical reproductions usually last the lifetime of author and composers plus 70 years. (Frost, 1967)
Pharmaceutical drug is a notable example of profitable product that are shielded for a time from direct competition by potential imitators. Because the basic technology for these products is uniquely assigned to only one firm, a monopoly position is established. In 2003 the pharmaceutical firm Pfizer earned revenues of over 9 billion US dollars worldwide from sales of Lipitor – the best selling prescription drug of the year. No other company can produce Lipitor, because Pfizer has a patent on the key chemical contained in the drug. (Bernheim & Whinston, 2008)
The rationale of the patent and copyright system, originally put forth by Thomas Jefferson, is that it makes innovation more profitable to recoup their high development cost and therefore acts as an incentive and encourages technical advancement that would not otherwise occur. Whether the benefits of such innovative behavior exceed the costs of having monopolies (higher price for consumers) is an open question that has been much debated by economist.
The second example of legally created monopoly is the awarding of an exclusive licenses or franchise to serve a market, such as post office, some television and radio station market and communications services. It is illegal to enter many industries without a government license or a certificate of convenience and public necessity.
Take the United States Postal Service (USPS) as an example.19th century laws make it illegal for anyone else to deliver letters, so there’s no competition in the letter-delivery business, almost all letters must be sent through the post office unless the letter is “extremely urgent.” It even gets approval to set the minimum price for its private competitors can charge which a letter must cost at least twice the applicable first-class rate to qualify as urgent, yet itself exempt from state and federal taxes and free from most government regulations. The effect of this circumstance is easy to see, because the country give it a monopoly, they lead to higher pieces than would occur under competition. (Feulner, 2003)
The argument usually put forward in favor of creating these monopolies is that having only one firm in the industry is more desirable than open competition. Or restrictions on entry into certain industries are needed to ensure adequate quality standards which act mainly to limit the competition faced by existing firms and seem to make little economic sense.
Finally is the market strategies that using to create the barriers to entry, like entry-deterrence, predatory pricing and excess capacity and so forth. Focusing on predatory pricing as the case, it is a method to deal with new firms who enter an industry by setting prices below the cost in an attempt to forcing rival firms out of business as they may be unable to make profit. In the short term, price competition can make a temporary loss for incumbent monopoly and require significant savings to finance as backup, whereas it is beneficial for consumers because of the lower prices; but in the long term, the company that wins a price war can effectively drive all its competitor out of the marketplace, then have a monopoly where it can set whatever price it wants.
To give an illustration for the case is the Darlington bus wars, Stagecoach Group offered free bus travel to try and force the rival Darlington Bus company out of business. (Grimond, 1996) However, Aberdeen Journals were fined £1.3million by the OFT (Office of Fair Trading) for abusing its dominant market position by predatory pricing. (Cutting, 2002)
Setting prices below a competitor’s prices or even their own costs is not illegal, but where that still need to pay more close attention is the implement, unless it becomes a viable strategy to eliminate competition.