Why Do Monopolies Exist

in this video we're gonna look at what is a monopoly and why do they exist well a monopoly is defined as a market in which you have a single company that is the one and only seller supplier but identifying the monopoly is not that easy because we have to look at what we mean by the market market to where buyers and sellers come together but how you define the market will really determine whether or not you have a monopoly so for example let's say you live in a small town that has one traffic light you probably also have one grocery store in one gas station that one gas station if we look at just your town is a monopoly right no competition because they're the only gas station in town but if we expand our market to be all of alberta then we start to see a lot more different brands different companies that provide gas and so there's more competition so now we have an Oleg awfully a handful of sellers if we expand globally then there's a lot more competition so how you define the market matters in terms of whether or not you have that definition of a monopoly a single firm selling particular goods or services well we will look at today is how do monopolies come into existence now what we'll look at in the next video is what does it mean to act like a monopoly so when it comes to antitrust law government regulations about competition what they care about is whether companies are acting like monopolies so we'll look at what that means and how monopolies set prices and quantities in the next video but in this video let's look at how does a monopoly come into existence so let's look at some examples of monopolies your monopolies can be government granted for example the East India Company came into existence in 1600 and was created by the British government so the British government said the East India Company is the only company allowed to collect cotton silk indigo tea and opium from India and sell it to England the Hudson Bay Company similar came into existence as a government granted monopoly the Hudson Bay Company was given the exclusive rights to buy pelts and and merchandise from what is now Canada and sell that to England in fact the Hudson Bay Company is one of the oldest continually operating companies in the world so your monopoly can come into existence because the government grants you the rights to be the only seller Hudson Bay Company in the East India Company are examples of this you can also become a monopoly by keeping out the competition so for example a Standard Oil controlled 91% of the production of kerosene the primary source for lighting and energy and they had 91 percent of the production in 1904 now the Standard Oil was owned by john d rockefeller man we've all heard john d rockefeller right we know about Rockefeller Plaza and New York City well Standard Oil wanted to keep out the competition they wanted to be the one to be the sole provider of kerosene and so what they would do is they would team up john d rockefeller was friends with a lot of the owners of railroad companies and so santa doyle teamed up with the railroad companies to keep the competition out the railroad companies mandated that pipelines could not go under their tracks their railroad tracks unless you were Standard Oil only seven oil could run pipe under the railroad tracks well think about how many rail road tracks there are across this country and across the US is it logistically possible that you could run pipe and then every time you hit a railroad track you have to pull it out from under the ground you'd have to pull the oil out you'd have to put it in containers you'd have to truck it across the railroad tracks put it back into the pipeline and set it on its way well there's so many sets of tracks that this would just be impossible to do it would be so cost prohibitive and so exactly it kept the competition out of the market well the US was not very happy about this practice why because the less competition what happens well if you have no competitors then you can drive up the price and so it kept up the price of oil at the expense of the customer so the u.s. actually created the Sherman Antitrust Act and what that did is it actually took Standard Oil and divided it up into a number of smaller companies and these are the oil companies you know today Exxon Mobil Chevron and so on so we have Napoles that exists because the government created them we have monopolies that exists because they kept out the competition another example of monopolies would be well according to the Union in 2003 Minette microsoft was found guilty of monopolistic practices behaving like a monopoly and keeping out the competition so the charge against microsoft was that they were participating in anti-competitive behavior because their products came with the Microsoft created web browser right Internet Explorer and they made it very difficult to install other web browsers and for the other web browsers to become the default okay so some argue this is the downfall of Netscape Navigator a web browser you've probably never heard of because it didn't live for very long well in 2003 the European Union charged Microsoft found them guilty of anti-competitive practices now Microsoft argued at these hearings that they couldn't be a monopoly it was all about how you define the market right they couldn't be a monopoly because they did have competition like Apple computers so as long as Apple computers existed they weren't a monopoly so how are you defining the market is the market the Microsoft products in which case different software can go on or is the market computers in which case you have Microsoft products and you have Apple products well later in 2003 Microsoft bought a hundred and fifty thousand non-voting shares of Apple okay so when the largest owners of Apple is Microsoft why because as long as Microsoft as sorry as long as Apple exists then Microsoft can argue that they're not a monopoly so Microsoft sits on the board of Apple they know what Apple is planning on doing but they don't vote on there so that Microsoft is insured that they're not a monopoly to by helping make sure their competitor continues to thrive so let's talk about really where monopolies come from so monopolies come into existence because we have barriers to entry it's remember in a perfectly competitive market there are no barriers to entry so you could join in if you saw others making economic profit and you could get out if you weren't making economic profit in the long run well monopolies exist because we have barriers to entry and there are three general barriers to entry technical barriers legal barriers and economic barriers so let's look at each one of these so let's start with our technical barriers so a technical barrier is created when your company is the only one with access to the raw materials so for example when it comes to diamonds De Beers has 90 percent of the world's diamond mines and in fact in Canada just this year there was a Canadian owned diamond mine that De Beers just bought as so they've been increasingly consolidating their ownership over the market so if two pairs is the only one has access to diamonds then of course they're going to be the only supplier they're going to be a monopoly now what happens when you're the only one with access to the raw materials while others can't join in and start up a business because they don't have access to the raw materials and what we see the impact of this is is that De Beers intentionally reduces the quantity of diamonds that go on to the market and this helps keep the price of diamonds high the other way you can have a technical barrier is that only you know how to do something so if you know how to do something that no one else does that it's difficult for others to join in the market example in the 1960s IBM was essentially the only company providing computing services at the time a computer which does less than your cell phone would be about the size of a room like a classroom but only IBM knew how to build this computer and so they had a monopoly now the challenge is is that if you have a monopoly based on knowledge or techniques it is short-lived right because someone could buy an IBM computer take it apart learn how it works and then they could build their own and become a competitor whereas if you have access to the raw materials then this is going to be a much longer lived manopoly because it's much harder for others to gain access to those materials and so De Beers essentially is had a monopoly over diamonds for over a hundred years whereas IBM having a monopoly in computers you know it lasted about a decade and then we start to see more and more competitors and now you don't even see a lot of IBM based computers anymore so technical barriers is the first in terms of barriers to entry that can create monopolies the second barrier to entry are legal barriers so this is where the barrier is created by the government now you remember in our previous discussions we talked about how sometimes competition is inefficient or wasteful if competition is inefficient or wasteful then products that we could have as private okay leaving up to the market for supply and demand setting the price and quantity we could instead treat like public and public goods we have either fully funded or partially funded through taxes and the government provides them well if competition is an efficient or wasteful then one way to ensure that the good or service is still provided is for the government to be the monopoly or to appoint a company to be the monopoly so think about this male right why do we have to count it a post well what if you live in a remote location in none of it it's not cost-effective for a profit-driven company to provide mail to that location right you'd be paying like 50 bucks for a postcard because of all the colleges typical cost to get it there but how do we make sure the people in nunavut are still getting the government mail right so maybe they need information for their taxes may we're making sure they get notifications how do we make sure that you know your letter gets grandma well in order to ensure that people in all locations have access to mail then we can't have it be a profit-driven company instead we have the government be the company and then we use economies of scale that is because the government is the one company across the entire country then the costs the infrastructure cost the sorting we can spread out that transit cost across multiple locations so remember economies of scale means that the more you produce the lower the per unit cost and so we can spread that out across all of the letters going across Canada not just the cost of a single letter – none of it so if the government is the monopoly then we have what is called a crown corporation so Canada posts a crown corporation CBC or the Canadian Broadcasting Company their crown corporation in other words the government is the monopoly okay we can also have the government grant a monopoly to a particular company so let's look at an example and that would be fuelling airplanes okay so in in Vietnam for example the company that was providing fuel for airplanes was a company called Wanaka okay so why would you do this why would you have the government grant a monopoly well the government grants a monopoly when there's security issues for example right we don't want just anybody putting fuel and airplanes after September 11th right we have concerns about security in terms of people getting access to airplanes and the more different companies you have providing this the harder it is to control that security issue well in this particular case and in Vietnam the challenge was is that Wanaka wanted to get paid more and so what they told the airlines they told the airlines they weren't going to refuel the planes until the nap go got more money what's the problem with this well essentially you're holding the country hostage because there's no fuel being put into any planes because the government had granted the monopoly to this one company and this one company was refusing to fuel the planes until they got paid more well in this case in 2009 the Vietnamese government decided well maybe we shouldn't have just one company refueling planes maybe we should open it up and have a handful more companies so that competition prevented one company from preventing air traffic but if we look at other examples you know you can't just open your own nuclear power plant there's government regulations there that creates barriers and those barriers are created by the government and restricts the number of companies that can be the sellers so in terms of barriers created by the government we do it because competition is inefficient or wasteful we do it because there is some kind of licensing requirements we need to basically have more government oversight and the third reason that the government would create a a legal barrier would be to encourage research and development so we look at patents and copyrights patents and copyrights create a temporarily a temporary monopoly well why do we put patents on on drugs the reason that drug companies get a patent for a certain amount of time it means that they can recoup some of the costs in terms of coming up with the drug if they immediately had lots of competition then that would make prices go down and so then they wouldn't make as much profit and profit is what is used for developing that new drug you need that profit so that for a period of time you can put money into creating a new product that may or may not work well patents don't last forever we have patents expire if we look at for example and 20:18 Cialis will expire lyrica which is for nerve pain or stasis for dry eye advair for asthma Neulasta for blood cell production these drugs will expire when they expire then it comes open to competition and so we want it to be open to competition to drive down the price for the customer but we also need a period of time where there's less competition to encourage these companies to do research and development and we can see the impact of this if we look at Canada versus the US so in the US a patent on drugs like the ones we've just discussed is about twenty years in Canada the drugs patents are about ten years well if your patent is shorter what impact will that have on pharmaceutical companies decisions as to what they will do in your country versus others what we see is that in Canada there is less research and development so pharmaceutical companies they do their research and development in the u.s. they release the drugs first to the US and then after a number of years they will eventually make it to Canada and then the patents will expire at the same time in Canada and the US so the shorter your patent period the less likely the companies are to invest in in new products because they're not gonna receive as much profit that means for your country it takes longer for the drugs to get here as well alright so in terms of barriers we had technical barriers we had legal barriers and the third is economic barriers so economic barriers are barriers that exist because of economies of scale and so let's think about economies of scale so as our company produces a greater and greater quantity our law run average cost curve declines so when you double your inputs you get more than double your output your per unit cost is falling and we've looked earlier this semester at how you can achieve economies of scale economies of scale right when you do things like divisions of labor the fact that you don't have to specialize your depart the fact that you can specialize your departments right I don't have to double the accounting department in the marketing department to produce twice as much stuff so I can the cost per unit will fall I could do things like a buy in bulk and sell in bulk those will help me achieve economies of scale I look bigger my company the cheaper it is to borrow those things create economies of scale well when we look at the existence of monopolies what we call natural monopolies exist because they can get bigger and bigger and bigger and continue to achieve economies of scale that long-run average cost curve declines for a large quantity and so these are companies that have real big start-up costs real big fixed costs so so think about utility companies so if I wanted to start a power plant based on hydroelectric right I'm going to build a dam there's gonna be a lot of infrastructure that needs to be built with us a big fixed cost and so the more I produce the more I can take those millions of dollars billions of dollars that are put into that big fixed cost and I can spread them out so my long-run average fixed cost keeps going down and down and down so what we tend to see is power power sorry power companies like New Brunswick powerpc hydro these utility companies they tend to be monopolies and the reason is is because they need a large customer base to get that per unit cost out so I think about it if you had a hydroelectric power plan you had one customer than that one customer I've paid billions of dollars but if we can have millions of customers then the cost of the power gets a lot smaller so any company with large startup costs big large fixed cost big infrastructure that's going to have economies of scale up to large quantities and it makes sense for them to be a natural monopolies and we can look here so if at small quantities the cost per unit is very high at large quantities the cost per unit is much lower so as a society if there is economies of scale to be had we would rather the companies get bigger because if we can get the company to get there per unit cost go down then we should be able to sell the product at a price much lower to the customer as well so the customer benefits from a natural monopoly if that cost savings and that lower per unit cost gets passed on to the customer in terms of lower prices now it's not a guarantee when you have a monopoly because there's not competition driving down price so often we have some kind of overseeing body some kind of commission that is going to make sure that the per unit cost is lower so for example when it comes to to cable to television we have the Canadian radio and television Commission and there to make sure that this cost savings gets passed on to the customer in Alberta we have the Alberta Utilities Commission to make sure that the energy companies are passing on that savings that they get from having less competition in producing at a larger quantity so their per unit cost goes down that gets passed on to the customer okay so if you have a natural ah Polly you need to make sure that this low-cost also goes on to the customer in terms of low prices so either you have an overseeing body like the CRTC E or the AUC and they have to get approve the utility companies or you know talk about Shaw and tell us they have to get approval when they want to change their prices they have to get approval by these Commission's so that's one option to make sure that this low cost gets passed on to the customer the other is to have the government be that monopoly in which case you have a crown corporation so we like natural monopolies because the per unit costs are lower but we need to make sure that per unit cost gets passed on to the customer and lower prices as well so you can see here on this graph we can see because of that continually declining long-run average cost curve you could have two companies provide the this energy here right so we could have two firms and they're each going to provide 2 million kilowatts per hour and if they do that then according to that long-run average cost curve the cost is going to be 10 cents a kilowatt but if instead of having two companies each producing a smaller quantity and therefore at a higher cost if we had one company producing all 4 million kilowatts of energy you can see according to the long-run average cost curve that they could do it for just 5 cents a kilowatt instead of 10 so here it's a benefit to have a monopoly instead of have competition because of that economies of scale because the long-run average cost curve keeps declining but again we have to make sure that that cost saving this gets passed on to the customer in terms of lower prices now we talked about monopolies we said the definition of a monopoly is one seller but in reality when we look at the different types of markets it's a continuum somewhere between perfect competition where we have thousands of sellers and a monopoly where we have one seller and so it's quite possible for a company to fall somewhere in between that's why we're gonna look at in the next video do they act like a monopoly so we can say that a company is a natural monopoly even when it has competition for example Microsoft has about 83 percent of the market share when it comes to operating systems there are other operating systems like Apple ok but when they're so small in comparison then Microsoft can act like a monopoly ok and we'll talk about what does it mean to act like a monopoly in the next video it's how you set price and quantity well why does Microsoft end up as a monopoly well because when it comes to developing computers and software all of the costs in the initial creation right so just like the pharmaceutical companies with the research and development coming up with new technology and new way to deliver information that's a lot of cost upfront and so then when you go and provide one more copy of the operating system to people especially since we don't even put things on CDs and anymore it's a download right so the cost of distribution the cost of selling one more unit is so tiny so we have that long-run average cost curve that continues to decline that economies of scale so natural monopolies have a very small marginal cost the extra cost to make one more unit to sell one more copy of the operating system is teeny-tiny what they have is a big fixed cost a lot of big costs up front and so the more you produce the more you can spread that out other examples of natural monopolies would be eBay right they have about seventy six percent of the market share search engines like Google Google has 91 percent of the market share the costs are all in the initial startup and providing one more auction on eBay to do one more search on Google the extra cost the marginal cost is minuscule and so the companies get bigger and bigger and bigger and those per unit costs go down

Leave a Reply

Your email address will not be published. Required fields are marked *