How Does a Monopoly Affect Business and Consumers?

As the sole providers of a product or service, monopolies have no competition and no price restrictions. Monopolies use patents, mergers, and acquisitions to obtain industry dominance and prevent market entry. If left unmonitored and unregulated, monopolies can adversely affect businesses, consumers and even the economy.

Price, Supply and Demand

A monopoly’s potential to raise prices indefinitely is its most critical detriment to consumers. Because it has no industry competition, a monopoly’s price is the market price and demand is market demand. Even at high prices, customers will not be able to substitute the good or service with a more affordable alternative.

As the sole supplier, a monopoly can also refuse to serve customers. If a monopoly refuses to sell an important good to a company, it has the potential to indirectly shut down that business. If the supplier sells to consumers, it can refuse to serve areas that have lower profit potential, which could further impoverish a region.

Natural Monopolies can Reduce Costs

A natural monopoly, like the water and sewage system, can prevent the duplication of infrastructure and thus reduce potential costs to consumers. Natural monopolies that are run by non-profit organizations and local governments can afford to keep prices low enough to provide services to the majority of the public. When monopolies are privately owned by for-profit organizations, prices can become significantly higher than in a competitive market. As a result of higher prices, fewer consumers can afford the good or service, which can be detrimental in a rural or impoverished setting.

Economic Repercussions of Monopolies

Some argue that monopolies are beneficial because highly-profitable companies tend to pump more funds into research and development. Because the monopoly is in a dominant position, it can comfortably bear the risks associated with innovation. However, a highly-profitable monopoly also may have little incentive for improvement as long as consumers still demonstrate a need for their current product or service. In comparison, businesses in a competitive market can compete by making changes to existing products and services and lowering prices.

Monopolies ensure there are high barriers to entry and thus no free riding or adaptations to their current patents. The labor force in a monopolized industry may also be significantly less than that of a competitive industry.

Dismantling a Monopoly

One option for policy makers would be to dismantle the monopoly. This can be accomplished by splitting the monopoly into two companies, divide their bundled products or services, or separating services into smaller competing regional services. The monopoly’s separation will lower the barriers to entry for new companies. The new competition will eventually provide a wider variety of options and most likely lower prices for consumers.

For example, in the 1980s the US experienced nation-wide deregulation in the telecommunications industry. While four of the seven “Baby Bells” are back under the AT&T umbrella, the breakup is still considered a great success. Competition in the telecommunication industry again is increasing as start-ups begin using mobile technology to disrupt the cost structures of the telecom companies.

Lowering Prices with Policy

Another option for policy makers would be to focus on lowering prices instead of breaking apart a monopoly. Regulators can set pricing controls called price caps in order to prevent the company from setting unreasonable prices. Price capping is a way to reduce the price benefit of being a monopoly as the price lowers to that of a competitive market. Once competition increases in the industry, policy makers can reduce or remove the price caps.

According to The Energy Journal, all US electricity independent system operators have price caps. Similarly, setting rate-of-return price regulations can help reduce artificially high utility prices. The government can also opt to nationalize natural monopolies to ensure that utility prices are in the best interest of the public.