Pure monopoly occurs when there is a total absence of competition, due to entry barriers independent of the competitive capacity of the company.
A single company offers a product that has homogeneous characteristics, which has no substitutes and for that reason has a large number of buyers. In addition, there are economic, technological or legal barriers that prevent the entry of potential competitors. That is, there are barriers to entry.
In general, a monopoly situation occurs in the market when a single company controls the level of production and price of a product in the market. We could say that this single company has the ability to determine the price that will be charged for that product and will have the power to decide the amount of production that it will offer to the market.
Characteristics of a pure monopoly
This circumstance occurs because the companies that enjoy this condition do not have competition in the market.
For a company to acquire this position in the market it needs:
- Have a production infrastructure that meets certain technological requirements that allow you to take advantage of the economy of scale to a certain level. Taking advantage of economies of scale means that the higher the level of units produced, the lower the unit cost. But, as we have clarified, up to a certain level. Among other things, this point distinguishes it from natural monopoly in which marginal costs are always decreasing.
- Having low costs, by having low costs, acquires the ability to be able to sell their products at cheaper prices, the larger the company, the lower its cost of production. But being a single company in the market they control the price and the price charged is usually higher.
- Dominate the market, due to the fact that no competitors can emerge, it is almost impossible for them to compete due to the existing barriers.
- Generate technological, legal and economic barriers that prevent the entry of other potential competitors.
Profit maximization in pure monopoly
Any company maximizes its profit or reaches its optimum volume of production (VoP); when CMa (marginal cost) equals IMa (marginal revenue).
- Marginal cost is the increase that occurs in TC (total cost) when one more unit is produced.
- Marginal revenue is the increase that occurs in IT (total revenue) when one more unit is sold.
- For all companies the marginal cost is decreasing in the early stages of the production process. This is because the principle of economy of scale begins to work. Then the marginal cost becomes increasing, because the law of diminishing marginal returns operates.
In the pure monopoly, profits are maximized in the optimal volume of production where the CMa and IMa coincide, for the monopolist his demand curve is a negative slope, because he has the total market demand.
While the IMa of the pure monopoly is decreasing, because if it decides to increase or decrease the level of production, the degree of scarcity of the product causes significant changes in the price.
To understand it easily, let's look at the following example graph:
- Demand (D) is represented by the red line.
- Marginal cost (CMa) is represented by the blue line.
- Marginal revenue (IMa) is represented by the green line.
We can realize that the optimal volume of production (VoP) or the point where profits are maximized coincides where the IMa and CMa are intercepted. However, the pure monopoly can sell at a higher price, because it is in control of supply. The yellow box is monopolistic profit. Unlike small producers who do not have market power, the monopolist can sell his product at a price that is higher or higher than his marginal cost.
Which factor influences the pure monopoly the most?
The factor that most influences the case of a pure monopoly is the legal aspect; These are usually government decisions that abrogate the right to determine that a single public or private company offers certain public goods or services such as water or electricity.
These concessions and licenses granted by the government keep certain companies in a privileged position within the market. Not because of its competitive capabilities, but quite the opposite, because of the favor conferred by the public sector.