Page 311 - The Principle of Economics

N A key resource is owned by a single firm.
N The government gives a single firm the exclusive right to produce some
good or service.
N The costs of production make a single producer more efficient than a large number of producers.
Let’s briefly discuss each of these.
MONOPOLY RESOURCES
The simplest way for a monopoly to arise is for a single firm to own a key resource. For example, consider the market for water in a small town in the Old West. If dozens of town residents have working wells, the competitive model discussed in Chapter 14 describes the behavior of sellers. As a result, the price of a gallon of wa- ter is driven to equal the marginal cost of pumping an extra gallon. But if there is only one well in town and it is impossible to get water from anywhere else, then the owner of the well has a monopoly on water. Not surprisingly, the monopolist has much greater market power than any single firm in a competitive market. In the case of a necessity like water, the monopolist could command quite a high price, even if the marginal cost is low.
Although exclusive ownership of a key resource is a potential cause of mo- nopoly, in practice monopolies rarely arise for this reason. Actual economies are large, and resources are owned by many people. Indeed, because many goods are traded internationally, the natural scope of their markets is often worldwide. There are, therefore, few examples of firms that own a resource for which there are no close substitutes.
CASE STUDY THE DEBEERS DIAMOND MONOPOLY
A classic example of a monopoly that arises from the ownership of a key re- source is DeBeers, the South African diamond company. DeBeers controls about 80 percent of the world’s production of diamonds. Although the firm’s share of the market is not 100 percent, it is large enough to exert substantial influence over the market price of diamonds.
How much market power does DeBeers have? The answer depends in part on whether there are close substitutes for its product. If people view emeralds, rubies, and sapphires as good substitutes for diamonds, then DeBeers has rela- tively little market power. In this case, any attempt by DeBeers to raise the price of diamonds would cause people to switch to other gemstones. But if people view these other stones as very different from diamonds, then DeBeers can ex- ert substantial influence over the price of its product.
DeBeers pays for large amounts of advertising. At first, this decision might seem surprising. If a monopoly is the sole seller of its product, why does it need to advertise? One goal of the DeBeers ads is to differentiate diamonds from other gems in the minds of consumers. When their slogan tells you that “a diamond is forever,” you are meant to think that the same is not true of emeralds, rubies, and sapphires. (And notice that the slogan is applied to all diamonds, not just DeBeers diamonds—a sign of DeBeers’s monopoly position.) If the ads are
CHAPTER 15
MONOPOLY 317
“Rather than a monopoly, we like to consider ourselves ‘the only game in town.’”