The term supply monopoly is to be understood as a type of market in which a single supplier faces many customers. This supplier, known as a monopoly, has a high level of market power and controls the price of its product based on the quantity it produces.
Supply monopoly: Many buyers – one supplier
In this lesson we explain the most important features of a supply monopoly, the typical behavior of market participants and the situations that result from this constellation. At the end of the lesson, we offer you a few practice questions to test your knowledge.
Why should you know the supply monopoly?
According to gradphysics.com, the supply monopoly is also known as the classic type of monopoly. Often, colloquially, this is also meant when there is only talk of a monopoly. Since supply monopolies can be found again and again in practice, it is important to familiarize yourself with this type of market.
Origin and characteristics of supply monopolies
The supply monopoly is primarily characterized by the fact that there is only one single supplier for a product and there are many buyers.
This provider, known as a monopoly, has a high level of market power because it does not have to take any competitors into account when making decisions.
Such a monopoly can arise in different ways. It is possible, and has already been the case several times, for the state to commission individual companies with a specific task or service (e.g. post office) or the production of a specific product. A supply monopoly can, however, also arise when a single company is the sole owner of a certain production factor.
A third variant is the “natural monopoly”. These are characterized by globally falling average costs. The production of a good becomes cheaper the more copies are produced. The minimum of production costs is consequently reached when only one single supplier produces the product and thus becomes a monopoly. Such a monopoly is formed in a “natural” way, with more and more competitors leaving the market and only one company ultimately prevailing.
The prerequisites for a supply monopoly do not only exist when the monopoly covers 100% of the demand. What matters is the control exercised on the market. In this case one speaks of a quasi-monopoly, as the following example shows.
Example Deutsche Bahn
In Germany, Deutsche Bahn is regarded as a monopoly with regard to long-distance transport. Only in the area of local transport have several providers been able to establish themselves over the years, so that the railway has lost its monopoly in this area – albeit not nationwide. In long-distance transport, however, there are very few competitors with occasional trains (e.g. Flixtrain and EuroNight), so that in view of the market power in this area, one can still speak of a monopoly of Deutsche Bahn.
Effects of a supply monopoly
As already described, the monopoly has high market power. This applies above all to pricing, in which he does not have to take into account the prices of a competitor or an average market price. Accordingly, we are talking about a monopoly market and no longer a competitive market, since the latter, by definition, can only take place between several competitors. It would therefore require at least a duopoly (two providers).
The monopoly is able to control the price through the amount of production. If he shortens the quantity while demand remains the same, prices rise. If he raises the price, the demand falls. In perfect competition, customers would simply switch to a competitor’s product. If the monopoly increases the production volume, on the one hand demand increases, but the price also falls.
Supply monopoly: the demand function
Determination of the correct production volume in the monopoly
The monopoly must determine the right amount of production in order to be able to maximize its profit. To do this, he directs his attention to the marginal revenues for different production quantities. It is still true that he has to lower the price in order to be able to sell a higher quantity of products on the market. However, this price reduction applies not only to the last goods produced, but to all goods.
The marginal revenue must therefore be below the price. In addition, he considers the marginal costs, i.e. those costs for the last or each additional good produced. The production volume is set in such a way that marginal revenue and marginal costs are the same. This means that the price is also above the marginal costs.