In my class, I often see students equate large firms with monopolies based solely on their size or perceived “dominance” of an industry.
Earlier this week I ran across a 10-year-old cover of Forbes declaring Nokia the “cell phone king” and asking if any other firm can possibly “catch” them.
A decade later, I would wager the average 18-year-old doesn’t even know what a Nokia is. I haven’t seen a Nokia device in a television commercial or in a cell phone store in several years, and I can safely assume that you haven’t either. So much for being a threat to market competitiveness.
MySpace and eBay are also examples the misapplication of monopoly theory. Once thought to be natural monopolies, MySpace is barely relevant in the social media world, and eBay faces stiff competition from Amazon, Craigslist, Facebook Marketplace and many other competing websites.
These examples illustrate quite clearly the problem with economics education on monopoly theory. As an economics professor, I’ve often seen the effects of the insufficient treatment of the market forces surrounding monopoly power. In my course on agricultural policy, I often see students equate large firms with monopolies based solely on their size or perceived “dominance” of an industry, not by their ability to manipulate prices and quantities or to maintain such behavior over a long period of time.
The typical and most-emphasized perspective on monopoly in basic and intermediate economics courses is a static one. That is, there is relatively little consideration of how monopolies form and how their market power might dissipate over time. Rather, the discussion focuses on monopoly as a divergence from perfect competition. While this divergence is a useful theoretical tool, it doesn’t necessarily tell us much about the real world.
Economics education on monopolies should focus more on dynamics and less on the specifics of the static model. How does a firm become a monopoly? It can either:
1) spend money, time, labor, and other resources to convince politicians or regulators to establish some kind of regulation or other barrier to entry into the industry
2) it can innovate and create a unique product with which few firms can compete.
In both cases, the standard static monopoly diagram is accurate, but only for a period of time. In the case of the legal-privilege-seeking firm, the firm’s monopoly profits can only persist while the regulation or other barrier to entry is in place. Such regulations and barriers can effectively keep out new entrants and incentivize acquisitions of smaller firms to the extent that such barriers act as fixed costs. Compliance costs are one example of the fixed costs associated with regulation. These fixed costs are a bigger drag on the profitability of small firms than large firms. Thus, after the passage of some regulation or other barrier to entry, larger firms benefit at the expense of smaller firms or potential new entrants. The deadweight loss associated with the monopoly and the cost of the rent seeking represent the costs to broader society of the monopoly privilege given to the firm.
The innovating firm can only earn excess profits so long as other firms are unable to draw customers away from the firm with competing products. Absent legal barriers such as patents or other regulations, other firms need only do the requisite market research and develop the products necessary to compete. This can be difficult in cases in which the innovative monopoly has specific assets or personnel that make them particularly adept at creating highly desirable products. In the case of innovative firms, the “deadweight loss” is simply part of the cost of innovation.
While all of the above is part of the standard theory of monopoly, the fact that so many people think only about the static conception of monopoly when examining the real world means that there is significant miseducation on this topic. If economists want students to be able to understand the real world better as a result of the education we provide, we should focus more heavily on the real-world phenomena that both give and take firms’ monopoly power.
Levi A. Russell is an Assistant Professor at the University of Georgia.