Three conditions characterize a monopolistic market structure. First, there is only one firm operating in the market. Second, there are high barriers to entry. These barriers are so high that they prevent any other firm from entering the market. Third, there are no close substitutes for the good the monopoly firm produces. Because there are no close substitutes, the monopoly does not face any competition.
Barriers to entry. A barrier to entry is anything that prevents firms from entering a market. Many types of barriers to entry give rise to a monopolistic market structure. Some of the more common barriers to entry are
- Patents: If a firm holds a patent on a production process, it can legally exclude other firms from using that process for a number of years. If there are no other production processes that can be used, the firm that holds the patent will have a monopoly.
- Large start‐up costs: In some markets, firms will face large start‐up costs—for example, the cost of building a new production facility. If these start‐up costs are large enough, most firms will be discouraged from entering the market.
- Limited access to resources: A monopolistic market structure is likely to arise when access to resources needed for production is limited. The market for diamonds, for example, is dominated by a single firm that owns most of the world's diamond mines.
Natural monopolies. Not all monopolies arise from these kinds of barriers to entry. A few monopolies arise naturally, in markets where there are large economies of scale. For example, a local telephone company's marginal and average costs tend to decline as it adds more customers; as the company increases its network of telephone lines, it costs the company less and less to add additional customers. The telephone company's long‐run average costs may eventually rise but only at a level of output that is beyond the level the local market demands. Hence, in the market for local telephone services, there is a need for only one firm; competition will not naturally arise. Gas, electric power, and other local utilities are also examples of natural monopolies.
