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A market structure that has a sole producer or seller is considered as a monopoly, which tends to label this structure as an industry on its own (Beggs, n.d). Monopoly firms much like competitive firms, have the desired aim of maximizing profit, but each market structure has different results in comparison to the other. Firms under competitive markets are unconsciously led by the ‘invisible hand’ to promote general economic stability. While on the other hand, firms that have a monopoly structure are not affected by competition and the outcome in the market is usually not favored by most societies. The entry into such a market is rendered impossible due to comparatively high costs or other barriers, which are either politically, socially or economically driven. This barrier to entry tends to be the fundamental cause of monopoly and is branched out into 3 main forms which are; natural barriers to entry (natural monopoly), Ownership barriers to entry (monopoly resources) and legal barriers to entry (government-created monopolies).
Natural barriers to entry is when a lone firm possesses
the ability to supply a good or service to an entire market at a lower cost in
comparison to other firms in the market(Mankiw , 2004). This form of monopoly
comes to view when there are economies of scale over the relevant range of
output, were a large number of firms leads to less output per firm and a higher
total cost, for any given amount of that output. In other words, when
production of goods is divided among several firms, the production from each
firm is less, and the average total cost rises, this in turn results in a
single firm having the ability to produce any given amount at the smallest
cost. An example of this is the distribution of water in a town. In order to
provide water, firms are required to develop a network of pipes throughout the
town. If there is more than one firm to compete in providing this service to
the town, each firm would have to pay the fixed cost of building the network of
pipes. Therefore it is more advisable if it is just one firm because in that
sense, the average total cost of water will be at its lowest. Under natural
monopoly, firms within that market are less concerned about new firms entering
the market and wearing down its monopoly power. The competing firms always face
problems trying to maintain a monopoly position without the possession of any
key resource or protection from the government. The profit earned by a firm
under monopoly urges other firms into that market, but competitive firms know
that entering such a market which has another firm that holds a natural
monopoly is highly unattractive. It is almost impossible for them to achieve
the same low costs that the monopolists enjoy due to the fact that once that
firm enters the market, each firm would have a smaller piece of the market,
which in turn labels the market competitive.
Another barrier to entry is the ownership barrier to
entry, which is a form of monopoly that arises when a single firm has the
ownership to a key resource (Vorobyova, 2010). A perfect example of this is
DeBeers, the South African diamond company. It controls about 80 percent of the
world’s diamond production, and even though it is not 100 percent, it still has
a considerable influence on the market price of diamonds. Monopolists within
this market structure hold much greater market power than any firm in a
competitive market, the commanding of high prices even if the marginal cost is
low is considered a norm within this structure. Although ownership of key
resources is a potential cause of monopoly, in a practical sense monopolies
rarely arise for this reason. Economies are usually large and resources are
owned by a lot of people and due to the fact that goods are regularly traded
internationally, the scope of the market is usually worldwide. Therefore, there
are scarce numbers of firms that possess resources for which there are no close
substitutes.
Finally, the legal barrier to entry is a form of
monopoly where the government gives a firm the exclusive right to sell several
goods or services. Under the legal barrier to entry, according to Lutzenberger
(n.d.) the government is either directly or
indirectly the only provider of a service or product, and other competition is
not allowed. They create this form of monopoly which serves the public interest by
issuing patents and copyright laws. For example, if a novelist completes a
book, he has the capability of copyrighting his piece and this copyright is the
governmental guarantee that no one can print and sell the work without gaining
permission from him. The patent and
copyright laws provide the producers with a monopoly, which leads to higher
prices than which would be found under perfect competition. Looking back at the
novelist’s example, they are allowed to be monopolists in the selling of their
books in order for them to write more and better pieces. Therefore it can be
seen that the laws of patents and copyrights acquire certain benefits and
costs, in the sense that they increase the creativity of the individual firms
but could result in the cost of the markets structures’ pricing.
The case study which relates to these barriers to entry
is Tenaga National Berhad (TNB), the Malaysian electricity supplier. TNB is
Malaysia’s sole electricity supplier due to the fact that, to start such a monopoly
business firms would need to invest on a large capital and this capital is
basically just to start up the power plants. The other reason which is the main
one is because of its legal barrier to entry which is granted to them via the
Malaysian government. TNB possesses the license which allows them to operate
the business and as the sole supplier of electricity to consumers it helps to
maintain a healthy market.
In addition, TNB encompasses the ownership of a rare
raw material which tends to play a part in creating an effective barrier to
entry as other firms do not have access to this raw material. In this case, TNB’s
access to coal which is the cheapest raw material used in generating
electricity in Malaysia, gives it total possession of the material and thus
allows it to have total control in the industry.
Moreover, having a single firm in this industry aids
in keeping the production costs low, if there were more than one firm in this
industry, the result would be a higher price in coal. With the higher number of
firms, coal suppliers would have to sell their scarce resources at a higher
price which in turn results in the increase of production cost.
As the sole supplier of electricity in Malaysia and
the only firm in the industry, TNB possesses the possibility of gaining super
normal profits indefinitely based on the graph where production at the Marginal
Revenue is equal to the Marginal Cost Output. In order for a company to gain
maximum profit, the price must be set at a point on the demand curve which is
above the Average total cost.
In other words, if the firm increases production by
1 unit, additional revenue would be more than the additional costs, and profits
rises. Thus, when the marginal cost is less than the marginal revenue, the firm
has the ability to increase profit by producing one extra unit.
This year, TNB has made RM 1 billion profit which was a
comparatively better turn over compared
to the previous year were they made a loss of about RM 338.6 million and a
revenue rise from RM 9.15 billion to RM 9.33 billion (COALGURU, 2013). Alongside
its recent acquiring of a new combined gas turbine plant, TNB has the ability
to increase the capacity to supply electricity to its consumers as well as gain
higher profits in the future, and with this profit increase, they can utilize the
raw materials while at the same time keep the prices low. Tenaga National
Berhad tends to be labeled as a price maker due to its monopoly structure in
the market. If its prices were to remain constant or increase even if the new
plant was up and producing electricity at a cheaper rate, TNB would still make
super normal profits and in turn boost its income to a much higher rate.
References
Beggs , (n.d.) What is a monopoly? Available
from http://economics.about.com/od/monopoly-category/a/What-Is-A-Monopoly.htm
[ Accessed 08 June 2013 ]
COALGURU, ( 2013) TNB posts MYR 1 billion profit in the Q4. Available from http://www.coalguru.com/other_asia/tnb_posts_myr_1_billion_profit_in_the_q4/4912 [ Accessed
08 June 2013
Lutzenberger,T.
(n.d. ) What Is a Government Monopoly? Available from http://www.ehow.com/about_5471337_government-monopoly.html
[Accessed 08 June 2013]
Mankwin, N.G (2004) Principles of Economics. 3rd ed. Thomson. South Western
Vorobyova, E. ( 2010) Barriers to Entry in a Monopoly (blog).
4 November. Available from http://ekaterina1225.blogspot.com/2010/04/monopoly-price-setting-strategies.html
[Accessed 08 June 2013]
