A Monopoly Structure's Barriers to Entry

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. 3^rd 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]