A monopolistic market is a market structure with the characteristics of a pure monopoly. A monopoly exists when there is only one supplier of a good or service, but many consumers.
In a monopolistic market, the monopoly has full control of the market, so it sets the price and supply of a good or service. This characteristic makes it a price maker. A monopoly is a profit maximizer because it can change the supply and price of a good or service to generate a profit. It can find the level of output that maximizes its profit by determining the point at which its marginal revenue equals its marginal cost.
With generally only one seller who controls the production and distribution of a good or service, it is very difficult for other firms to enter the market, creating high barriers to entry, which are obstacles that prevent a company from entering into a market. Potential entrants are at a disadvantage because a monopoly has first mover’s advantage and can set prices lower to thwart a potential newcomer’s entry.
Since there is only one supplier and firms are not able to easily enter or exit, there are no substitutes for the goods or services. A monopoly also has absolute product differentiation because there are no other comparable goods or services.
Why Are Monopolistic Markets Inefficient?
Both historically and in modern times, economists have been relatively divided on the theory of monopolistic competition. While all economists that agree most monopolistic activity arises out of special government privileges to certain firms, many believe natural industry concentration, or a monopoly or oligopoly, does not result in market inefficiencies.
Monopoly market inefficiencies do not arise simply because there are large firms; in fact, competition could possibly be more pervasive among a small number of powerful producers. Inefficiencies only arise when less of a good or service is provided, and at higher economic profits, than the market-clearing level.
There are two forms of challenges to the theory of natural monopoly inefficiencies: theoretical and empirical. Most of the theoretical challenges point to methodological problems in general equilibrium microeconomics and flaws in perfect competition models. Other economists suggest the record of history does not support natural monopoly theory; unregulated industries dominated by large firms show rising productivity, declining real costs and no shortage of new company formation.
(For related reading, see: Early Monopolies: Conquest and Corruption.)