Imperfect Competition: Monopoly and Cartel

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A monopoly is an industry with only a single seller or provider of goods and services. In a monopoly, there is no competition and therefore the seller can charge prices that are higher than they would be in a competitive market. Because the price being offered by the monopoly is usually high, the quantity demanded is smaller than in competitive enterprises. In monopoly firms, prices are set at the point where total profit is maximized. They can sell more at lower prices, or they can sell less but at higher prices. In either case a monopoly can either control the output or fix the product price. Once the price is set, market demand will determine the quantity that can be sold at that price. Conversely, given the output, market demand determines the price at which that quantity can be sold.

Monopolies are characterized by a lack of viable substitute goods or the existence of high barriers against the entry of potential competitors into the market. The former could be because the monopoly controls a major resource such as raw material or a specific technology necessary to produce a product. The latter could include laws that forbid competition (exclusive control over a patent on a product or on the processes needed to produce the product), laws that effectively forbid competition (through heavy regulations and subsidy), state monopoly (such as printing money and issuing stamps), or natural monopoly where production conditions and high initial cost make a sole provider more efficient (power and water distribution to private households). The term is also loosely applied to companies which have de facto control of a large share of a total market; Microsoft and AT&T (before its breakup), could, because of their shear sizes, be involved in practices that prevented others from fair competition (a). Also classified as monopolies are firms that control the entire market through many smaller, seemingly diverse companies; in the early twentieth century, Standard Oil controlled the exploration, extraction, and transportation of petroleum.

Just like a competitive firm, a monopoly maximizes its profit when MR = MC; unlike a competitive firm, marginal revenue in monopolies is not equal to the price. In fact, marginal revenue is below price.

Example: Consider the market for heating oil in a large metropolitan area. Data of consumer behavior from previous seasons indicate that the total quantity of fuel oil sold decreases as price increases, as more and more customers switch to electricity to meet their energy needs. The cost is also a strong function of the quantity, as additional units must be imported from farther and farther distances. The total fixed cost for all firms is $4,000. The cost of production of each additional unit and the projected demand curve are given below. What is the total volume of heating oil and price offered to the market assuming that:

a. There are 100 firms who are competing for the same market?

b. The biggest firm buys out the remaining 99 smaller firms and thus becomes the sole supplier of the heating oil?

Table 1

Quantity 0 100 200 300 400 500 600 700 800 900 1000
Price ($) 42.00 40.00 38.00 36.00 34.00 32.00 30.00 28.00 26.00 24.00 22.00
Marginal Cost ($) -- 10.00 8.50 8.00 8.50 10.00 12.50 16.00 19.50 26.00 32.50

Solution: Whether a firm operates as a monopoly or competes in a competitive market, it is interested in maximizing its profit. As long as the revenue of producing one additional unit (marginal revenue) is higher than its marginal cost, the firm makes a profit. In a competitive market, there are a large number of competitors, so each firm can only charge a price equal to the marginal cost. Since for a competitive firm P = MR, its profit-maximizing output is where MC = MR = P. Attempting to charge any price above its marginal cost brings in additional profit and signals competitors to enter the market. In the example given, marginal costs are reduced initially but increase as additional units are produced. At the same time, prices continue to decline with increasing output. The price becomes equal to marginal cost ($26) when 800 barrels of heating oil are sold cumulatively among the 100 retailers, bringing a total of $7,500 in profit.

Increasing production does not necessarily mean more profit. In a competitive market, each firm is only after its self-interest and tries to maximize its own profit, even if it does not bring maximum profit for all firms collectively. In a monopolistic firm, there is no competition so a firm can set the price as it wishes and marginal revenue need no longer be equal to the price. In this example, the monopoly’s interest is in reducing the total quantity from 800 to 600 but to sell it at a higher price of $30 a barrel (A barrel of oil is exactly 42 gallons) instead of $26, increasing total profit by $750 to $8,250. As could be expected, monopolistic enterprises lead to higher prices and lower outputs.

Table 2

1 2 3 4 5 6 7 8
Qty Price Total Cost Marginal Cost Total Revenue Marginal Revenue Total Profit
0 42 4,000 0.00 -4,000
10.00 40
100 40 5,000 4,000 -1,000
8.50 36
200 38 5,850 7,600 1,750
8.00 32
300 36 6,650 10,800 4,150
8.50 28
400 34 7,500 13,600 6,100
10.00 24
500 32 8,500 16,000 7,500
12.50 20
600 30 9,750 18,000 8,250 Monopoly
16 16
700 28 11,350 19,600 8,250
19.50 12
800 26 13,300 20,800 7,500 Competitive
26 8
900 24 15,900 21,600 5,700
32.50 4
1000 22 19,150 22,000 2,850

Advantages and Disadvantages of Monopoly

The major disadvantages of a monopoly are lower efficiency, higher prices, and somewhat poorer quality. Because they don’t have to compete in the marketplace, monopoly firms can set prices artificially high, the firm is less efficient, and innovation is restricted. As a result, the product quality compared to quality in a competitive market is poor. Some economists do not consider these actions as necessarily harmful if firms reinvest their profit into the industry to expand their internal R&D (research and development) effort, building new plants and upgrading existing equipment. According to the Wall Street Journal, Japan owes its impressive energy efficiency to big energy companies who tacitly agreed among themselves to increase the price of energy but reinvest the windfall back into energy research and development (1).


Figure 1 OPEC Official Bulletin.
Figure 1 OPEC Official Bulletin.
Figure 2 Oil prices from the 1960s to present adjusted to 2007 dollars.
Figure 2 Oil prices from the 1960s to present adjusted to 2007 dollars.

When, instead of a single seller, a combination of a group of firms control the flow of a good or a service to a market, we have a cartel (also called a trust). In a cartel, a group of industries form an alliance where they can jointly decide on strategies that effectively control production and set prices. Like monopoly enterprises, cartels’ main objective is to maximize profit, except that cartels strategize to maximize collective profit of their members even when different firms have conflicting interests. In practice, one or two larger firms control cartel policies and set quota and prices. Smaller firms must exit or follow suit.

OPEC is one such entity formed in 1960 by six major oil-producing countries to control production and combat falling oil prices (Figure 1). In the years following the 1960s, OPEC had limited success, as the price of light crude was raised modestly from $1.80 to $2.59 in 1973. The most striking success was the Arab Oil Embargo and OPEC’s cutback following the 1973 Arab-Israeli war. This resulted in a rapid rise in the price of oil to $11.65 by January 1974, which was gradually raised to $14 a barrel by 1978. The Iranian revolution in 1979 and Iran-Iraq war of the 1980s gave OPEC another opportunity to push prices to as much as $40 a barrel in 1981. Adjusted for inflation to 2007 prices, this exceeded $100 a barrel (Figure 2). The rapid rise in the price of petroleum forced industrial nations to consume oil more efficiently and invest heavily in alternative sources of energy such as wind and solar. Furthermore, high prices gave incentives to other nations to explore more of their own reserves and expand their production capacities. Due to these changes, along with the discovery of the North Sea and Norwegian oil deposits and the flow of Russian oil, OPEC’s role as an effective cartel was greatly reduced.

Within the next few years, Saudi Arabia lost its leadership role in controlling prices, and the price of oil continued to decline – falling to $15 a barrel by February 1986. OPEC tried many times to control prices by cutting production, but the strategy remained largely ineffective, and except for a short time during the 1991 Gulf War, prices stayed under $20. As of May 2008, various economical factors and the turmoil in Iraq resulting from the US occupation have resulted in a spike in oil prices to $130 a barrel, the highest they have ever been in OPEC history.

It is important to point out that for a cartel to work efficiently, all members must agree to set aside economic differences and work in unison. In the case of OPEC, the internal economic factors and external political pressures, along with rivalry among members and emergence of non-member powerhouses, have effectively stopped OPEC from performing efficiently as a cartel.


(1) “How Japan became so Energy Efficient” Wall Street Journal, September 10, 1990.

(2) Toossi Reza, "Energy and the Environment:Sources, technologies, and impacts", Verve Publishers, 2005

Additional Comments

(a) Some argue that a monopoly can lead to higher quality - Microsoft working hard to maintain monopoly, for example, by improving its product.

Further Reading

Colander, D. C., Economics, 3rd E., Irwin-McGraw-Hill, 1998.

Bosselman, F., Energy, Economics and the Environment, Second Edition, Foundation Press, 2005.

Energy Economics, Science Direct Elsevier Publishing Company. Publishes research papers concerned with the economic and econometric modeling and analysis of energy systems and issues.

External Links

United States Association for Energy Economics (

International Monetary Fund (

The World Bank (