A monopoly market structure emerges and continues to exist for three primary reasons. One is by taking advantage of economies of scale and decreasing average cost over the range of market demand. A second is through authorization that legally designates a single firm as the exclusive provider of a good. The third is through complete ownership of a resource or input that is essential to the production of a good.

Consider these three sources of monopoly market control.

Economies of Scale

A monopoly naturally emerges in a market that experiences decreasing average cost. Suppose, for example, that two firms (4M and Clear Cable) provide cable television services to the local Shady Valley television market. Each firm has a vast network of underground cables, converter boxes, computers, satellite receivers, and other capital equipment. With this capital, average cost declines as the relative high fixed cost is spread over more subscribers.

If each firm has half of the market, then each has equal average cost and can charge comparable prices. However, what happens if 4M obtains a few additional customers? With lower average cost, 4M can profitably charge a lower price than Clear Cable. This is bound to induce some Clear Cable subscribers to switch. As 4M provides cable services to an increasing number of subscribers, its average cost and prices decline. And as Clear Cable loses subscribers, its average cost and price rise. Clear Cable is increasingly at a competitive disadvantage. It is forced to charge higher and higher prices and 4M charges lower and lower prices.

An avalanche of subscribers flock to 4M, forcing Clear Cable out of business. The end result, naturally, is a single seller of cable television--a monopoly.

Government Decree

Government often extends monopoly control to a single firm in markets characterized by decreasing average cost. Such government authority, however, is usually accompanied by government regulation. Because a monopoly market tends to be inefficient, government often steps into those markets that naturally tend toward monopoly, preemptively establishing the monopoly, then regulating the firm to address any inefficiency that might occur.

Government effectively says, "You can be a monopoly, but you must play by our rules."

Of course, government has the power to create monopoly where none would exist otherwise. Government patents provide an example. In the world of pharmaceuticals, government patents establish monopoly in the markets for assorted drugs. Although dozens of firms could, in principle, provide the same drug, government often restricts the market to a single firm.

This is generally done to encourage pharmaceutical firms to invest time and money in the research and development of new drugs. The exclusive patent allows the firm to recoup this investment. For example, in the hypothetical world of Feet-First Pharmaceutical, their patent on the drug Amblathan-Plus used to cure the deadly foot ailment known as amblathanitis, generates oodles of revenue and profit. However, this is a reward for the years of research and millions of dollars of investment spent developing the drug. Had they lacked the expectations of such reward, then they probably would not have undertaken the investment, and society's health would have suffered.

Resource Ownership

Resource ownership is often a key source of monopoly control. The firm that controls the resource input is able to control the good produced. Because mineral deposits and fossil fuels tend to be geographically concentrated, they often emerge as monopoly-enabling resources. The petroleum market, in particular, has been perpetually prone toward monopoly from J. D. Rockefeller and the Standard Oil Trust in the late 1800s to the Organization of Petroleum Exporting Countries in more recent times.