Question

Why do monopolists exist? What are some of the economic arguments to support a monopoly?

How does the De Beers cartel maintain control of the price in the diamond market? How might this control be threatened?

Answer 1

Monopolies are made due to barriers that prevent other companies from entering the market and creating the monopolistic competition. Such barriers occur in different forms, therefore there are various reasons for the existence of monopolies.They are:

• Ownership of a Key Resource: When sole control is exerted over a resource by another company which is necessary for the production of a specific product then the market is said to be a monopoly.
• Government Franchise: A monopoly may be explicitly created by the government in certain situations the right to conduct business in a particular market if granted to a single company.
• Intellectual Property Protection: When intellectual property protection is extended to a company in the form of patents and copyrights is an another way in which monopolies are created.It is in giving a single company a right to provide a particular product or service to the market.
• Natural Monopoly: As it may be more cost-effective for one company to serve the whole market than to have several smaller firms in competition with one another,a market may become monopoly. A company with unlimited economies of scale can be called as a natural monopoly.

Under the United Kingdom and the European law ,when a firm controls more than 40% of the market which it operates,monopolyis said to exist. Therefore, it is described as the opposite of perfect competition. Perfect competition is a market situation where many sellers and buyers exist who are well informed about goods and services and they can all be active as price takers. Here,suppliers aim to producers use their resources is the best way while consumers are not loyal to producers since their aim is to maximise their benefits. However, the most important characteristic of a perfect competition is the fact that there are no barriers of entry or exit so  that supernormal profits can be achieved in the short run.On the other hand in the long run only normal profits can be achieved.

A distribution channel was created by De Beers called the Diamond Trading Co., or the DTC. Only approved buyers or sightholders were allowed to purchase in the non-negotiable DTC sales. Price was controlled by them by holding onto rough during a weak market or flooding the market in times of increased demand.The monopoly of De Beers was built upon supply control. To regulate the supply of diamonds into the market, De Beers took control of distribution channels and the Central Selling Organization (CSO) was formed, which functioned as the company’s marketing apparatus and around 90 percent of the world’s diamonds were controlled. CSO suppliers who were eager to sell their stones, were forced to sign an agreement that prevented them from forming outside contracts with other distributors. De Beers cartel's ability to control prices was threatened by economic depression and outside actors.Investors would capitalize on the stability of diamond prices by holding large quantities of the gem,when inflation was high or the stock market was suffering in a given country . De Beers also faced the threat of a market flooding if those investors were to engage in a mass sell-off.