MONOPOLY

Monopoly: Why?
• Ownership of strategic raw material
• Patent right for product
• Government licensing
• Size of the market may not support more than one plant
• Exclusive Knowledge of production technique
Monopoly: Characteristics
• Many buyers

• Only one seller i.e. Product produced has no competition

• Barriers of entry of new firm

• Firm has to determine the price

• Firm has to determine the level of output it would produce

• Monopolist can sell two different levels of output at one price

• Monopolist can sell a particular level of output at two different price.

• There is no unique supply curve for the monopolist

Monopoly: Features
• The monopolist’s demand curve (market demand
curve) is the downward sloping demand curve.

Monopolist can reduce the price and sell more or can raise
the price and still retain the customers.

• MR curve lies below the AR curve and the slope

of MR is twice that of AR.
 Monopoly: Market Behaviour
p(y)
Higher output y causes a
lower market price, p(y).

y=Q
Monopoly: Market Behaviour
At the profit-maximizing output level, the slopes of the revenue and
total cost curves are equal, i.e.

MR(y*) = MC(y*)
Marginal Revenue: Example
p = a – bq (inverse demand curve)

TR = pq (total revenue)

TR = aq - bq2

Therefore,

MR(q) = a - 2bq < a - bq = p for q > 0

Marginal Revenue: Example
MR= a - 2bq < a - bq = p
for q > 0
P
P = a - bq
a

a/2b a/b q
MR = a - 2bq
Monopoly: Equilibrium

MR AR Q
Monopoly: Equilibrium
MC
P

MR Demand y
Monopoly: Equilibrium
MC
P AC

MR Demand y
Monopoly: Equilibrium
MC Output
Decision
P AC
MC = MR

ym y
MR Demand
Monopoly: Equilibrium
MC Pm = the price
P AC

Pm

ym y
MR Demand
Determination of Price, Output and Firm Equilibrium
under Monopoly Competition
Equilibrium under Monopoly Competition: Like the firms working under perfect competition , the goal
of the monopolist is also to maximize profits . The monopolist gets maximum profit when he is producing
equilibrium output . Under monopoly equilibrium output and price are determined by two different
approach.

I. Total Revenue ( TR ) and Total Cost ( TC ) Analysis ;

II. Marginal Revenue and Marginal Cost Analysis .

Total Revenue and Total Cost Analysis: The TR and TC curves method applies to a monopoly firm as
well as firms in other kinds of market structure . According to this approach a firm is in equilibrium when
it produces that amount of output at which the difference between total revenue ( TR ) and total cost ( TC )
, i.e .; total profit , is maximum .
Equilibrium under Monopoly Competition

Marginal Revenue and Marginal Cost Analysis: Another

method to find out the profit maximizing output and price for a
firm under monopoly is to calculate its marginal cost ( MC )
and marginal revenue (MR) at different level output.
According to this approach, a monopolist will be in equilibrium
when two conditions are fulfilled, i.e., ( i ) MC = MR and ( ii )
MC must cut MR from below, i.e., the slope of MC > slope of
MR Once the profit-maximizing output level is determined,
the monopolist finds out the price which this quantity can be
sold. Accordingly, the price is determined.
PRICE AND OUTPUT DETERMINATION UNDER SHORT
PERIOD OR SHORT - RUN EQUILIBRIUM
In the short period , the time available is not sufficient to alter production , to adjust with the
demand . So in the short - run a firm can be in equilibrium in the following three positions with
respect to profits .
PRICE AND OUTPUT DETERMINATION UNDERSHORT-
PERIOD ORSHORT-RUN EQUILIBRIUM

Super normal profit : In Fig, the monopolist will produce OM units of output and sell it at MB
price which is more than average cost AM by BA per unit ( BM - AM = BA Thus , in this situation
the total super normal profit of the monopolist will be ABPC .
Normal profit : In Fig ., OM is equilibrium output . At this output , average cost ( AC ) curve
touches average revenue ( AR ) curve at point A. Thus , at point ' A ' price OP ( AR ) is equal to the
average cost ( AM ) of the product . Monopoly firm , therefore , earns only normal profit in
equilibrium situation , as at equilibrium output is AC = AR .
Incurring loss : In Fig ., OM output is being produced at MN cost per unit , but this is being sold
at AM price per unit . Monopolist incurs a loss of AN per unit . His total loss is being represented
by the shaded area ANP₂P .
Monopoly: Equilibrium
MC The shaded area is
the excess profit
P AC

Pm

ym y
MR Demand
Long Run Equilibrium under Monopoly
Price Discrimination
• Charging different price from different customers for the same
product is know as price discrimination.
• Reason of PD – to obtain increase in total revenue by taking away
part of consumer’s surplus
Necessary conditions for Price discrimination
to be possible
• Different markets must be separable for a seller
• Elasticity of demand must be different in different markets.
• There must be effective separation of sub markets so that no
reselling can take place from a lower price market to a higher price
market.
• Ideally, a firm would like to charge a different price to each customer. It would charge each customer the
maximum price they are willing to pay for each unit bought. We call this maximum price the customer’s
reservation price. Charging each customer his or her reservation price is perfect first-degree price
discrimination.

PERFECT PRICE DISCRIMINATION

• What happens if the firm can perfectly price discriminate? Because each consumer is charged exactly what
he or she is willing to pay, the marginal revenue curve is no longer relevant to the firm’s output decision.
Instead, the incremental revenue earned from each additional unit sold is simply the price paid for that unit;
it is, therefore, given by the demand curve. Since price discrimination does not affect the firm’s cost
structure, the cost of each additional unit is again given by the firm’s marginal cost curve. Therefore, the
additional profit from producing and selling an incremental unit is now the difference between demand and
marginal cost.
First Degree Price Discrimination
Second Degree Price Discrimination
• Sometimes, however, firms can discriminate imperfectly by charging a few
different prices based on estimates of customers’ reservation prices. This
practice is often used by professionals, such as doctors, lawyers, accountants,
or architects, who know their clients reasonably well.

• In such cases, the client’s willingness to pay can be assessed, and fees can be
set accordingly.

• For example, a doctor may offer a reduced cost to a low-income patient whose
willingness to pay or insurance coverage is low but charge higher fees to
upper-income or better-insured patients.
• In some markets, as each consumer purchases many units of a good over any given
period, his reservation price declines with the number of units purchased. Examples
include water, heating fuel, and electricity.

• A firm can discriminate according to the quantity consumed. This is called

second-degree price discrimination, and it works by charging different prices for
different quantities of the same good or service.

• Another example of second-degree price discrimination is block pricing by electric

power companies, natural gas utilities, and municipal water companies. With block
pricing, the consumer is charged different prices for different quantities or “blocks” of a
good. If scale economies cause average and marginal costs to decline, the government
agency that controls rates may encourage block pricing.
• Because it leads to expanded output and greater-scale economies, this
policy can increase consumer welfare while allowing for greater
profit for the company. While prices are reduced overall, the savings
from the lower unit cost still permit the company to increase its
profit.
Degrees of Price Discrimination

Third degree Price Discrimination

A well-known liquor company has a strange pricing practice. The company produces a vodka
that it advertises as one of the smoothest and best-tasting available. This vodka is called “Three
Star Golden Crown” and sells for about $16 a bottle. However, the company also takes some of
this same vodka and bottles it under “Old Sloshbucket,” which is sold for about $8 a bottle.
• Why does it do this?
• Has the company presidency been spending too much time near the vats?
Perhaps, but this company is also practicing third-degree price discrimination, and it does so
because the practice is profitable. This form of price discrimination divides consumers into two
or more groups with separate demand curves for each group. It is the most prevalent form of
price discrimination, and examples abound: regular versus “special” airline fares; premium
versus non-premium brands of liquor, canned food or frozen vegetables; discounts to students
and senior citizens; and so on
Monopolistic Competition
• Large number of sellers
• Free entry and free exit
• Perfect factor mobility
• Complete dissemination of market information
• Differentiated product, yet close substitutes of
one another
• The prices of factor and technology are given
Product Differentiation
• Product differentiation is intended to differentiate the product of
one producer from that of another producer in the industry.
• Can be real- when inherent characteristics of the product are
different
• Or fancied - when products are basically the same ,yet consumer is
persuaded via advertising and selling techniques that the products
are different.
 Effect of product differentiation

Producer has some discretion in determination of price

(monopoly power)

However faces competition of close substitutes

Monopoly + Competition
Product Differentiation creates brand loyalty of
consumers. This gives the seller an opportunity to
increase the price and still retain the customers.

This results in downward sloping demand curve.

Monopolistic competition – Short Run
Monopolistic Competition – Long Run
Model 1 : equilibrium with new firms entering the industry
Model 2: Equilibrium with price competition
Model 3: Equilibrium with Non Price Competition
Critical Appraisal of Monopolistic Model

• Assumption that monopolistic competitors act independently and their price

changes are unnoticed by rival firm is questionable
• In monopolistic competition firms are naïve, they do not learn from their past
experiences.
• Heroic assumption of identical cost and revenue curves are questionable.
• Chamberlin’s assumption of free entry is considered to be incompatible with
product differentiation. Product differentiation and brand loyalty act as a barriers
to entry.