College of Business
and Economics
Department of Economics
Microeconomics
By Desalegn N,
1 September 2, 2024
Chapter Five: PURE MONOPOLY
Outlines
Introduction
Nature of monopoly
Source of Monopoly
Short and long run equilibrium
Price discrimination
Multi-plant Monopoly
Introduction
There are four market structure: perfect competition, monopolistically
competition, pure monopoly and oligopoly.
In this chapter we are going to see the nature, reason and profit
maximization of pure monopoly market structure by considering
price discrimination and multi-plant production.
Nature of monopoly
Pure monopoly is the form of a market in which a single firm sells a
commodity for which there are no close substitutes.
Thus, the monopolist represents and faces the industry's negatively
sloped demand curve for the commodity.
Characteristics of monopoly:
Single seller
Absence of close substitute for the product of monopolist
Blocked entry
Price maker
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Source of monopoly
Monopoly can arise from several causes (barriers to entry):
control the entire essential raw material
Patent right
Economies of scale
Nature of market
Government policy
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Demand curve of Monopoly
A pure monopoly can increase its sales only by charging a lower
unit price for its product. But each additional unit sold will add to
total revenue its price less
As a result, the demand curve of monopolist becomes very
inelastic and hence, marginal revenue is less than price (average
revenue) for every level of output except the first..
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Demand curve of Monopoly
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Demand curve of Monopoly
From the above relation it can be shown that:
MR is positive (but less than P), when demand is elastic
MR is zero when demand is unitary elastic,
MR<0 when <1, and
MR=P when = demand is perfect elastic
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Short Run and Long Run equilibrium
Inthe short-run, a monopolist maximizes total profits by producing the level of
output at which marginal revenue equals marginal cost or where the distance
between the total revenue and total cost curves is the largest).
Short Run and Long Run equilibrium
If price is smaller than ATC at the point where MR = MC, the monopolist
will incur a loss in the short-run.
However, if P > AVC, it pays for the monopolist to continue to produce
because production covers part of the fixed costs.
Unlike other market structure the monopolist firm can obtain
super normal profit in the long run.
In the long-run, the best or profit maximizing level of output is given by
the point where the monopolist's LMC = MR (and LMC curve intersects
MR curve from below).
Price Discrimination under Monopoly
Price discrimination occurs when a monopolist sells the same output at different
prices for different consumer.
The objective is to maximize profit (revenue) by receiving consumer surplus.
Price discrimination is based on income of the consumers, geographical location,
age, quantity of purchase, relationship with the seller, and frequency of visit to the
shop.
Example: Ethiopian Airlines charge lower fares to senior citizens than foreigners.
There are three types of price discrimination – first-degree, second-degree, and
third-degree.
Price Discrimination under Monopoly
In general, price discrimination is workable when three conditions are
realized.
The seller must possess some degree of monopoly power,
The seller must be able to segregate buyers into separate classes
where in each group has a different ability and willingness to pay
for the product.
The original purchaser cannot resell the product.
Price Discrimination under Monopoly
1. First degree (or perfect/primary) price discrimination: Here, the monopolist sell
the good or service to each consumer by different price and thus it transform the
consumer surplus into revenues..
But, the monopolist require to know the absolute maximum price (or reservation price)
that every consumer is willing to pay.
As a result, the demand curve becomes the MR curve of the monopolist.
Example: medical doctor may charge different price for different consumers.
2. Second degree price discrimination
It occurs when prices differ depending on the number of units of the good bought,
but not across consumers.
Price Discrimination under Monopoly
Monopolist charge different price depending on the quantity purchase of
consumer.
3. Third degree price discrimination
It’s known as market segmentation
It charging a different price to different consumer groups and it is the
most common type.
The monopolist divides the entire market into submarkets and different
prices are charged in each submarket.
Price Discrimination under Monopoly
Example: suppose the demand function of foreign and domestic residents
of Ethiopian Airlines are given by q1=55- p1 and q2=70- 2p2 respectively and
total cost of Ethiopian Airlines is given by TC=5Q+20. Then determine
A. Determine q1, q2, p1, and p2 that maximises profit?
B. Find the elasticity of DD in the two markets?
C. Calculate the total profit the monopolist will obtains from its sell in the
two markets?
MULTIPLANT MONOPOLY
A monopolist maximizes profit by producing goods and services at
different plant and setting output at a level where marginal revenue of
the monopolist equals to the marginal cost of each plants.
Thus, it’s very crucial to determine the level of output produce in
each plant so that maximizing the level of profit.
MULTIPLANT MONOPOLY
Example: A drug company has a monopoly on a new patented medicine. The
product can be made in either of two plants. The costs of production for the
two plants are MC1 = 10 + 2Q1 and MC2 = 25 + 5Q2. Further, the firm’s
estimate of demand for the product is P = 2000 – 3(Q1+Q2). How much
should the firm plan to produce in each plant? At what price should it plan
to sell the product?
