Micro 2
• Ch-1
• perfectly competitive market structure in which there is large number
of firms selling homogeneous products.
• Monopoly is quite opposite to perfectly competitive market. And it is
defined as:
• a market situation in which a single seller sells a product or provides
a service for which there is no close substitute.
• In monopoly there are no similar products whose prices or sales will
influence the monopolist price or sales.
• In another words, cross elasticity between monopolist product and
other commodities is zero or low.
• cross elasticity in a monopoly context, we're referring to how the
demand for one product changes when the price of another product
changes.
• Since there is a single seller in monopoly market structure, the firm is
at the same time the industry.
• Common characteristics or features of monopoly
• can increase the price of its product by decreasing the quantity of supply.
• Monopoly markets share the following common characteristics.
• [Link] seller and many buyers: There is a single seller who sells the product to
many buyers.
• [Link] of close substitutes: A product produced by a monopolist has no close
substitute so that consumers have no alternative choices to substitute one product
for another.
• 3. Price maker:
• in perfectly competitive market, we have said that, both sellers and buyers are price
takers.
• However, the monopolist is a price maker.
• Facing a down ward sloped demand curve for its product.
• the monopolist can change its product price by changing the quantity of the Product
supplied.
• For example, the monopolist can increase the price of its product by decreasing the
quantity of supply.
• [Link] to entry: In monopoly, new competitors cannot freely enter
in to the market due to some barriers which can be economical,
technical, legal or other type of barriers.
• 5. Price discrimination: in a monopoly the firm can change the price
and quantity of the good or service.
• In an elastic market the firm will sell a high quantity of the good if the
price is less. If the price is high, the firm will sell a reduced quantity in
an elastic market.
• 6. Profit maximizer: a monopoly maximizes profits. Due to the lack of
competition a firm can charge a set price above what would be
charged in a competitive market, thereby maximizing its revenue.
• Sources of monopoly
1. Capital requirements
2. Technological superiority
3. No substitute goods
4. Control of natural resources
5. Network externalities
• Network externalities, also known as network effects, refer to the
phenomenon where the value of a product or service increases as more
people use it.
6. Legal barriers
7. Deliberate actions.
• Exclusive knowledge of production technique:- Most of the
beverage (soft drink) companies such as Coca Cola Company have
maintained monopoly power over supply of their product partly due
to exclusive knowledge of the ingredient chemicals required for the
production of their product.
• Government Franchise and License :-Another cause for the
emergence of monopoly is government franchise.
• Franchise is a promise by the government for a firm to prohibit the
establishment of another firm (by another person) that produces the
same product or offers the same service as the original one.
• Government franchise and license refer to permissions or rights
granted by a government to individuals or entities to conduct certain
activities or operations within a specified jurisdiction
• For example, when the first Bank in Ethiopia, Abyssinia Bank was
established, Emperor Minilik has promised for the Egyptian firms (the
owner of the Bank) that they will monopolize the Banking service in
Ethiopia for 50 years. Postal service in Ethiopia, Ethiopian television,
telecommunication service in Ethiopian etc. are other examples of
monopoly..
Profit maximization of monopoly in short run equilibrium
• Price and output combination that maximizes the monopolist profit
can be determined in the similar fashion as that of the perfectly
competitive firm. That is, price- output combination that yields the
monopolist the maximum profit can be determined in two ways:
• 1. Total approach
• 2. Marginal approach
• Monopoly's Revenue
a) Total Revenue TR=P.Q
b) Average Revenue TR/Q = AR = P
c) Marginal Revenue dTR/ dQ = MR
d) A monopolists marginal revenue is always less than the price of its
good.
A monopolist's marginal revenue is indeed typically less than the price
of its good, and this is due to the nature of the demand curve it faces.
e) The demand curve is downward sloping.
• Profit Maximization
• A monopoly maximizes profit by producing the quantity at which
marginal revenue equals marginal cost.
• It then uses the demand curve to find the price that will induce
consumers to buy that quantity.
Comparing Monopoly and Perfect Competition
• For a perfectly competitive firm, price equals marginal cost at
equilibrium.
P = MR = MC
• For a monopoly firm, price exceeds marginal cost .
P > MR,P> MC
The Monopolist's Profit
• The monopolist will receive economic profits as long as price is
greater than average total cost.
• Zero-profit monopolist
1. When P > ATC, the monopolist enjoys positive profit.
2. When P = ATC, the monopolist is at breakeven point (earns zero economic profit).
3. When P < ATC, the monopolist faces negative profit (loss).
4. When ATC > P > AVC, the monopolist should continue operation under loss in the short run
to minimize its total loss.
5. When ATC > P = AVC, the monopolist is indifferent.
In this situation, the firm is not making any economic profit because its total revenue (P *
Q) is just enough to cover its variable costs, but not enough to cover both variable and fixed
costs. Likewise, it's not incurring any losses because it's covering its variable costs.
Therefore, the monopolist is said to be "indifferent"
6. When ATC > AVC >P, the monopolist must shut down in the short run.
Price discrimination
• Price discrimination refers to the charging of different prices for the
same good.
• But not all price differences are price discrimination.
• If the costs of offering a certain uniform commodity (service) to
different group of customers are different (say due to difference in
transport costs), price of the commodity may differ for each group
owing to this cost difference.
• But this cannot be considered as price discrimination.
• A firm is said to be price discriminating if it is charging different
prices for the same commodity without any justification of cost
differences.
• By practicing price discrimination, the monopolist can increase its
total revenue and profits.
