UNIT SIX : PURE MONOPOLY
Definition: Pure monopoly is the form of market
organization in which there is a single seller of a
commodity for which there are no close
substitutes.
o Thus, it is at the opposite extreme from perfect
competition.
o A monopoly is opposite of perfect competition
in every facet of its organization.
o Monopoly is a market structure in which there is
Since there is only one firm in the market,
the demand and supply curves of a
monopoly are also the industry demand and
supply curves.
When there is only one firm in the market,
the firm is unlikely to take the market price
as given. Instead, the monopolist would
recognize its influence over the market price
and choose that level of price and output
that will maximize its overall profit.
Of course, a monopoly firm cannot
choose price and output independently.
Because, for any price, the monopoly
will sell only what the market will bear.
If it chooses high price, consumers will
demand small quantity.
In other words, the demand behavior of
consumers will constrain the
monopolist’s choice of price and
quantity.
Assumptions (Features) of Monopoly
The following are assumed to be the
features of a monopoly.
o Single Producer/seller
o No Close Substitutes or unique
product
o Barriers to the Entry –entry banned
o Independent Price Policy-price
maker
o Price Discrimination is Possible
In short, monopoly depends basically on
two factors:
absence of close substitutes; and
restriction on competition.
Example: Electricity market in Ethiopia
and Ethio Telecom before the coming
of safari com into Ethiopian market.
Reasons for the Existence of Pure Monopoly
The origin and existence of a monopoly
may be legal or technological or both.
Following are the main causes that
lead to a monopoly situation:
Government policies such as related to
granting licences or imposing foreign
trade restrictions (like quotas, etc.)
result in limiting the number of sellers;
Legal restrictions-to protect public
interests.
Ownership and control of some strategic raw
materials; (control over key raw materials- this
called raw material monopoly)
Efficiency: a primary and technical reason for
growth of monopolies is economies of scale.
The most efficient plant (probably large size
firm,) which produces at minimum cost, can
eliminate the competitors by curbing down its
price for a short period and can acquire
monopoly power. Monopolies created through
efficiency are known as natural monopolies.
Patent rights -Patent rights for
the products or production
processes give legal monopoly
rights to firms; and copy rights.
Exclusive knowledge of technology
by the firm;
Profit Maximisation Under Pure
Monopoly
In this section, profit maximisation
or a firm’s equilibrium determination
under monopoly is based on the
following assumptions:
The monopolist does not charge
discriminating prices (but in reality
the monopolist charges different
prices)
The monopolist is rational in the
sense that she/he aims at maximising
profits.
The individual buyer is a price-taker,
There are no restrictions on the
monopolist with regard to her/his price.
Also, there is no threat of entry by
other firms into the industry.
Given these assumptions, the
equilibrium of a monopolistic firm
is determined by the forces of
demand and supply.
The monopolist can control both
the prices and the supply of the
product.
But at any point of time she/he
Either she/he can fix the quantity of output
and let the market determine the price of
the product on the basis of market
demand;
or she/he can fix the price of the product
and let market demand determine the
quantity which she/he can sell at the given
price.
In order to determine the profit-maximisation
output of a monopolist, we need to combine
the monopolist’s revenue curves and cost
curves and apply the profit-maximisation
rules.
As far as cost curves are concerned, they
have the same U-shape for the monopolist as
for a competitive firm because they depict
technological conditions, which are common
to all types of market structures.
Similarly, profit-maximisation rules are the
same in all market structures because
producers in all the markets operate with
the objective of earning profits.
The difference lies in the demand
conditions or the revenue curves.
While a firm under perfect competition
faces a perfectly elastic demand curve, a
monopolist faces a negatively sloping
demand curve or average revenue curve.
We can show a monopoly with the
help of the following example and
TR, MR AND AR
the corresponding diagram.
under Monopoly
TR, MR and AR curves under
monopoly
Remarks:
Both AR and MR are falling, and MR
falls at a greater rate than AR.
In other words, the AR and MR curves
are downward sloping curves, and the
MR curve always remains below the
AR curve.
MR can be negative, but AR is always
positive.
In other words, the MR curve can go
Profit Maximisation
The profit of a monopoly firm is
maximum at the level of output at
which MR = MC and MC is rising.
Profit maximization under
monopoly
To maximize profit, a monopoly firm
should produce and sell up to the point
at which revenue from the last unit is
equal to the cost of last unit.
Thus, we may conclude, a monopolist
firm maximizes its profit when
MR = MC, and
MC is rising
Note:
Profit maximization under monopoly
conditions can also be explained by
using the total revenue and total
cost approach, just as we did in the
case of the perfectly competitive
market.
o Mathematically, profit is
maximum when TR – TC is
maximum (TR > TC).
Graphically, this is shown as in the
following diagram.
TR/TC approach to profit maximization under
pure monopoly.
Practical Exercise / work
Question 1: For a monopolist firm,
the following information is given:
MR = 100 – 7Q and MC = 30
Calculate its profit-maximising
level of output, or loss
minimization level of output.
Practical Exercise / work
Question 2:
Given below are the cost and revenue
functions of a monopolistic firm:
TC = 20 + 10Q; TR = 40 Q – 5 MC = 10
and MR = 40 – 10 Q
Calculate:
i Profit-maximising level of output
ii Total profit
Class Activities
1. A monopolist is currently producing
at an output level where MR = Birr 40
and MC = Birr 30. What do you think
he/she should do in order to achieve
the output level of profit maximisation?
2. The demand curve for a monopolist
is given by P = 80 – 5 Q, where P is
price (in Birr) and Q is quantity
demanded. Find out his/her total
revenue when quantity demanded is 4
units.
3. Identify the market form for the
two sellers of goods A and B, given
the following information.
4. ‘Monopoly is not a permanent phenomenon’ –
Discuss in a group and note down the outcomes
of your discussion.
