MONOPOLY

MONOPOLY

Monopoly is a market situation in which there is only one seller of a product with barriers to entry of others. OR Monopoly is the form of market organization in which there is a single firm selling a commodity for which there are no close substitutes. Monopolist can sell his commodity at any price he likes. He has the control over price, but not the demand. Demand is determined by the purchasers.

Features of Monopoly:

Single Seller: In a monopoly market there is only one firm producing or supplying a product. This single firm constitutes the industry. No distinction of firm and the industry. Restrictions to Entry: There are strong barriers to entry. The barriers could be economic or legal. No close substitutes: The monopolist generally sells a product, which has no close substitutes. Cross elasticity of demand for the monopolists product and any other product is zero or very small. Price elasticity of demand is also less than one. Abnormal profits: There are abnormal profits in long run.

Sources of Monopoly:
1. 2. 3. 4.

5. 6.

Economies of scale-huge investments-Capital requirements, which may be chemicals, electronics, R& D requirements, etc -large plant-more risky. Product differentiation-established brand new firms if do sell at lower price. Absolute cost advantage obtain resources at a lower cost than the potential entrants. Prime location (mineral deposits, oil supplies ) - as such established would charge prices above their MC and earn economic profits without attracting entry. Legal restrictions patents rights. Strategic barriers keep lower prices to discourage the new competitors. This is called as retaliation pricing. At the same time, engage in extensive advertising and brand building to quickly expand the capacity.

Behavior of Average Revenue and Marginal Revenue.

Output (Q)

Price (Rs)

TR (Rs)
PXQ

AR (Rs)
TR/Q

MR (Rs)
TR/Q

1 2 3

10 9 8

10 18 24

10 9 8

8 6

4
5 6

7
6 5

28
30 30

7
6 5

2 0

When prices do change with change in output (prices are not fixed, more output can be sold only by reducing price): Price = AR. Diagram: (AR and MR curves slopes downwards) MR curve is below the AR curve.

Price determination under Monopoly:

Two conditions for equilibrium in a monopoly market are: MC=MR. MC curve must cut MR curve from below. The aim of monopoly is to earn profits. He will produce up to a point and fix a price which will give him maximum profits. He can either fix the price or fix the quantity for sale. He cannot do both simultaneously. The AR curve and MR curve slopes downwards throughout its length. MR falls faster than AR. A monopolist will fix prices high or low based on two factors: Elasticity of demand Behavior of Average cost as determined by laws of production.

Demand elasticity's: If demand elastic (change in price is going to bring more changes in demand) low prices. Demand inelastic (change in price is not going to bring more changes in demand, but less) high prices. Laws of production: If constant returns (returns = Cost) - Average Cost does not change prices is fixed according to demand (based on elasticity of demand). If increasing returns (returns > Cost) - Average Cost is low try more sales-maximize profit- with lowering price. If decreasing returns (returns < Cost) - Average Cost is high try to cover variable cost higher prices less output.

Short run equilibrium of Monopoly:

In short run, monopoly firm attains equilibrium when its profits are maximized or attains equilibrium when losses are minimized. (Only variable capital can be increased). MR = MC The price determined by the monopolist may be equal to or greater than or less than average cost.

If the price is equal to Average Cost, then he will be earning normal profits. If prices is greater than Average Cost, then he will be earning maximum profits. If prices is less than Average Cost, then he will be incurring losses. Fix prices to cover variable cost. Diagrams:---.

Long run equilibrium of Monopoly:

In the long run, Equilibrium of a monopoly firm will be at that level of output where MR = MC. In long run fixed capital becomes variable capital and the price will be equal to or greater than average cost. But not less than average cost. Earn supernormal profits entry of new firms has strong barriers. Diagram: If losses occur external factors stop production and quit the market.

Price Discrimination

Meaning: When a Monopolist charges different prices for the same product from different buyers, it is called price discrimination. Types: Personal Discrimination- charging different prices for the same product. Eg: Doctor. Local Discrimination- When prices are different in different places, it is local discrimination Dumping. Trade/use discrimination when different prices are charged for different uses, it is called trade /use discrimination. Eg: Electricity.

Degrees of Price Discrimination (PD):

First Degree: When PD is such that monopolist charges a different price for each unit of the commodity sold. Maximum exploitation of the buyers is done- no savings/consumer surplus. Second Degree: Monopolist will try to divide buyers into groups, so that there are different price range for separate groups. Marginal buyer & potential buyer. Third Degree: Monopolist divides the entire market into few sub-markets and charge different prices in different sub-markets. Foreign market & domestic market.

Conditions of Price Discrimination:

PD is possible only when there is: 1. Monopoly in the market. 2. Total market is divided into sub markets. 3. Buyer should not resell the good from cheaper market to costlier market. 4. Buyer should not transfer his demand for a cheaper market from costlier market preferences should not change. Successful: 1. PD is possible in service sectors rather than goods market. 2. Possible if consumers are separated by a greater distances/tariff barriers. 3. PD is possible only if special orders are placed for his services/products. Profitable: 1. Imperfect competition. 2. Sub-markets with elasticities of demand.

Equilibrium in a Price Discriminating Monopoly:

1. 2. 3.

Conditions of equilibrium are: Maximize the profit. Equate MC with total AMR. MC=MRA =MRB. MC should cut AMR (aggregate) from below. The objective of price discrimination is to secure maximum profits by adjusting the price and the output in each distinct sub-market according to the demand conditions. Assuming constant conditions in each market, the monopolist has to determine: How much total output is to be produced and its distribution in each market; and what prices should be charged in different markets.

Diagram:_________.

First divides the total market into two sub-markets: Sub-market A & Sub-market B. Second, Each sub-market demand is shown with AR and MR curves. To determine the overall output, we need to know aggregate marginal revenue (AMR). It is the summation of both the markets respectively. Equilibrium of the output will be determined at a point E where MC cuts AMR. Now the output is distributed in both the markets in such a way that MR in each market equals MC of entire output. (horizontal line) Equilibrium in both markets:

MC=AMR=MRA =MRB.

Monopolist benefits from both the markets with equilibrium output:

A discriminating monopolist produces and sells such quantities in each market at which the marginal revenue in each of the markets is equal to the combined or common marginal cost of production, which is also equal to aggregate marginal revenue.

If Marginal revenue in one market exceeds than in the other, it becomes profitable for the monopolist to divert sales from the other market towards the market, wherein additional sales bring in more marginal revenue. He produces OQ output and sells different amounts of output in different markets. Accordingly, he fixes the price.

Monopolist charges high price from the market who has relative inelastic demand (less responsive) and low price from the market who has relative elastic demand (high responsive).

Monopolist sells his product in two separate markets with different elasticities of demand so that he

maximizes his profits when he sells more at a lower

price in foreign market with elastic demand & sells less at a higher price in domestic market with less elastic demand.

It follows that Price Discrimination is possible and

profitable in Monopoly.

Monopoly Power : Measurement

Several economist gave different types of measurement: Lerners Measure: According to him, the difference between price and marginal cost gives the degree of monopoly power. Monopoly power depends upon his ability to sell the commodity at a price above its marginal cost. The degree of monopoly will be greater than zero as the gap increases. (P-MC/P). Bains Measure: According to him degree of monopoly is based on super normal profits. Triffin's Measure : Triffin suggested cross elasticity of demand of products as a measure of monopoly power. If cross elasticity of demand is zero, it implies other firms products are not its substitutes and indicated monopoly power.

End of Monopoly Market Structure

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