EPGP Term I

Monopolys price and output decision Social cost of monopoly Taxation under monopoly Market power: measurement and sources Natural monopoly and price regulation Monopoly compared to Perfect competition
Price setter Single seller Barriers to entry

Profit=Total Revenue-Total Cost If firms profit maximizing output level is q, then profit:
(q) R(q) C(q) R C 0 q q q MR(q) MC(q) 0 MR(q) MC(q)

Cost, Revenue, Profit A

C(q) C R(q)

output
q1 q* q** q2 (q)

TR=PQ, P is same as AR For linear demand, P=AR = a bQ TR=aQ-bQ2 MR = a 2bQ Suppose P= 20 -2Q. Then, AR=20-2Q MR = 20 -4Q

Competition
Price Price a P MR=AR

Monopoly

MR

AR=P

a/2b

a/b

P=AR=a-bQ MR = a 2bQ

MR MR P

R Q P

P Q Q P MC

Q P Q P Q P

P P

Q 1

P Q

Equating MR P P P 1

MC, we get

MC .........Rule of thumb for pricing 1 1

MR MR P

R Q

P Q

Q P Q P Q P

P P

Q 1

P Q

Q P P MC 1

Equating MR P P 1

MC, we get

P - MC P

.....Lerner index

MR

P P 1

MC

a >1 =1

P1 If, If

MC

0, P MR MC and, 1, MR 0

<1

a/2b

MR<0

a/b

Price

P* Profit MC=MR Q* MR

MC

ATC

P (=AR) Quantity

Deadweight Loss= BCD

Price
A PM B

Deadweight loss due to monopoly MC

PC
E Monopolists best point D

C
MR QM

Socially best point (P=MC)

P =AR

QS

Price A F C E B K H

MC+t
MC

J
G I Q2 Q1 L

Quantity

Price

P2 P1

P t D=AR MC+t MC MR Quantity Q2 Q1

Multi-plant monopolist
P

PM
MC1 MC2

MC Total

D MR Quantity Q1 Q2 Q = Q1 + Q2

Entry barrier
Natural (Economies of scale) Artificial (Govt. regulation, patent, trademark etc)

Product differentiation

Price

PM P1 PC MR

MC

ATC

P (=AR) Quantity

QM Q1 QC

Price

PM

AR=P
MR PMC

MC AC

QM

QMC

Quantity

EPGP Term I

Discrimination is Not a negative word here. Firms with market power can charge different prices to different consumers or for different quantities purchased. Producer surplus increases by capturing consumer surplus. Social cost of monopoly may also reduce with price discrimination.

Requirements: Price 1. Market power 2. No Arbitrage P1 3. Identifying P different groups P2m of consumers Pc

A B MC

MR Q*

P (=AR) Quantity

First degree: Perfect price discrimination, hard to find in real world Second-degree price discrimination: Discrimination by self-selection, quantity related price discrimination (quantity discounts, block pricing) Third-degree price discrimination: Customer specific price discrimination (based on observed characteristics). Two part tariff, inter-temporal price discrimination, peak-load pricing.

price p1 p2 p3 p4 p5 p6 MC

MR

D=AR quantity

P1Q 1

P2Q 2 0

C(Q T )

Profit maximizing conditions : Q1 or, MR1 Q2 MR2

MC 1
1

Since, MR1

P1 1

and MR2

P2 1

1
2

Relative price will be, P1 P2 1 1 1

2

1
1

price P1 MCT

P2

MRT MR1 Q1 Q2 D1 QT MR2

D2

quantity

price P1 PM

P2 P3
MR Q1 QM Q2 Q3

AC MC D

quantity

Two-part pricing: A firm charges the consumers a fixed fee (entry fee) and a variable fee which depends on the units of consumption. Examples: Retail electricity, landline and post-paid phone connections, amusement parks, cricket club memberships. Works well for bundled products like razor and blades, camera and films etc.

price a

Usage fee: P=MC Entry fee= abc

price a

c MC

b f

c g

d h D1

e i D2

MC Dtotal

D
quantity

quantity

Price

Price

P1 P2 D2 AC=MC MR2

AC=MC MR1 Q1 T=0 D1 Quantity Q2 T=1

Quantity

Price

Price

MC

MC P1

P2

D1

MR2 Q2

D2 Quantity Q1

MR1 Quantity Daytime

Night