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Managerial Economics

Market Structure
Monopoly

Veena Pailwar
Professor
1
IMT Nagpur

Monopoly
Single firm serves the relevant market
No Substitutes
No new entries possible
The demand for the firms product is the market
demand curve
Firm has control over price: Monopoly is price
maker

But the price charged affects the quantity demanded


of the monopolists product

Monopoly firms ability to set its market price is


limited by the demand curve (demand elasticity)
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Source of Monopoly Power


Natural Sources
Economies of scale
( Arising from increasing scale
of production)
Economies of scope
(Two products can be
produced Jointly at a
cheaper cost)
Cost complementarities
(As the output of a particular
product increases the cost
of complementary goods
goes down)

Created Sources
Patents and other legal
barriers
(like licenses)
Exclusive access to a
essential resource (input)
(raw material purchase
etc.)
Collusion
(Cartels: formal or informal)
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Managing a Monopoly
Market power permits
you to price above MC
Is the sky the limit?
No. How much you sell
depends on the price
you set!

A Monopolists Demand and


Marginal Revenue Curves
P

MR

Demand
Q
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Monopoly Profit Maximization

Produce where MR = MC.


Charge the price on the demand curve that corresponds to
that quantity.
$

MC
ATC

Profit

PM
ATC
D

QM

MR

Q
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A Numerical Example
Given estimates of
P = 10 - Q
C(Q) = 6 + 2Q

Optimal output?

MR = 10 - 2Q
MC = 2
10 - 2Q = 2
Q = 4 units

Optimal price?
P = 10 - (4) = Rs6

Maximum profits?

An Useful
Formula
Whats the MR if a firm
faces a linear demand
curve for its product?
P(Q) = a - bQ
MR = a - 2bQ

PQ - C(Q) = (6)(4) - (6 + 8) = Rs10

Long Run Adjustments?


None, unless the
source of
monopoly power is
eliminated or
threatened.

The Dynamics of a Monopoly Market


As a profit maximizer a monopoly may try
to take advantage of economies of scale
A monopoly tends to try to protect its
monopoly position
A monopoly may take advantage of
technological advances
A monopoly may face changes in
demand
A monopoly may try to promote its
product to maintain demand
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$
ATC>MC, P>MR, P>MC, P>ATC
SMC

LATC

k
SATC

D
Q
o

Qe
MRthe long run
Supernormal profits may be earned even in
depends on how contestable the market is

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Monopoly and Profit Maximization


A monopoly faces the industry demand curve
To maximize profit: MR = MC
P = 80 - .0008Q ;
MR = 80 - .0016Q
TC = 10,000 + .0092Q2 ; MC = .0184 Q
Set MR = MC Q = 4000; P = 76.8
Profit = 307,200 147,200 10,000 = 150,000
Profit = (P- ATC). Q
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Things Change
Demand may go down
Cost could increase
In an attempt to keep the potential
competitors out, the monopolist may lower
its price to near its average cost
Rent seeking: an attempt to maintain its
monopolistic position by influencing the
political processes-e.g., zoning laws
Closer substitutes may emerge
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ATC>MC, P>MR, P>MC, P = ATC


SMC

LATC

SATC

MC

Qe
L-R Zero Economic Profit

MR
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Arguments for Monopoly


The beneficial effects of
economies of scale, economies of scope,
and cost complementarities on price and
output may outweigh the negative effects
of market power
More Research & development and
Investment
Encourages innovation
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Why Government Dislikes Monopoly?


P > MC
Too little output, at too high a
price

Deadweight loss of
monopoly

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Monopoly Vs. Competition

Monopoly versus competition (smaller q, higher p)

Imposing a tax on a monopoly similar to competition in


that producer still bears part of it.

Price controls and monopoly ...a case where controls


may increase efficiency.

Price discrimination.

The tradeoff associated with patents and copyright deadweight loss in consumption versus possible new
products.

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Monopoly charges higher price, produces smaller quantity.


Monopoly causes Deadweight Loss 1+2. Area 3+4 is transferred to the
producer from consumers

MC
S
Pm

Pc

D
Qm

Qc

MR
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