Monopoly

Introduction
• Monopoly is a market in which a single seller
sells a product or service which has no close
substitute.
• Pure monopoly: The market where there is
absolutely no substitute. More or less this is a
hypothetical situation because every good and
service has at least some substitutes.
Natural Monopoly: when the size of the
market is so small that it can accommodate only
one player. Under this situation, only one firm
can produce the entire profit maximising output
due to the small size of the market and other
firms may not be able to survive in that market.
Features of monopoly
• Single seller: The production, distribution and
selling of the product are all controlled by the single
firm. Hence there is no competition whatsoever.
Before liberalisation, telephone, electricity, post and
telegraph, oil and gas were all govt monopolies.
• Single product
A monopoly sells a product which has either no
substitute or at least close substitute in the market.
• No difference between firm and industry: The
demand curves of the firm and industry are the
same.
• Barriers to entry: The entry of firms under
monopoly is restricted.
 Demand curve and marginal revenue curve under
monopoly:
• The demand curve under monopoly is like the normal
downward sloping demand curve. The demand curve under
monopoly is highly price inelastic because there is no
close substitute and consumers have no or very little choice.
The demand curve under monopoly is not perfectly inelastic
because pure monopoly does not exists in real life.
• The monopoly firm is able to independently determine
an optimal combination of output. It can sell more when it
reduces the price of its product.
• Since Demand curve is the same as Average revenue curve of
a firm, and the demand curve under monopoly demand curve
is like a normal demand curve, the AR curve under
monopoly is also downward sloping. The demand curve
and the average revenue curve under monopoly determines
the slope of the marginal revenue curve.
• The MR curve also slopes
downwards but lies below the AR
curve. Why?
The monopolist has to lower the price of
all units if it wants to sell an additional
unit. This addition to its revenue as a
result of selling this additional unit would
be less than the price the firm would
receive for this unit. Hence for the
monopolist ,MR is less than the price and
the MR curve would lie below AR curve.
 AR and MR curve under
monopoly Let a linear demand
function is given as
Q=a-bp and a price
function is given as p=q-
bQ where b is the slope
of the demand curve.
Given the price function,
total revenue equation
can be worked out as:
TR=Q.P=Q(a-bQ)=aQ-
bQ2
MR=dTR/dQ=a-2 bQ
The slope of MR curve is
-2b whereas the slope of
AR=-b. Thus the rate of
fall in MR is twice that
of AR

The demand curve under monopoly slopes

downwards and the MR curve lies below the AR
curve. Technically the slope of the MR curve is
twice that of AR curve.
 • Assume the demand schedule as
follows:
• Price Quantity TR MR
• 20 200
• 15 300
• 10 500
• 5 700
1. Calculate TR at each P and Q combination
2. Calculate MR for each combination
3. For change in price from 20 to 15, Is the demand elastic or
inelastic? How much revenue does the firm lose from reducing
the price on 200 units it could have sold for Rs 20? How much
revenue does the firm gain from selling 100 more units at Rs
15? Compare the two changes and compare these with MR
M
R
, 2
P 0
r
i 1
c 5
e 10
,
C
o 5 MR AR
s
t 0 20 40 800
0 0
Quantity

a. If the firm wants to sell 200 units, what price does it

charge?
b. If the firm charges Rs 15, how much will it sell?
c. What is MR for parts of b? Is the demand elastic or
inelastic?
d. If the firm charges Rs 10, how much will it sell?
What is demand elasticity?
• Short run equilibrium condition under monopoly
The condition of equilibrium is the same as in case
of PC except the demand curve under PC is
horizontal line while the same under monopoly is
downward sloping.
The monopolist will continue producing additional
units of output as long as MR exceeds MC.
Because it is profitable for the monopolist to
produce an additional unit if it adds more to
revenue than to cost.
Maximum profit of the monopolist: MR=MC
Equilibrium output is
OQ where MC=MR
and the firm earns
maximum profit. If
the production is
beyond Q, the MR is
less than MC and it
is a case of loss. It is
therefore only OQ
out put where the
monopolist is at
equilibrium and
earns maximum
profit (MR=MC).
Total area of
profit:P1PMP2. At
equilibrium under PC
Price =MC while at
this point under
monopoly Price>MC
because the
monopolist faces a
down ward sloping
 At E, MR=MC.
OdcM is the
SMC total revenue.
ATC
a b
d c Total cost:
AVC
f OabM.
g
Total cost>
total revenue.
E
Firm incurs
losses by the
area abcd.
If the monopolist
D shuts down, it
would lose its
MR
entire fixed cost.
O The shut down
M Quantity
rule under
Loss faced under monopoly in short run monopoly is the
same as it is
 Long run equilibrium condition under monopoly

Under monopoly no new firm can enter and

share the profit like PC in the short run.
In the long run the monopolist would design the
plant size to produce in such a way that the
long run marginal cost equals to the MR.
Profit in the long run :P*Q – LAC*Q=Q(P-
LAC)
New entrants can not come into the industry to
compete away the profits. In the long run the
manager will adjust plant size to the optimal
level. The optimal plant is the one where
the short run average cost curve is
tangent to the long run average cost at
the profit maximising output level.
 The profit
maximizing
output is
MR=LMC at
SMC
E. The
output is
produced at
the lowest
possible
total cost.
The total
profit is
abcd.
PRICE DISCRIMINATION UNDER MONOPOLY
Price discrimination is the practice of discriminating the buyers
on the basis of the price charged for the same good or service.
Example: different prices charged by doctors, lawyers, etc.

Determinants: The price discrimination is determined by:(i)

market imperfection, (ii) Segmentation of the market,
(iii)Different price elasticities of demand in different markets,
(iv) Purpose of use of a good/service, (v) Prejudices of the
buyers etc.

Degree of Price discrimination

A.C Pigue identified three degrees of price discrimination on
the basis of sellers estimation of consumers paying capacity
and their willingness to pay (Consumers Surplus).
(i)Price discrimination of first degree: When the seller is
able to charge different prices for different units of the same
product from the consumer. Joan Robinson referred it as
perfect price discrimination by a monopolist. The firm in
this case charges maximum price for each unit of the
product in such a way that the entire consumer surplus is
taken away by the monopolist. This is also referred to as
reservation price or take it or leave it situation. In this case
the seller will charge maximum price form the buyer to sell
the first unit and extract the consumer surplus as much as
possible. Then he will gradually lower down the prices to sell
the rest of the goods and take away the consumer surplus in
a gradual manner. This process will continue till MR=MC and
the entire consumer surplus will be taken away from the
monopolist. The market size in this case is very small.
 Price discrimination of first degree:
When the seller is able to charge
different prices for different units of
the same product from the
consumer. The firm in this case
charges maximum price of the
P
product in such a way that the entire
consumer surplus is taken away by
the monopolist. This price
p discrimination is feasible when the
r market size of the product is small
i M and the monopolist is in a position to
c know the price each consumer or each
e group of consumers is willing to pay
(buyer’s demand curve). In this case
the monopolist’s income is OPMN.
This is possible by charging a price
D=AR=MR exactly equal to the marginal utility
derived by the consumer. Hence the
O N demand or AR curve coincides with
the MR curve. Both the curves are
the same.
Quantity
(ii)Price discrimination of second degree :
When the seller charges separate prices from
different groups of consumers on the basis of their
paying capacity and discriminates on the basis of
consumer surplus. The market in this case is so
large that the monopolist can not know the demand
of each and every consumer. Division of consumers
into groups by the monopolist enables him to charge
different prices from different groups of consumers.
Highest price from the higher paying capacity group
and gradually lowers the price of the commodity for
other groups. The entire consumer surplus is not
taken away under second degree PD.
 The seller charges the
prices in such a way that
he allows every group
to avail some consumer
E0 surplus and still
E1 maximises the total
P1 income.

E2 In the fig, when the

P2 A1 quantity sold is OQ1, the
Price consumer surplus is
E3 E0P1E1, at OQ2, the
P3
A2 consumer surplus is
E1A1E2 and at OQ3 the
consumer surplus is
E2A2E3. In case the firm
D=AR=MR charges uniform price
O the income of the firm is
Q1 Q2 Q3 either OP1E1Q1 or
OP2E2Q2 or OP3E3Q3.
Because he has charged
Quantity
different prices to
different groups he has
maximsed his total
Price discrimination of Third degree
When the price is charged as per different
price elasticity of demand of different
groups, it is referred to as third degree
price discrimination. Thus the seller
charges higher price to the buyers with
less elastic demand and lower price to
those with highly elastic demand and
maximises its revenue. The graph is
shown below:
 If the product is
sold at a higher
price at home
and lower price
P1 E1 abroad. Price
charged for
Price E2
P2
A1 electricity for
domstic use
and industrial
use etc.
D
O
Q1 Q2
Quantity
Price and output determination under
discriminating monopoly
Condition of equilibrium: MC=MR
The monopolist will: (i)Charge lower price and supply more in
the market with high price elasticity, (ii)Charge higher prices
and supply less in the market with low price elasticity. The
total profit is OPEQ. Discrimination profit is OP1QE+OP2E2Q2
which is much higher than OPEQ.
Market: A+B Market- A Market-B

MC
E2
P2

E E1
P P1

AR
MR AR MR
MR AR

O Q O
Q1 O Q2

Quantity
The demand equation of a local theatre for balcony and
dress circle are given respectively as; Qb= 60-2Pb and Qdc
=56-Pdc. The total cost of running the show by multiplex is
TC=40+20Q.
a.What would be the price of tickets with discrimination?
b.What would be the price if the multiplex decides to charge
the same price across both types of seats?
Answer: With discrimination: Priceb =Rs 25, Pdc=Rs 38
Without discrimination: pricedc = Rs 26.9