MONOPOLY

Features of Monopoly

Single seller of an unique product No close substitutes Price Maker- firm has control over price Barriers to entry

Why monopolies arise? Barriers to entry are restrictions on the entry of new firms into an industry

Legal restrictions-licenses and patents Economies of scale Control of an essential resource- Debeers owns most of the diamond mines Natural monopolies

NATURAL MONOPOLIES

A monopoly sometimes emerges naturally when a firm experiences economies of scale as reflected by the downward-sloping, long-run average cost curve In these situations, a single firm can sometimes supply market demand at a lower average cost per unit than could two or more firms at smaller rates of output

The monopolist can choose either the price or the quantity, but choosing one determines the other Because the monopolist can select the price that maximizes profit, we say the monopolist is a price maker

More generally, any firm that has some control over what price to charge is a price maker

Competition vs monopoly:
Monopoly

Is the sole producer Faces a downward sloping demand curve Is a price maker Reduces price to increase sales

Competition

Many producers Faces a horizontal demand curve Is a price taker Sales cannot affect price

Profit maximization for a monopolist:

The demand curve for the monopolist is downward sloping The marginal revenue curve is below the demand curve The monopolist maximizes profit by producing the quantity at which marginal revenue equals marginal cost It then finds uses the demand curve to find the price at which the consumers will buy that commodity

Profit maximization

For competition, P= MR= MC For a monopolist, P>MR =MC A monopolist will make economic profit as long as price is greater than average total cost A monopolist always operates on the elastic portion of the demand curve

Profit maximising under monopoly

MC

AC

AR

AC

AR MR
O

Qm

Profit maximising under monopoly MC

Total profit

AC

AR

AC

AR MR
O

Qm

Equilibrium of industry under perfect competition and monopoly: with the same MC curve MC ( = supply under
perfect competition)

P1 P2

Comparison with Perfect competition

AR = D

MR
O
Q1 Q2

The Monopolist Minimizes Losses in the Short Run

Marginal cost

A monopolist may not always make profit

a Loss p b

Average total cost Average variable cost

e Demand = Average revenue Marginal revenue 0 Q Quantity per period

Short-Run Losses and the Shutdown Decision

A monopolist is not assured of profit

The demand for the monopolists good or service may not be great enough to generate economic profit in either the short run or the long run

In the short run, the loss-minimizing monopolist must decide whether to produce or to shut down

If the price covers average variable cost, the firm will produce If not, the firm will shut down, at least in the short run

Monopolists Supply Curve

The intersection of a monopolists marginal revenue and marginal cost curve identifies the profit maximizing quantity, but the price is found on the demand curve Thus, there is no curve that shows both price and quantity supplied there is no monopolist supply curve

Dead Weight Loss:

Since a monopolist sets its price above the marginal cost, the high price makes monopoly undesirable. The monopolist produces a level of output less than the socially efficient level output The welfare effect of a monopoly is similar to a tax, except that the government gets revenue from the tax whereas the private firm gets the monopoly profit

Dead-Weight Loss:

Price Discrimination

Price Discrimination is the business practice of selling the same good at different prices to different customers even though the cost of producing for the two customers is the same Price discrimination is of three degrees: First degree or perfect price discrimination Second degree or block pricing Third degree price discrimination

Types of price discrimination

First-degree: the firm is aware of each buyers demand curve Second-degree: the firm charges a different price, depending on the quantity each buyer purchases Third-degree: the firm breaks buyers into groups based upon their price elasticity of demand

Perfect Price Discrimination refers to the situation when the monopolist knows exactly the willingness to pay of each customer and can charge a different price for each unit sold. In reality perfect price discrimination is not possible . Block pricing refers to charging a different price for different ranges of quantity sold.

First Degree Price Discrimination (Perfect Price Discrimination)

Each consumer is charged the price he/she is willing to pay. Producer takes all the consumer surplus

1st. degree price discrimination

Price

P1

PL

Demand

Q1

Quantity

1st. degree price discrimination

Price
P1 P2 P3 P4 . .

For each consumer price charged=price willing to pay

Monopolist appropriates all consumer surplus

Demand

PL

Quantity

2nd Degree Price Discrimination

(non-linear pricing)

Different price is charged for a different quantity bought (but not across consumers). set one price for a 1st bundle, a lower price for a 2nd bundle, .... extract some, but not all of consumer surplus Note: In 3rd deg case=>different prices charged for different consumers In 2nd deg case=>different prices charged for different quantities (for same consumer)

Profit-maximising output under third degree price discrimination

MC 9 5 DY DX O 1000 O MRY 2000 O 3000 MRT

MRX

(a) Market X

(b) Market Y
fig

(c) Total (markets X + Y)

Price and output in Mkt1 & Mkt2 (Maximise Profits)

In Market1 MR1=MC In Market2 MR2=MC that is, MR1=MR2=MC set higher price and sell lower Q in Mkt1 (inelastic D)