Topic 5
Market Structure (Part 2)
Monopoly
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Learning Objectives
5.1 Monopoly
a) Characteristics
b) Price and output decisions
c) Short run and long run profit maximization
d) Shut down, continue and exit decisions
e) Price Discrimination
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5.1 Monopoly
a) Characteristics
1. One seller
2. Price maker
3. Product has no close substitutes / unique
4. High barriers to entry (blocked)
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Barriers to Entry
1. Legal Barriers
• The government undertakes rules and
regulations to restrict competition in certain
industries in the form of:
a. franchising
b. licensing
c. patents and copyrights
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Barriers to Entry
2. Economies of Scale
• Economies of scale can be a barrier because the
existing large producers are able to produce
goods at a lower average cost compared to those
new firms just starting up in the industry.
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Barriers to Entry
3. Control of Important Inputs
• A monopoly can exist because the firm has
managed to control/owns an essential resources.
• Example:
DeBeers Company, a company in South Africa
controls more than 80% of the world’s production
of raw diamonds.
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Examples of Monopoly Firm in Malaysia
b) Price and Output Decisions
Price decision
• Price is set at the firm can charge for the profit maximizing
quantity.
• The price is determined from the demand curve of the
firm’s product.
• The demand curve for a monopolist is downward sloping
and inelastic.
Profit maximizing output decision
• Firms should produce output when:
MC = MR
• When MC = MR:
firm maximize profit
firm minimize cost 8
Revenues for a Monopoly Firm
Quantity Price Total Revenue Marginal Revenue Average Revenue
(Q) (P) (TR = P × Q) (MR = ∆TR / ∆Q) (AR = TR / Q)
0 6 0 - -
1 5 5 5 5
2 4 8 3 4
3 3 9 1 3
4 2 8 -1 2
5 1 5 -3 1
From the table above, we can see that:
D = P = AR
P > MR
c) Short Run and Long Run Profit Maximization
(i) Short Run Profit Maximization
• All firm’s objective is to maximize profits.
• There are 3 types of possibilities a monopoly firm can
faced in short run:
1. Economic profit (P > ATC)
2. Economic loss (P < ATC)
3. Zero economic profit (P = ATC)
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Losses for the Monopolist
• Being a sole supplier does not guarantee that consumers
will demand your product.
• A monopolist will incur a loss if there is insufficient
demand to cover average total costs at any price and
output combination along the demand curve.
A Monopolist’s Zero Economic Profit
(ii) Long Run Profit Maximization
• In long run, monopoly firm will only earn economic profit.
• This is due to the effect of high barriers to entry (blocked).
Other firms cannot enter, so economic profit can persist in
the long run.
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d) Continue, Shut Down and Exit Decisions
• A firm generating economic losses in short run faced a tough
choice.
• There are 2 possibilities for a firm:
1. whether to continue to produced
OR
2. whether to shut down its operation
• To make this decision, the firm needs to consider the
Average Variable Cost (AVC).
• If:
1. P > min AVC : Continue the operation
2. P = min AVC : Continue the operation
3. P < min AVC : Shut down the operation 18
e) Price Discrimination
Definition:
Sometimes sellers will charge different customers
with different prices for the same good or service
when the cost of providing that good or service
does not differ among customers.
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Conditions for Price Discrimination
In order to price discriminate, a monopoly must be able to
have:
1. Monopoly power
• Price discrimination is possible only with monopoly or
where members of a small group of firms follow
identical pricing policies.
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2. Market segregation
• Price discrimination can only occur if the demand
curve for markets, groups or individuals are
different.
• If the demand curves are not different, a profit
maximizing monopolist would charge the same price
in both markets.
• In short, price discrimination requires the ability to
separate customers according to their willingness to
pay.
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3. No resale
• For price discrimination to work, the purchaser buying
the product at a discount must have difficulty or too
costly in reselling the product to customers being
charged more.
• Otherwise, consumers would buy extra product at
the discounted price and sell it at a profit to others,
reducing the number of customers paying the higher
price.
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Reference
Tucker, I.B.(2017).
Economics for today’s world.
(9th ed.). Mason (OH):
Thomson South Western.
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