MONOPOLY

UNIT 2
 Features/Characteristics:
 Single seller and several buyers
 The primary feature of a monopoly is a single seller and several buyers. Also, in a monopoly,
there is no difference between the firm and the industry.
 This is because there is only one producer and/or seller. Therefore, the firm’s demand curve
is the industry’s demand curve. Since there are several buyers, an individual buyer cannot
affect the price in a monopoly market.
 No close substitute
 In a monopoly, the product that the monopolist produces has no close substitute. If a close
substitute exists, then the monopoly cannot exist. Therefore, the monopolist can determine
the price of his own choice and refuse to sell below the determined price.
 Strong barriers to the entry of new firms
 Even if the monopolist firm is earning super-normal profits, new firms
face many hurdles in trying to enter the industry. There are many
reasons for this like legal barriers, technology, or a naturally occurring
substance which others cannot find. Sometimes, the monopolist works
in a small market making it economically challenging for new firms to
enter.
 Revenue curves under a Monopoly
 A monopolistic firm is a price-maker, not a price-taker. Therefore, a
monopolist can increase or decrease the price. Also, when the price
changes, the average revenue, and marginal revenue changes too.
 Price Maker:
 Under monopoly, monopolist has full control over the supply of the
commodity. But due to large number of buyers, demand of any one
buyer constitutes an infinitely small part of the total demand.
Therefore, buyers have to pay the price fixed by the monopolist.
 Monopoly is also an Industry:
 Under monopoly there is only one firm which constitutes the industry.
Difference between firm and industry comes to an end.
Nature of Demand and Revenue
under Monopoly:

 Under monopoly, it becomes essential to understand the nature of

demand curve facing a monopolist.
 In a monopoly situation, there is no difference between firm and
industry. Therefore, under monopoly, firm’s demand curve constitutes
the industry’s demand curve.
 Since the demand curve of the consumer slopes downward from left to
right, the monopolist faces a downward sloping demand curve. It
means, if the monopolist reduces the price of the product, demand of
that product will increase and vice- versa. (Fig. 1).
In Fig. 1,
 AR curve of the monopolist slopes
downward from left to right.
 MR curve also falls and slopes
downward from left to right.

 MR curve is below AR curve

showing that at OQ output, AR(=
Price) is PQ where as MR is MQ.
 That way AR > MR or PQ > MQ.
 Conditions for Price and Output
Determination Under Monopoly and
Equilibrium
 To maximize profits, firms must operate at a maximum output level at which margin revenue
and marginal cost are equal. Price makers are firms in monopoly, and setting market prices
influence the production decisions of the companies.
 The following are the two conditions for price and output determination under monopoly and
achieve the equilibrium of a monopoly market which form the basis of price-output decision-
making:
 MC=MR
 The MC curve must cut the MR curve from below.
 Price and Output Determination
Under Monopoly During Short-Run

1. SUPERNORMAL PROFIT:
A firm earns super-normal profits when the average cost of
production is less than the average revenue for the
corresponding output.
AR>AC

In the figure above, you can see that the price per unit =
OP = QA. The firm is selling OQ output at QA price.
the cost per unit = OP’
Therefore, the firm is earning more revenue and
incurring a lesser cost.
In this case, the per unit profit is
OP – OP’ = PP’ o
Hence, the total profit earned by the monopolist is PP’BA.
 2. NORMAL PROFIT:
A firm will earn normal profit when the average cost of Production
is equal to the average revenue.
AC=AR
in the fig, the price per unit is OP = QA. The firm is selling OQ
output at QA price.
However, the cost per unit is also OP=QA
Therefore, the revenue of the firm is equal to its cost of
production.
In the fig, o

Average revenue(QA) = Average Cost(QA)

Total Revenue (OPAQ) = Total Cost (OPAQ)
Therefore, no profit no loss.
 3. LOSS/ABNORMAL LOSS:
 A firm earns losses when the average cost of
production is higher than the average revenue for
the corresponding output.
 AC> AR
 In the figure above, you can see that the average
cost curve lies above the average revenue curve
for the same quantity.
 The average revenue = OP and the average
cost = OP’.
 Therefore, the firm is incurring an average
loss of PP’ and the total loss is PP’BA.
 Summary of Short-run Equilibrium in
Monopoly
 In the short-run, a monopolist firm cannot vary all its
factors of production as its cost curves are similar to
a firm operating in perfect competition. Also, in the
short-run, a monopolist might incur losses but will
shut down only if the losses exceed its fixed costs.
Further, if the demand for his product is high, then
the monopolist can also make super-normal profits.
 Long Run Equilibrium of
Monopoly:
 Under monopoly, barriers to entry allow profits to remain
supernormal in the long run.
 Therefore, in the long-run, a monopoly firm will
maximize profit by producing when Marginal Revenue
(MR) is equal to Long-run Marginal Cost (LMC), as
long as price (P) is greater than or equal to Long-run
Average Cost (LAC).
 It also follows that the monopoly firm is not forced to
operate at the minimum point on the LAC curve, hence,
long-run prices will tend to be higher and output lower,
under monopoly than under perfect competition.
 the monopoly firm`s supernormal profit is
represented by the rectangle P1ABC, while the price
charged and the profit-maximizing output is given as P1
and Q1 respectively.
 Social Cost of Monopoly:

 An important difference between monopoly and perfect competition is that under

per­fect competition allocation of resources is optimum and therefore
social welfare is maximum, under monopoly resources are misallocated
causing loss of social welfare.
 A monopolist restricts output and charges a price higher than what a firm would be
able to charge under perfect competition. This output restriction leads to loss
of consumers’ surplus and producers’ surplus.
 The two losses together constitute welfare cost or social cost of
monopoly.
 Since Monopolists sell their products at a higher price, the monopolist gains at the
expense of consum­ers because they have to pay a price higher than marginal cost
of production. This results in loss of consumers’ welfare.
 To measure welfare gain or loss some economists have used the concept of consumer’s surplus.
 Consumer’s surplus, is the surplus of price which consumers are prepared to pay for a commodity
over and above what they actually pay for it.
 Producer surplus is the difference between how much a person would be willing to accept for a given
quantity of a good versus how much they can receive by selling the good at the market price.
 When monopolists charge a higher price, there is a redistribution of income from consumers to the
monopolist, but the loss of consumer surplus is greater than the profits made by the monopolist
 The loss in consumer surplus can be divided into two components.
 First part is the profits made by the monopolist at the expense of the consumers. This component of
loss in consumer surplus is suffered by those who are still purchasing the product.
 The second component of the loss of consumer surplus is the allocative ineffi­ciency caused by the
monopolist by reducing output of the product and raising its price. This second component of loss in
consumer surplus is called dead-weight loss of welfare caused by the monopolist.
 This is called a dead weight loss of welfare because though
consumers suffer a loss of welfare, no one else, not even
monopolist, gains from it.
 This is loss of welfare caused by allocative inefficiency of the monopoly.
 To conclude, mo­nopoly causes misallocation of resources and dead-
weight loss of welfare. This is also called social cost of monopoly.
 Price Discrimination Under Monopoly

 A monopoly firm can charge different prices from different buyers for its product.
This act selling the same product at different prices to other buyers is known as price
discrimination, and it differentiates the pricing under monopoly.
 A monopoly that pursues the policy of price discrimination is called a discriminating monopoly.
 Pricing under monopoly is different prices from different individuals in the same market or can
charge different prices in other markets. Also, it can charge different fees based on the use of
goods.
 Accordingly, there may be different types of price discrimination such as personal price
discrimination, geographical price discrimination. Price discrimination based on time and price
discrimination which differentiate pricing under monopoly firm.
 Degrees Of Price Discrimination In
Pricing Under Monopoly
 Price Discrimination Of First Degree
 First-degree price discrimination is where a business charges each customer the maximum they are
willing to pay, the monopoly firm may differentiate every consumer in the market in terms of price.
Pricing under monopoly may charge one price from one consumer and another price from others. It
can also set the maximum price for a consumer if the consumer is willing to pay. Thus, in the case
of the first degree of price discrimination, the consumer surplus is zero.
 Price Discrimination Of Second Degree
 When a monopoly is able to sell different units of a commodity at different prices to other buyers, it
is a case of second-degree price discrimination. Electricity tariff in India is a classic example of
second-degree price discrimination.
 Price Discrimination Of Third Degree
 In the case of third-degree pricing under monopoly, the firm divides the market into different sub-
markets and charges different price into other submarkets. However, the submarket where the
monopolist will charge more, the submarket where it will charge less depends on the price elasticity
of demand for the commodity produced by it in different sub-market.
 Intertemporal Price Discrimination

 The objective of intertemporal price discrimination is to divide consumers into high-demand and low-
demand groups by charging a price that is high at first but falls later.
 think about how an electronics company might price new, technologically advanced equipment, such as
high- performance digital cameras or LCD television monitors, there is a small group of consumers who
value the product highly and do not want to wait to buy it (e.g., photography buffs who want the latest
camera). Whereas there is a broader group of consumers who are more willing to forgo the product if
the price is too high. The strategy, then, is to offer the product initially at the high price, selling mostly
to consumers of first group. Later, after this first group of consumers has bought the product, the price
is lowered, and sales are made to the larger group of consumers.
 There are other examples of intertemporal price discrimination. One involves publish- ers, charging a
high price for the hardcover edition of a book and then release the paperback version at a much lower
price about a year later.
 Many people the paperback version is sold for much less not because it is much cheaper to print but
because high-demand consumers have already purchased the hardbound edition. The remaining
consumers— paperback buyers—generally have more elastic demands.
Peak–Load Pricing

 Peak-load pricing also involves charging different prices at different

points in time. Rather than capturing consumer surplus, however, the
objective is to increase eco- nomic efficiency by charging consumers
prices that are close to marginal cost.
 For some goods and services, demand peaks at particular times—for
roads and tunnels during commuter rush hours, for electricity during
late summer afternoons, and for ski resorts and amusement parks on
weekends. Marginal cost is also high during these peak periods because
of capacity constraints. Prices should thus be higher during peak
periods.
 Price Output Determination under
Price Discrimination:
 When a firm charges different prices to different customers for the same commodity, it is
engaged in Price Discrimination.
 So suppose a discriminating monopolist sells his output in two markets, Market A and Market B.
Market A has less elastic demand and Market B has more elastic demand. Suppose the
monopolist has only one production facility, then he is faced with the questions
 How much to produce?
 How much to sell in each market?
 How much price to charge in each market?
 The monopolist will first decide profitable level of total output (ie where MR=MC) and then
allocate the qty between the two markets.
 The condition for equilibrium would be:
 1. MC = MRa = MRb. It means that MC must be equal to MR in
individual markets separately.
 2. MC = AMR (aggregate marginal revenue) It means that the
monopolist must be in equilibrium not only in individual markets but
also when the two markets are treated as one.
 The process of
price
determination
under price
discrimination
as shown in the
following figure:

a b
 In the fig MC curve intersects the AMR curve at pt. E
 Pt E shows the total output is OQ
 When a perpendicular EH is drawn it intersects MRa at E1 and MRb at
E2. these are the equilibrium pt of market A and B.
 Pt E1 shows that qty sold in market A is OQ1 and price is OP1
 Pt E2 shows that qty sold in market B is OQ2 and price is OP2
 Price charged in market is higher than that in market B
 Thus a discriminating monopolist charges a higher price in the market A
having less elastic demand and a lower price in the market B having
more elastic demand.
 The marginal revenue is different in different markets.