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Monopoly
1
Lecture plan
• Objectives
• Introduction
• Features
• Types of Monopoly
• Demand and MR Curve
• Price and Output Decisions in Short Run
• Price and Output Decisions in Long Run
• Supply Curve of Monopolist
• Multiplant Monopolist
• Price Discrimination
• Price and Output Decisions of Discriminating
Monopolist
• Economic Inefficiency of Monopolist
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Objectives
3
Introduction
PE B PE C
E
E AR
A MR
M
R
O R O QE Quant
QE Quan
tity ity
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Supply Curve of Monopoly Firm
A monopolist is a price maker
The firm itself sets the price of the product it sells,
instead of taking the price as given.
It equates MC with MR for profit maximization,
but unlike perfect competition, it does not
equate its price to MR.
Supply of the good by the monopolist at a given
price would be determined by both the market
demand and the MC curve.
As such, there is no defined supply curve for a
monopolist.
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Multi Plant Monopoly
A monopolist may produce a homogeneous product in different
plants.
different cost functions but the same demand function for the entire
market.
hence the same AR and MR curves for the entire market.
A multi plant monopolist has to take two decisions:
how much to produce and what price to sell at, so as to maximize its profit
how to allocate the profit maximizing output between the plants.
Assuming that a monopoly firm produces in two plants, A and B.
Profit maximising output will be at MR= MCA= MCB
If MCA< MCB, it would increase production in A, (lower MC) and
reduce production in B (higher MC), till the equality is satisfied.
The firm produces till MCA and MCB are individually equal to MR, which
is same for both plants.
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Multi Plant Monopoly
Price, M
Reven MC ACA MC
ue, C A AC
Cost C A B
B B1 B2 B
P R P=
E
R R E E2 AR
2
1 1 MC=
AR MR
MR
O Quan
Q QA QB
tity
OQ is the profit maximizing output satisfying MR=MC, when MC is
rising. QA+QB= OQ, i.e. total output
Price is shown by PP, which determines AR in both the plants.
OP is the equilibrium price and RPBE is the total profit (TR-TC) of the
firm (Panel a).
Panel b shows the cost function of plant A, in which MC is lesser.
Panel c shows the cost function of plant B in which MC is greater.
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Price Discrimination
Discrimination among buyers on the basis of the price charged for
the same good (or service).
Objective is to maximise sales
Preconditions of Price Discrimination
Market control
Market imperfection and control are necessary
Monopoly is the most suitable market condition, because it is a
price maker.
Division of market
when the whole market can be divided into various segments,
and transfer of goods between the markets is not possible
Different price elasticities of demand in different markets
Separation of market is a necessary condition for price
discrimination, but the sufficient condition is that price elasticities
of demand should be different in these market segments
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Bases of Price Discrimination
Personal
On basis of the paying capacity and/or the intensity of needs.
Since this discrimination is being done on a personal basis, the
good (or service) is non transferable.
Geographical
People living in different areas are required to pay different
prices for the same product.
E.g. edible oils and many packaged food items are sold at different
prices in different States of India.
Time
The same person may be required to pay different prices for the
same product.
E.g. off season discounts.
Purpose of use
Customers are segregated on basis of their purpose of use.
E.g. electricity rates are lower for domestic purpose and higher for
industrial purpose.
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Degrees of Price Discrimination
D
D=MR D
O O O
Q Quantity Q1 Q2 Q3 Q1 Q
Price, Firm
Cost,
Revenu M Market 1 Market 2
e C
P2 E2
E P E1
P
1
MC=MR1
M AR AR=MR2
M A R1 MR
1
R
O Q
R
Quantity
O O 2
2
Q1 Q2
In the market M1 the optimum output is OQ1 and in the market M2 the
optimum output is OQ2. (OQ1> OQ2 and OP1< OP2)
Price discrimination leads to greater profits.
Without price discrimination, for output OQ, the firm would earn the area
OPEQ, which is less than the area given by OP1E1Q1+OP2E2Q2.
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Economic Inefficiency of Monopoly
A monopoly firm operates at less than optimum output and charges
a higher price.
Monopoly does not allow optimum use of all the factors of
production, thereby allowing loss of output and creating excess
capacity in the economy
Considered as a loss of social welfare, hence authorities make
regulations to check and prevent monopoly practices.
Also termed as deadweight loss to the economy, since this increase
in output is actually possible under perfect competition.
Compare two firms, one under perfect competition, and the other
under monopoly to explain the condition; assuming that both the
firms earn normal profits.
The firm under perfect competition faces a horizontal demand curve
(DC), whereas the monopoly firm faces a downward sloping curve DM,
which is less elastic.
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Economic Inefficiency of Monopoly
The monopolist produces an output QM(<QC), and sells at price PM(>PC)
OQC-OQM (i.e. QMQC), is regarded as excess capacity (Fig 1).
Perfectly competitive firm allows maximum consumer surplus (PCDB);
Monopoly takes away PCPMAE from consumers to the firm. (Fig 2).
AEB is neither part of firm’s income nor of consumer surplus; hence is the
deadweight loss or economic inefficiency due to monopoly.
Price, LAC
Reve D
nue,
Cost
EM P A
P
EC
P
MC D
M
E B
PC MC=AC=MR
P=ARP
C
AR
DM
MR M
O O
Q Q Quan QM Q Quan
tity tity
Fig 1: Excess
M CCapacity Fig 2:
M
Deadweight
C
Loss 21
Summary
A monopoly is that form of market in which a single seller sells a product (or
service) which has no substitute.
Pure monopoly is where there is absolutely no substitute of the product, and
the entire market is under control of a single firm.
A monopoly has a single seller, sells a single product (pure monopoly) and
decides on its own price and output, based on individual demand and cost
conditions and is hence regarded as a price maker.
In monopoly the firm and the industry are one and the same.
Barriers to entry are the major sources (or reasons) of monopoly power and
may include restriction by law, control over key raw materials, specialized
know how restricted through patents or licences, small market and
economies of scale.
A monopoly firm has a normal demand curve with a negative slope. The
demand curve is highly price inelastic because there is no close substitute.
A monopolist firm may earn supernormal profit, or normal profit, or may even
incur loss in the short run, but would not incur loss in the long run.
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Summary
The monopolist being a price maker does not have any supply curve.
A multi plant monopolist decides on how much to produce and what price to
sell at so as to maximize its profit on the basis of the principle of
marginalism.
When a seller discriminates among buyers on basis of the price charged for
the same good (or service), such a practice is called price discrimination.
Price discrimination can be done on personal basis (demographical, paying
capacity or need), on the basis of geography, on the basis of time or
purpose of use.
The discriminating firm will charge a higher price and supply less to the
market having higher price elasticity and a lower price and supply more in
the market having lower price elasticity.
Monopoly runs at less than optimum level of output and generates excess
capacity in the economic system, which in turn results in deadweight loss
that adds neither to consumer surplus, nor to seller’s profit.
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