ECONOMICS FOR MANAGERS

PSG INSTITUTE OF MANAGEMENT MBA 2011-13 BATCH I TRIMESTER

S E S S I O N X I I - F O R B AT C H C A N D D M A R K E T S A N D C O M P E T I T I O N - M O N O P O LY
EMF Faculty P.Uday Shankar

19/09/11

What is Monopoly ?
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Monopoly exists when a firm produces a

good or service for which there are no close substitutes and other firms are prevented by some type of entry barrier from entering the market. (Thomas & Maurice)
Baumol and Blinder attribute only one firm can be

present in the industry and no close substitutes for the monopolists product may exist to what is called as Pure Monopoly. ( For instance, a citys sole provider of cooking gas cannot be called a pure monopoly as there are other firms providing close substitutes like kerosene, fire wood and electricity.)
EMF Faculty P.Uday Shankar

19/09/11

Monopoly- Characteristics
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1. Single seller in the market. 2. No close substitutes. 3. No entry for new firms. 4. One firm industry- monopoly industry is

essentially one-firm industry. This signifies that under monopoly there is no difference between a firm and an industry.

EMF Faculty P.Uday Shankar

19/09/11

Monopoly- Characteristics
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5) Profit in the Long Run: A monopolist can earn

abnormal profit even in the long run because he has no fear of a competitive seller. In other words, if a monopolist gets abnormal profits in the long run, he cannot be dislodged from this position. However, this is not possible under perfect competition. If abnormal profits are available to a competitive firm, other firms will enter the competition with the result abnormal profits will be eliminated.

EMF Faculty P.Uday Shankar

19/09/11

Monopoly- Characteristics
6) Losses in the Short Period: Generally, a common man thinks that a monopoly firm cannot incur loss because it can fix any price it wants. However, this understanding is not correct. A monopoly firm can sustain losses equal to fixed cost in the short period. Therefore, anybody who would like to buy that commodity will buy it from the monopolist only. However, if a firm has monopoly of such a commodity which people buy less or do not buy, it can incur losses or it may have to stop production even. For example, if someone has the monopoly of yellow hair dye, it is natural that the firm has the possibility of incurring losses because it is a product which people generally don't buy.
EMF Faculty P.Uday Shankar

19/09/11

Monopoly- Characteristics
7) Nature of Demand Curve: Under monopoly the demand for the commodity of the firm is less than being perfectly elastic and, therefore, it slopes downwards to the right. The main reason of the demand curve sloping downwards to the right is the complete control of the monopolist on the supply of the commodity. 8) Price-discrimination: From the point of view of profit a monopolist can change different prices from different consumers of his commodity. This policy is known as price discrimination. He adopts the policy of price discrimination on various bases such as charging different prices from different consumers or fixing different prices at different places etc.
EMF Faculty P.Uday Shankar

19/09/11

Monopoly- Characteristics
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8) Firm is a Price-Maker 9) Price-discrimination: From the point of

view of profit a monopolist can change different prices from different consumers of his commodity. This policy is known as price discrimination. He adopts the policy of price discrimination on various bases such as charging different prices from different consumers or fixing different prices at different places etc.
EMF Faculty P.Uday Shankar

19/09/11

Monopoly- Characteristics
10) Increased Scope for Mergers: In a monopoly, due to the dictates of a single entity, scope for vertical and/or horizontal mergers increase. The mergers take on coercive form to effectively blot out competitors and carry on supply chain management. 11) Lack of Innovation: On account of absolute market control, monopolies display a tendency to lose efficiency over a period of time. 12) Legal Restrictions: Some entities like for eg. the government run postal department has a restriction on anyone doing the same business. 13) Control over a Scarce Resource: A monopolist can have an absolute control of a raw material. The South African Syndicate is an example close to this case.
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EMF Faculty P.Uday Shankar

19/09/11

Schedule for profit maximisation under Monopoly (T&M Part IVTable 12.1.)
Output (Q) Price (P) Total Revenue (TR=PQ) 0 35000 65000 84000 100000 107500 Total Cost (TC) 40000 42000 43500 45500 48500 52500 Marginal Revenue MR=TR Q 35.00 30.00 19.00 16.00 7.50 Marginal Cost MC=TC Q 2.00 1.50 2.00 3.00 4.00 Profit

0 1000 2000 3000 4000 5000

40.00 35.00 32.50 28.00 25.00 21.50

-40000 -7000 21500 38500 51500 55000

6000
7000

18.92
17.00

113520
119000

57500
63750

6.02
5.48

5.00
6.25

56020
55250

8000
9000

15.35
14.00

122800
126000

73750
86250

3.80
3.20

10.00
12.50

49050
39750
19/09/11

EMF Faculty P.Uday Shankar

Monopoly
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Draw a graph using the schedule given above and

plot all the three curves viz. Average Revenue-AR, Marginal Revenue MR, Short-run Marginal CostSMC in the same graph.

Assumptions: The monopolist maximises profit at MR=MC. Patents, economies of scale, or resource ownership secure the monopolist's status. No unit of government regulates the firm. The firm is a single-price monopolist; it charges the same price for all units of output.
EMF Faculty P.Uday Shankar

19/09/11

Monopoly- Profit
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EMF Faculty P.Uday Shankar

19/09/11

Monopoly- Demand Curve

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The three implications of the downward-sloping demand curve are:

Marginal revenue is less than price:

The monopolist's downward sloping demand curve means that it can increase sales only by charging a lower price. MR is less than price for every level of output except the first This is because the lower price applies not only to the extra unit sold but also to all prior units of output. Thus, the MR decreases because the monopoly has sacrificed this price for greater output.
19/09/11

EMF Faculty P.Uday Shankar

Monopoly and price setting power

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To say that "monopolies can charge any

price they like is wrong.

It is true that a firm with monopoly

has price-setting power and will look to earn high levels of profit. However the firm is constrained by the position of its demand curve. Ultimately a monopoly cannot charge a price that the consumers in the market will not bear.
EMF Faculty P.Uday Shankar

19/09/11

Monopolists Demand Curve

A pure monopolist is the sole supplier in an industry
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and, as a result, the monopolist can take the market demand curve as its own demand curve. A monopolist therefore faces a downward sloping AR curve with a MR curve with twice the gradient of AR. The firm is a price maker and has some power over the setting of price or output. The profit-maximising output can be sold at price P1 above the average cost AC at output Q1. The firm is making abnormal "monopoly" profits (or economic profits) shown by the yellow shaded area. The area beneath ATC1 shows the total cost of producing output Qm. Total costs equals average total cost multiplied by the output.
EMF Faculty P.Uday Shankar

19/09/11

Monopoly- Shift in Demand

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EMF Faculty P.Uday Shankar

19/09/11

Monopoly- Shift in Demand

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Total monopoly profits have increased. The gain in

profits compared to the original price and output is shown by the light blue shaded area. A change in demand will cause a change in price, output and profits. In the graph above, there is an increase in the market demand for the monopoly supplier. The demand curve shifts out from AR1 to AR2 causing a parallel outward shift in the monopolist's marginal revenue curve (MR1 shifts to MR2). We assume that the firm continues to operate with the same cost curves. At the new profit maximising equilibrium the firm increases production and raises price.
EMF Faculty P.Uday Shankar

19/09/11

Monopoly- Reduction in Demand

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Not all monopolies are guaranteed profits - there can be occasions when the costs of production are greater than the average revenue a monopolist can charge for their products. This might occur for example when there is a sharp fall in market demand (leading to an inward shift in the average revenue curve). In the diagram below notice that ATC lies AR across the entire range of output. The monopolist will still choose an output where MR=MC for this reduces their losses to the minimum amount.
EMF Faculty P.Uday Shankar

19/09/11

Monopoly- Reduction in Demand

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EMF Faculty P.Uday Shankar

19/09/11

Monopoly- Economic case against monopoly

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The usual textbook argument against monopoly power in

markets is that existing monopolists can continue to earn abnormal (supernormal) profits at the expense of economic efficiency and the welfare of consumers and society.
The standard case against monopoly is that the monopoly price

is higher than both marginal and average costs leading to a loss of allocative efficiency and a failure of the market mechanism. The monopolist is extracting a price from consumers that is above the cost of resources used in making the product and, consumers needs and wants are not being satisfied, as the product is being under-consumed.
EMF Faculty P.Uday Shankar

19/09/11

Monopoly- Economic case against monopoly

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The higher average cost of production if there are

inefficiencies in production also means that the firm is not making optimum use of its scarce resources. Under these conditions, there may be an economic case for some form of government intervention to limit or reduce the scale of monopoly power, for example through the rigorous application of competition policy or by a process of market deregulation (liberalisation). X inefficiency is a term first coined by Harvey Libenstein. The lack of real competition may give a monopolist less of an incentive to invest in new ideas or consider consumer welfare. It can also be argued that even if the monopolist benefits from economies of scale, they will have little incentive to control production costs and 'X' inefficiencies will mean that there will be no real cost savings.
EMF Faculty P.Uday Shankar

19/09/11

Monopoly- Profit in the long run

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The monopolist creates barriers of entry for the new

firms into the industry. The entry into the industry is blocked by having control over the raw materials needed for the production of goods or he may hold full rights to the production of a certain good (patent) or the market of the good may be limited. If new firms try to enter in the field, it lowers the price of the good to such on extent that it becomes unprofitable for new firms to continue production etc.
EMF Faculty P.Uday Shankar

19/09/11

Monopoly- Profit in the long run

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When there is no threat of the entry of new firms into the

industry, the monopoly firm makes long run adjustments in the scale of plant. In case, the demand for the product is limited, the monopolist can afford to produce output at sub optimum scale. If the market size is large and permits to expand output, then the monopolist would build an optimum scale of plant and would produce goods at the minimum cost per unit. However, the monopolist would not stay in the business, if he makes losses in the long period. The long run equilibrium of a monopoly firm is now explained with the help of the following diagram.

EMF Faculty P.Uday Shankar

19/09/11

Monopoly- Profit in the long run

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EMF Faculty P.Uday Shankar

19/09/11

Monopoly- Profit in the long run

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In the long run, all the factors of production

including the size of the plant are variable. A monopoly firm will maximize profit at that level of output for which long run marginal cost (MC) is equal to marginal revenue (MR) and the LMC curve intersects the MR curve from below. In the figure above, the monopoly firm is in equilibrium at point E where LMC = MR and LMC cuts MR curve from below. QP is the equilibrium price and OQ is the equilibrium output.
EMF Faculty P.Uday Shankar

19/09/11

Monopoly- Profit in the long run

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At OQ level of output, the cost per unit is QH (LAC),

whereas the price per unit of the good is QP. HP represents the per unit super normal profit. The total super normal profit is equal to KPHN. It may here be noted that at the equilibrium output OQ, the plant is not being fully utilized. The long run average cost (LAC) is not minimum at this level of output OQ. The firm will build an optimum scale of plant only if the demand for the product increases.

EMF Faculty P.Uday Shankar

19/09/11

Monopoly- Profit in the long run

Threat of Entry of New Firms:
If there is a threat of entry of new firms into the market, the monopolist adopts price reduction strategy. He instead of charging QP price per unit, lowers the price to BR. Since the per unit price BR is equal to the cost per unit at R, the monopoly firm is earning only normal profit in the long run. The reduction in price and so in profits is adopted to prevent the entry of new firms in the market.
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Summing up: If a monopoly firm is in a position to

maintain its monopoly status, it can earn super normal profit in the long period. However, if there is an effective threat of the entry of potential firms in, the industry, then the firm can earn just normal profit by reducing the price. The reduction in price depends on how strong is the threat of potential entry into the industry.
EMF Faculty P.Uday Shankar

19/09/11

Thanks
27 Courtesy: tutor2u Economicsconcepts.com Welkerswikinomics

EMF Faculty P.Uday Shankar

19/09/11