Monopoly

Dr. Kishor Bhanushali

Faculty – Economics
IBS-Ahmedabad
 Monopoly is a market structure in which there is
a single seller, there are no close substitutes for
the commodity it produces and there are barriers
to entry
The distinction between the firm and industry
disappear under conditions of monopoly
The cross elasticity of demand between the
product of the monopolists and the products of
other producers must be very low
Main causes that lead to monopoly
- Ownership of strategic raw materials or exclusive
knowledge of production techniques
- Patent rights for the product or production
process
- Government licensing
- Size of the market
- Pricing policy of existing firms
 Average and Marginal Revenue
P = a – bQ
R = aQ – bQ2
P
MR = ∂R
---
∂Q
AR = a – 2bQ
& Slope of the demand curve
MR is –b and that of MR curve
is -2b

AR (D)
MR

Quantity
0
The slope of MR Curve is double the slope
of demand curve
 Price Output Determination under Monopoly
Y

MC
AC
Price output analysis in the
P P’ case of monopoly is also an
Revenue
Profit analysis of the equilibrium
& Cost
of the firm and industry
T L under monopoly

E
AR
MR

Output
0 M
Few Properties of Equilibrium under Monopoly
1. Like a perfectly competitive firms operating in the short
run, the monopolists either earn excess profit or incurs
losses or only normal profit.
2. The monopolist can also produced at the minimum points
if the AC curve, though he will not earn normal profit at
that point. He will earn more than normal profit
3. Like perfect competition, monopolists can earn even
negative profits. In the long run monopolists will either
earn normal profits or more than normal profits. But a
perfectly competitive firm in the long run earns only
normal profits and neither more nor less
4. Under prefect competition, price = MR = MC, while under
monopoly MR=MC. Under monopoly, price>MR. hence
under monopoly, price >MC
5. If the MC curve is a horizontal straight line, equilibrium of
the firm under perfect competition remains indeterminate.
However this is not the case under monopoly. Even if the
MC curve is horizontal, the equilibrium level of output is
determined
6. Monopolist does not operate on that portion of the demand
curve which is inelastic i.e. where the elasticity of demand
is less than unity
 Price Discrimination
When a monopolists charges different prices form
different buyers for the same good, he is known as a
discriminating monopolist
Price discrimination is not possible under perfect
competition because every one knows the price at
which the good is being bought and sold
Two conditions must be fulfilled for price
discrimination to be possible (1) Markets must be
divided into submarkets with different price elasticities
(2) there must be effective separation of the
submarkets so that no reselling can take place from a
low priced market to a high price market
Types of Price Discrimination (a) Personal (b) local (c)
according to trade or use
When Price Discrimination is
Possible
When consumers have certain preference or
prejudices
Nature of good – direct services
When consumers are separated by distances or
tariff barriers
Government regulations – Railways, Electricity
Ignorance of the consumers
Same service for different purposes
Special orders
Possible only in imperfect competition
 Types of Price Discrimination
First-degree discrimination involves
charging of maximum prices possible for
each unit of output
Second degree price discrimination,
instead of setting different prices for each
units, involve the pricing based on the
quantities of output purchased by
individual consumers
Third degree price discrimination involves
the separating the consumers or markets
in terms of their price elasticity of demand
When Price Discrimination if
Profitable
Price discrimination is profitable only
if elasticity of demand in one market
is different from elasticity of demand
in the other
Marginal Cost of Total Output =
Combined Marginal Revenue
Marginal Revenue in Market A =
Marginal Revenue in Market B =
Marginal Cost
 In order to maximize profit the
monopolist will distribute his output
in the two market in such a way that
the MR is the same in both the
markets as is equal to the MC. So
long as MR1>MR2 it will be profitable
for the monopolist to shift one unit
from second market to the first
market as it increase his total
revenue
 Equilibrium of a Discriminating Monopolist

P, AR. MR P, AR. MR P, AR. MR

MC

P2
E
P1

AR AR
MR MR
MR
Q
Q1 Q2
0 Q1 Q2 0
0 Q = Q1+Q2
Effect of a Shift in the Demand on Monopoly
In a perfectly competitive market, the
demand curve is downward sloping and the
supply curve is upward rising, and upward
shift of demand curve will increase the
equilibrium price and the equilibrium level of
output
However in the case of monopoly, an upward
shift of the demand curve. MC curve
remaining the same, will increase the
equilibrium output but the effect on
equilibrium price is indeterminate. It may
increase, decrease or remain constant
depending on the extent of shift in the
demand curve and the change in the
elasticity
 Effect of Shift in Cost
In the case of increase in the fixed cost, there will
be no impact on the equilibrium prices and
output, since the fixed cost when differentiated,
in other words, when fixed cost increases, it will
have no impact on the MC curve. Hence the
equilibrium will remain the same.

In the case of increase in the variable cost the MC

curve will shift to the left. i.e. in the upwards
direction. Given the MR curve this will lead to an
increase in the equilibrium price and a decrease
in the equilibrium level of output. The extent by
which the price will rise and the quantity will
decrease depends on the slope of the MR curve.
Imposition of Lump Sum Tax Under
Monopoly
Imposition of Lump Sum Tax will
reduce the excess profit of the
monopolist because it will increase
its fixed total cost. However the MC
curve of the monopolist will not be
affected, and hence the equilibrium
in the monopoly market will remain
the same even in the long run
(Provided that lump sum tax does
not exceed the supernormal profits
of the monopolist)
 Imposition of Profit Tax Under
Monopoly
Imposition of a profit tax on the
profit of the monopolist are the same
as in the case of the lump sum tax.
The profit reduces the subnormal
profit, but the equilibrium in the
market is not affected, so long as the
profit tax does not bite into the
normal profits of the monopolists.
Imposition of Specific Sales Tax
Under Monopoly
The imposition of specific tax will
shift the MC curve of the monopolist
upward, which will result in a change
in his equilibrium; in the new
position the prices will be higher and
the quantity smaller as compared
with the initial equilibrium. This is
the same qualitative prediction with
the model of perfect competition
 Measure of Monopoly Power
By monopoly power we mean the amount of
discretion which a producer or a seller enjoys in
regard to the framing of his price and output
policies
Monopoly power indicates the degree of control
which a seller or producer yields over the price
and output of his product
It also indicates the deviation form perfect
competition.
Prof. Lerner’s Measure: the difference between
price and MC indicates the deviation from perfect
competition. Greater the difference the greater is
the degree of monopoly power
Monopoly Power = P – MC
P
Prof. Triffin: Cross Elasticity of
Demand as a measure
Lower is the value of cross price
elasticity of demand, the greater will
be the degree of monopoly power
and vice versa
Rothchild’s Index of degree of
monopoly power shows how far a
particular firm controls the market
for a particular good.