Curriculum
- 14 Sections
- 14 Lessons
- Lifetime
- 1 – Introduction to Managerial Economics2
- 2 - Market Demand2
- 3 – Market Supply and Equilibrium2
- 4 – Consumer Behaviour (Utility Analysis)2
- 5 – Elasticity of Demand2
- 6 - Production Theory2
- 7 – Laws of Production2
- 8 – Cost Analysis2
- 9 – Market Structure: Perfect Competition2
- 10 – Monopoly2
- 11 – Monopolistic Competition2
- 12 – Oligopoly2
- 13 – Basic National Income Concepts2
- 14 – Calculation of National Income2
10 – Monopoly
Introduction
The word “monopoly” comes from putting together the words “mono” and “poly.” With mono, you get a single input, and with poly, you get control. When one firm or a single firm is the only seller or maker of a product in a market with no close substitutes, it is referred to as a monopoly.
Prof. Bober rightly remarks, “The privilege of being the only
seller of a product does not by itself make one a monopolist in the
sense of possessing the power to set the price. As the one seller,
he may be a king without crown.”
According to Koutsoyiannis, “Monopoly is a market situation
in which there is a single seller. There are no close substitutes of
the commodity it produces, there are barriers to entry.”
-There are barriers to entry because there are no close substitutes for the commodity it makes.
-A monopolist is a seller in a monopoly market.
When there is only one seller in a market and the monopolist controls it, he sets the prices, not the buyers. To make money, a monopolist can control both the quantity and the price of a commodity. However, it is said that a firm will only control one at a time if it is a rational monopolist.
10.1 Features of Monopoly
Certain features of monopoly markets are as follows:
1. Single Seller and Large Number of Buyers:
As previously mentioned, a single vendor, or monopolist, controls a monopolistic market. The monopolist’s firm dominates the market and is the sole firm in the industry. However, a sizable number of purchasers are anticipated.
2. No Close Substitutes:
The absence of close substitutes for the monopolist’s product in the market is a crucial characteristic of monopolies. There must be little to no cross-elasticity of demand between the monopolist’s product and those of competitors.
3. Difficulty of Entry of New Firms:
Businesses cannot enter a monopoly market unless they overcome artificial or natural barriers.
4. Price Maker:
The monopolist has complete control over the commodity’s supply in a monopolistic market. However, because there are so many buyers, each buyer’s desire makes up a very small part of the total demand. As a result, customers are required to pay the monopolist’s set price.
5. There is no distinction between the firm and the industry:
In a monopolistic market, the firm functions as both the industry and the single seller. Thus, it is not necessary to comprehend the company and the industry independently.
10.2 Sources of Monopoly Power
The monopoly has many characteristics that provide the monopolist monopoly power.
1. Natural monopoly power:
Some monopolists naturally obtain monopoly power from the products they manufacture, which are readily available to them. One kind of monopoly that develops naturally results from the high startup costs associated with operating in a particular industry. A corporation with a natural monopoly may be the exclusive supplier of a good or service in a certain sector of the market or area, giving it monopoly power. When a single business can provide a good or service at a lower price than any possible rival in the market, natural monopolies are permitted.
2. Product differentiation:
A differentiated product with no close substitute on the market is what is sold in a monopoly market. Every product is flawlessly homogeneous and a perfect substitute for every other product on the market in a fully competitive market. Since a monopolised good has no viable substitute, there is great to absolute product differentiation when there is a monopoly. The monopolist is the market’s exclusive supplier of the good.
3. Legal protection:
A firm must use legal power to shield this product from different types of market competition and make it distinctive. Copyrights, patents, trademarks, and other forms of legal protection provide a firm with the monopoly power and make their product stand out from other firms on the market.
4. Barriers to Entry:
These are the conditions and factors that prohibit potential rivals from entering the market and restrict the ability of new businesses to operate and grow there. Because of their natural and man-made barriers, monopolies have comparatively high entry barriers. Strong enough barriers must be in place to deter or prohibit any prospective competitors from joining the market.
5. Control over the resources:
The firm has exclusive control over the resources used in the manufacture of the product since it is the only vendor in the market. Either natural or legal power is the source of control.
10.3 Equilibrium of a Monopoly Firm
The equilibrium conditions for a firm under monopoly mirror those under perfect competition, where Marginal Cost (MC) equals Marginal Revenue (MR), with the MC curve intersecting the MR curve from below. Let’s delve into the short-run and long-run equilibrium scenarios for monopolies.
I) Short-run equilibrium condition: In the short run, a monopoly firm can find itself in two situations:
1. Normal Profits or Excess Profit:
If the total cost is less than the total revenue, the firm earns normal or excess profits.
The equilibrium point (E) is where MR equals MC (MR = MC). At this point, the price (OP) and output level (OQ) are set.
The profit is calculated as TR – TC, where TR = P × Q, and TC = Q × AC.
Therefore, Profit = OQRP – OQTS = STPR, indicating excess profit when TR is greater than TC.
2. Loss Condition:
If total cost exceeds total revenue, the firm incurs losses.
The loss condition is explained using the figure. The profit formula remains the same but with TR < TC, resulting in a loss represented as PRVU.
II) Long-run equilibrium condition: In the long run, a monopolist can adjust all inputs. To determine equilibrium, only two cost curves – the Average Cost (AC) and the Marginal Cost (MC) – are essential. In the long run, a monopolist typically earns excess profit, as shown in figure
Profit = TR – TC, where TR = P × Q, and TC = Q × AC.
Therefore, Profit = OQTP – OQSN = NSTP, indicating excess profit when TR is greater than TC in the long run.
In summary, the equilibrium conditions for a monopoly involve balancing costs and revenues, with excess profit being a common outcome both in the short run and the long run.
10.4 Price Discrimination under Monopoly
If a seller offers the same product to different customers at different prices, that seller is engaging in price discrimination. Price discrimination is classified as “personal” when different prices are charged from different people, “local” when different prices are charged from people living in different localities, and “according to use” when, for example, higher rates are charged for commercial use of electricity than for residential use.
When a seller can identify individual units purchased by a single customer or group buyers into classes where cross-class resale is prohibited, price discrimination may be possible.
In the case of the services of doctors and lawyers, price discrimination is therefore possible. It is also possible when tariff barriers separate markets that are too far apart. As in the case of domestic and industrial users’ electricity prices, there may be legal consequences for price discrimination. It is also possible for some people to have preconceived notions about a certain market, like a posh market, or for some people to be too lazy to leave the closest shopping area.
Case 1: Equilibrium under Price Discrimination
A monopolist firm engages in the sale of a single product across two distinct markets, each characterized by different elasticities of demand. Importantly, there is no possibility of resale among customers in these markets. The central decision for the firm involves determining the total output to be produced and how it should be distributed between these sub-markets. Additionally, the firm must establish the pricing strategy for each market.
Assuming that production occurs at the same point, the equilibrium of the monopolist in the two sub-markets is illustrated in the provided figure. Notably, the monopolist encounters a demand curve with lower elasticity in sub-market 1 compared to sub-market 2. In part (c) of the figure, the aggregate demand and Marginal Revenue (MR) curves are depicted. Profit maximization occurs at the point E, where the Marginal Cost (MC) curve intersects the MR curve from below. The shaded area EFG, lying between the MR and MC curves, represents the total profits.
For optimal decision-making, the monopolist determines the quantity of output, denoted as Q units, to be produced. To distribute this quantity between the two sub-markets, the equilibrium aggregate MR is equated to MR1 and MR2 at points E1 and E2, respectively. Consequently, the monopolist sells quantity Q1 in sub-market 1 at a price P1 and quantity Q2 in sub-market 2 at a price P2. It’s important to note that the total output, Q, is the sum of Q1 and Q2. This strategic approach allows the monopolist to navigate the diverse demands of both sub-markets while maximizing overall profits.
Case 2: Dumping
This scenario presents a unique situation where a firm operates as a monopoly in the domestic market but encounters perfect competition in the global market. The equilibrium of such a firm is illustrated in Figure In this context, ARH and MRH stand for the average and marginal revenue curves that the firm encountered in the domestic market, respectively. On the other hand, ARW or MRW is a horizontal straight line reflecting the prices (Pw) prevailing in the world market. The marginal cost curve is denoted by MC, and the aggregate MR curve, represented by the curve AFEG, is the lateral summation of MRW and MRH.
Profit maximization occurs at the point E, where aggregate MR equals MC. At this point, the firm sells the total output, denoted as Q. Within the domestic market, the firm equates MRH to the equilibrium MC, resulting in the sale of QH units at a price PH, which is higher than the international price PW. The remaining quantity (Q-QH) is then sold in the world market at the price PW. The area AFED is a representation of the firm’s total profits.
It’s noteworthy to mention that the producer is engaging in ‘dumping’ in the world market by charging a lower price than in the home market. This strategic pricing approach allows the firm to navigate the dynamics of both the domestic and international markets, maximizing its overall profits.