20 Monopoly

Mrs. Ritu K. Walia

  1. Learning Outcome:

 

After completing this module the students will be able to: Understand the meaning and features of monopoly. Understand the reasons of its emergence

 

Learn equilibrium/Price & Output determination under monopoly. Knowledge about monopoly power

 

Know about price Discrimination and equilibrium under it. Understand Dumping.

 

MONOPOLY

 

2. INTRODUCTION

 

Earlier it was observe that there was no monopoly market. It was just exceptional case but now a day we can see many examples in real world of this market. There are two extreme cases of market one is perfect competition where there are large number of sellers selling homogenous product and other extreme end is pure monopoly when there is only single seller for example Indian railway.

 

MEANING

 

Monopoly is a market having single seller of a product which has no close substitutes. Literally Monopoly implies ‘Mono’ means One and ‘Poly’ means seller. Thus monopoly means ‘One Seller’ or ‘One Producer’ exist in a market.

 

There are three main important points regarding monopoly

 

i. There must be single seller of a product. The single producer can be in the form of individual owner, a single partnership or a joint stock company.

 

ii. No substitutes of the product in the market.

 

iii. There must be strong barriers to entry of new firms into the market.

 

DEFINITION

 

According to Koutsoyiannis “Monopoly is a market situation in which there is a single seller, there are no close substitutes for commodity it produces there are barriers to entry”

 

According to Lerner “Monopoly as any seller who is confronted with a falling demand curve for his product”

 

3. ASSUMPTIONS/ FEATURES OF MONOPOLY

 

The following are the main features or assumptions of monopoly market:

 

i. Single Seller & Large number of Buyers: This is the main feature of monopoly that there must be single seller of the product and there are strong barriers to entry for new firms. And there is an existence of large number of buyers.

 

ii. No Close Substitutes: There must be no close substitutes of the product in the market otherwise monopoly will break.

 

iii. Barriers to Entry: There must be barrier to entry for the new firms into the market. It can be through licence, limit pricing policy, economies of production etc.

 

iv. Price Maker: A monopolist is the whole seller of the product with no close substitutes. So it is industry itself. It is price maker as well as price taker also.

  1. Price Discrimination: When a monopolist charges different prices for the same product from different buyers it is case of price discrimination. In monopoly seller can practised price discrimination as he is single producer of the product.
  1. REASONS OF EMERGEMCE OF MONOPOLY POWER

 

There are many causes due to which monopoly generates

  1. Patent rights for a product or for a process of production of the product.
  2. Exclusive ownership of raw material and exclusive knowledge of production technique.
  • Some time government provide gnat for franchise to a firm.
  1. Monopoly may be generate due to scale of production which give economies of scale.
  2. Monopoly can be generated through limit pricing policy.
  1. REVENUE AND COST CURVES IN CASE OF MONOPOLY

To study the price and output determination under monopoly it is important to know the nature of demand curve under it.

  1. Demand Curve: under perfect competition demand curve for a firm is horizontal while for industry it is downward sloping. In monopoly a firm itself is industry so its demand curve is downward sloping implying if a monopolist want to increase the sale of its product it must lower the price or vice versa. So demand and average revenue curve are downward. When average revenue curve is downward marginal revenue curve is also downward and under it. It is shown in the table & Figure1.

Table 1: Total Revenue, Average Revenue and Marginal Revenue.

 

AR is average revenue curve and MR is marginal revenue curve. Implying if a monopolist want to sell more quantity it has to lower down its price of the product and he can sale less at higher prices. AR and MR are less elastic in monopoly because there are no close substitutes of the product.

  1. Cost Curves: Cost curves under monopoly also follow the shape of traditional theory of cost. Average Cost, Average variable cost, marginal costs are U shaped and average fixed cost is rectangular hyperbola.
  1. PRICE AND OUTPUT DETERMINATION/ EQUILIBRIUM UNDER MONOPOLY

 

Price and output determination under monopoly can be studies through two approaches:

 

  1. Total Revenue and Total Cost Approach: A firm will produce that level of output which provides it maximum profit or if it working under losses, it will produce upto that level of output where losses are minimum.

 

Maximum Profit = Total Revenue – Total Cost ——– Maximum

Minimum Losses = Total Cost – Total Revenue ——– Minimum and firm covers average variable costs.

 

In the diagram 2, TR is total revenue curve and TC is total Cost Curves, OP is profit curve. Initially TC is greater than TR so firm has losses and at the B point TR is equal to TC this is breakeven point when firm has no profit and no loss. Firm will increase its production upto the Q1 quantity as here difference between TR and TC is maximum and profit are maximum i.e. P1Q1. If firm increase its output more than Q1 profit will start falling and again at point C TR and TC are equal. So firm’s equilibrium will be at OQ1 level of output.

  1. Marginal Revenue and Marginal Cost

 

Under monopoly AR is downward sloping indicating a firm can sell more by reducing output and MR is below it. Monopolist will produce upto the point:

 

Marginal revenue is equal to marginal cost (MR=MC)

 

Marginal cost curve cut marginal revenue curve from below (MC cut MR from below)

 

These are the two conditions of Equilibrium of monopolist.

 

 

In figure 3 condition of equilibrium is shown. Both conditions are fulfilled at point E, so a monopolist will produce upto OQ level of output and charge OP prices. Before it MC > MR so monopolist will increase its production. After OQ level of output MR < MC so firm will reduce its output.

 

Equilibrium can be explained in short run and long run.

  1. Short Run Equilibrium of Firm

Short run is the time period in which there are fixed and variable factors of production. Monopoly can increase its output by increasing variable factors only upto existing production capacity. In short run a monopoly can face three situations depending upon cost conditions

 

  1. Super Normal Profit: Monopolist will get super normal profit when at the equilibrium output, average revenue is greater than average cost. In other words, prices are higher than per unit cost.

Figure 4 shows the Super Normal profit. Condition of equilibrium that MC equal MR and MC cut MR from below is fulfilled×××× at point E. Monopolist will produce OQ level of output. OP price will be charged. At this price average cost is BQ = OP1. Here monopolist is getting super normal profit as average cost is less than average revenue i.e. AB.

Total Revenue = OP × OQ = OPAQ

 

Total Cost = OP1 × OQ = OP1BQ

 

Super Normal Profit = PP1BA

  1. Normal Profit: Monopolist can get normal profit also. It is the situation when average revenue is equal to average cost at the equilibrium level of output

 

Figure 5 shows normal profits. Equilibrium is at point E. Monopolist will produce OQ level of output and charge OP price.. At this level of output Average revenue is equal to average cost i.e. AQ = OP.

 

Total Revenue = Total Cost = OP × OQ = OPAQ. Monopolist is getting normal profit.

  • Minimum Losses: Monopolists can incure minimum losses. It is the situation when average cost is greater than average revenue but a firm covers its average variable cost.

 

Figure 6 shows minimum losses. Equilibrium is at point E. OQ level of output will be produced and OP price will be charged. At this level of price and output average revenue is OP = QB and average cost is QA = OP1. Per unit Loss is AB.

 

Total Revenue = OP × OQ = OPBQ

Total Cost = OP1 × OQ = OP1AQ

Total Loss = PP1AB

 

These losses are minimum because monopolist is covering average variable cost i.e. QC.

 

b. Long Run Equilibrium

 

Long run is the time period when all the factors of production are variable. Monopolist can change the size of the plant and machinery. Monopolist will produce that level of output at which long run marginal cost is equal to marginal revenue curve. Monopolist will earn super normal profit in long run because he is the single seller of the product. There is barrier to entry. It will not produce upto optimum capacity. It will also not bear losses in the long run as it will shut down its business. AR > LAC

 

Figure 8 shows the long run equilibrium of monopolist. He is at equilibrium at point E. OQ is equilibrium output here MR = LMC. And OP price will be charged. Here monopolist is getting super normal profit equal to PP1AB as average revenue is greater than long run average cost.

 

Long Run Equilibrium and Laws of Cost

 

In the long run monopolist decides whether he will charge high or low price it will depend upon elasticity of demand and laws of cost of production. There are three laws of cost in the long run

  1. i. Diminishing Cost: It is the case when by increasing output additional cost of production goes down. In this situation monopolist should increase the sale by charging lower prices.

 

In figure 8 LAC and LMC are downward sloping indication diminishing cost condition of production. Condition of equilibrium that LMC equal MR is fulfilled at point E. Monopolist will produce OQ level of output. OP price will be charged. At this price average cost is BQ = OP1. Here monopoly is earning super normal profit as long average cost is less than average revenue i.e. AB.

 

Total Revenue = OP × OQ = OPAQ

Long Run Total Cost = OP1 × OQ = OP1BQ

Super Normal Profit = PP1BA

  1. Constant cost: it is the case when by expanding production additional cost remains constant. In figure 9 LAC and LMC are horizontal to X axis indicating constant cost condition of production. LMC equal MR at point E. Monopolist will produce OQ level of output. OP price will be charged. At this price average cost is BQ = OP1. Here monopolist is earning super normal profit as long average cost is less than average revenue i.e. AB.

 

Total Revenue = OP × OQ = OPAQ

Long Run Total Cost = OP1 × OQ = OP1BQ

Super Normal Profit = PP1BA

 

  • Increasing Cost: It is the case when for expanding output additional cost of production increases. In this condition monopolist should produce less and charge high prices.

In figure 10, LAC and LMC are increasing indicating increasing cost of production. LMC equal MR at point E. Monopolist will produce OQ level of output. OP price will be charged. At this price average cost is BQ = OP1. Here monopoly is earning super normal profit as long average cost is less than average revenue i.e. AB.

 

Total Revenue = OP × OQ = OPAQ

Long Run Total Cost = OP1 ×OQ = OP1BQ

Super Normal Profit = PP1BA

  1. PRICE AND OUTPUT DETERMINATION UNDER MONOPOLY FOR MULTI PLANT FIRM

 

If a monopolist produces its same product in two different plants he will decide what should be the price of the product and what should be the optimum level of output at each plant. Here we assume that monopolist know its market demand and cost. It is also assumed that monopolist has two plants A and B. So its cost will be MC= MCA + MCB

 

Monopolist will produce upto where MC1 = MC2 = MR

 

 

Figure 11 shows the equilibrium of monopolist when he is producing two different plans. MC is his combined marginal cost. His equilibrium is at point E. He will produce OQ level of output and will charge P* price. In plant A he will produce OQa level of output and earn PAP1B super normal profit. In plant B he will produce OQb level of output and earn P2P3DC super normal profit.

  1. MONOPOLY POWER

 

Due to single seller, a monopolist can enjoy its monopoly power. A monopolist Power to influence the price and output by monopolist is known as monopoly power. The two main methods to measure monopoly power are

  1. Lerner’s Measure: Lerner considers that larger the difference between price and marginal cost higher will be the monopoly power. It can be measure from following formula:

 

Monopoly Power = P – MC/P

  1. Bains Measure: He considers that higher the difference between price and average cost higher will be the monopoly power. In other words higher the super normal profit higher will be the monopoly power.

 

Monopoly Power = AR-AC

 

9. PRICE DISCRIMINATION

 

Price discrimination is a feature of monopoly market. It refers to a situation when a monopolist sells its same product at different prices to different buyers. For this seller can do slight product differentiation. It is practisised by seller when it is possible and profitable.

  1. Type of Price Discrimination
  1. Degrees of Price Discrimination

 

There are three degrees of price discrimination

 

 

c. When Price Discrimination is Possible:

 

i. Legal sanction: Price discrimination can be legally sanctioned. We can see the example of railway. There are different prices for sleeper, AC and general coaches in same train.

 

ii.Monopoly: There should be monopoly of a product or production technique to differentiate price.

  • Sub- markets: Monopolist should divide its market into two or more sub market for price differentiation. It is not possible to charge different price at a same market. It will break the trust of the consumers.

 

Non transferable: The difference between two markets should be so large that no consumer can shift to the other market.

 

Different group of customers: monopolist charges different price from different customers after studying there demand pattern. So if consumers are different then price differentiation is possible.

 

Minimum cost: The cost of sub dividing the market should be minimum; otherwise it is wasteful for monopolist to divide the market into two sub markets.

 

Commodity on order: if commodity is produce on order then it is possible to charge different prices.

  1. When Price Differentiation is Profitable:

Price differentiation is profitable only when the elasticity of demand in different markets is different. Monopolist charge low price in that market where demand is more elastic and charges high prices where elasticity of demand is less elastic.

  1. Price and Output Determination under Discriminating Monopoly

 

Monopolist indulges in price discrimination with the objective of maximising profit. There are two conditions for equilibrium

  1. He must earn same marginal revenue in both the markets.
  2. Marginal revenue in both the market should be equal to marginal cost i.e.

 

MR1 = MR2 = MC

 

 

In the figure 12, equilibrium under discriminating monopoly has been shown. MR and MC cut at point E monopolistic will produce OQ level of output. In market A equilibrium is at point E1.He will sale OQa level of output and charges OP1 price. In market B equilibrium is at point E2. He will sale OQb output on OP2 price. In market A demand is less elastic than b market so monopolist charges high prize in A market and low price in B market.

  1. DUMPING

Dumping is also known as international price discrimination. Monopolist faces two type of market. One in which he is single seller i.e. domestic market and second competitions in international market. He will charge high price at home market and low price in international market.

 

Figure 13 shows the price determination under dumping. It is assumed there are two markets domestic market and foreign market. ARd and MRd are average and marginal revenue of monopolist in home/domestic market and ARf and MRf are average and marginal revenue of monopolist in foreign market as it faces competition there. Here DEF is combined marginal revenue curve. MC cut it at point B. So it will charge P1 price in foreign market and OP price at domestic market.

 

Summary

 

Monopoly is a market in which there is only one producer of a product which has no close substitution. There is no difference between firm and industry under monopoly. The monopolistic while determining price and output can either fix the price or let the output are determined in the market or he may have the second option that he fixes the output and price will determine the market. Generally he is a price maker. Price discrimination is the main feature of monopoly.

 

REFERENCES:

 

  • Henderson, J.M. and R.E. Quandt (1980), Microeconomic Theory: A Mathematical Approach, McGraw Hill, New Delhi.
  • Koutsoyiannis, A. (1979), Modern Microeconomics, (2nd Edition), Macmillan Press, London.
  • Salvatore D (2006), Microeconomics-Theory and Applications, Oxford University Press. Varian, H. (2000), Microeconomic Analysis, W.W. Norton, New York.