Economics-1

BALLB-207

Unit 3:
Monopoly

Ms. Lavi Vats

Monopoly

• A monopoly is a situation where a single firm has the exclusive power to

influence market prices. e.g. the services of Microsoft’s Windows.
• Monopoly firms are price makers, in contrast to competitive firms which
are price takers.
• A monopoly firm is able to charge a price much above its marginal cost.
• The monopoly is able to control the price it charges, but its profits are not
unlimited because if it charges too high a price, fewer people would
purchase the product, reducing the quantity sold at that price.
Why Monopolies arise?

• Monopoly resources: A monopoly firm may be the only owner of a rare resource, giving it

complete market power over the sales of that good. For example, when the only well in a

village is owned by a single individual, he/she has monopoly rights over water in the village.

• Government created monopolies: The government may give one person the exclusive right to

sell some good or service either to promote research or because of the political clout of the

individual. E.g. patents and copyrights.

• Natural monopoly: An industry is a natural monopoly if a single firm can supply a good or

service to an entire market at a lower cost than multiple firms. This is possible because the firm

enjoys economies of scale in producing that good. E.g. electricity or energy supply in a region.
Origin of Monopolies
• Control over strategic raw materials
• Small size of market
• Patents, copyrights and licences
• Limit Pricing
• Public Utilities
• Monopolistic Combinations
• Fiscal factor
Perfect competition versus Monopoly

The demand curve of a competitive firm is a straight line since the demand is perfectly elastic due to the
presence of many substitutes of the good. The Monopolist controls the entire market and has a downward
sloping demand curve, which somewhat restricts the price that he can charge.
 A Monopoly’s revenue
• A Monopoly’s total revenue is also the product of the quantity sold and price, and it’s average revenue is equal to

the price at each level of output.

• A monopolist’s marginal revenue is always less than the price of the good since it faces a downward sloping

demand curve.

• To increase the quantity sold, a monopolist has to lower the price on all units, driving the marginal revenue from

that unit less than the price. The increase in output has two effects on the total revenue:

– Output effect: Increase in revenue due to more units sold.

– Price effect: Decrease in revenue due to lower price

• The marginal revenue curve of a monopolist lies below the demand curve.
Short run equilibrium of Monopolist

Conditions for the Equilibrium of a Monopoly Firm:

There are two basic conditions for the equilibrium of the monopoly firm.

First Order Condition: MC = MR.

Second Order Condition: MC curve cuts MR curve from below.

Short run equilibrium of Monopolist

(a) Short Run Monopoly Equilibrium With

Positive Profit:

In this diagram, the monopoly firm is in

equilibrium at point K where SMC = MR. The short
run marginal cost (SMC) curve cuts MR from
below. At point K both the equilibrium conditions
are fulfilled. As a result, therefore, OE is monopoly
price and OB, the monopoly output. At the
monopoly output OB, the average total cost OF =
BN. The profit per unit is FE. The short run
monopoly profit is ETNF
Short run equilibrium of Monopolist

(b) Short Run Equilibrium With Normal

Profit Under Monopoly:
a firm is in the short run equilibrium at
point K, where SMC = MR. The price line
is tangent to SAC at point C. The firm
charges CB price per unit for units of
output OB. The total revenue of the firm
is equal to the area OPCB. The total cost
of the firm is also equal to the area
OPCB. The firm earns only normal
profits and continues operating.
Short run equilibrium of Monopolist

(c) Short Run Equilibrium With Losses

I
Under Monopoly:
the best short run level of output is OB
units which is given by the point L where
MC = MR. A monopolist sells OB units of
output at price CB. The total revenue of
the firm is equal to OBCF. The total cost of
producing OB units is OBHE. The
monopoly firm suffers a net loss equal to
the area FCHE. If the firm ceases
production, it then has to bear to total
fixed cost equal to GKHE. The firm in the
short run prefers to operate and reduces
its losses to FCHE only. In the long, if the
loss continues, the firm shall have to close
down.
Long run equilibrium of Monopolist

• 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.
•
• 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.
Long run equilibrium of Monopolist

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.

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.
Control of Monopoly

• Specific Tax(per unit) under monopoly

• Lump Sum Tax under monopoly
• Profit Tax under monopoly
Price Discrimination

In the words of Mrs. Joan Robinson:

"Price discrimination is the act of selling the same article produced under single control at a
different prices to the different buyers".
Types and Examples of Price Discrimination:

Price discrimination may be of various types. It may either be (i) personal (ii) trade
discrimination (iii) local discrimination.

(1) Personal discrimination. It is personal, when separate price is charged from each buyer
according to the intensity of his desire or according to the size of his pocket.

For instance, a doctor may charge $20000 from a rich person for an eye operation and $500
only from a poor man for the similar operation.

(2) Trade discrimination. It may take place when a monopolist charges different prices
according to the uses to which the commodity is put.

For example, an electricity company may charge low rate for electric current used in an
industrial concern than for the electricity used for the domestic purpose.

(3) Place discrimination. It occurs when a monopolist charges different prices for the same
commodity at different places. This type of discrimination is called dumping.
Examples of Price Discrimination:

Movie theatres/Amusement parks: The ticket prices may be lower for senior citizens, as they

have a lower willingness to pay. This will lead to increase in profits as they join the family in

movie theatres.

Airline prices: Different prices are charged to economy and business class passengers.

Discount coupons: Customers with a lower willingness to pay will spend time cutting coupons to

get a discount, while a busy businessman will pay the original price.

Quantity discounts: A lower price may be charged when larger quantities of a good is bought,

since customers have a lower willingness to pay for larger quantities.

Degrees of Price Discrimination:

(1) First degree price discrimination:

• The monopolist charges a different price equal to the maximum amount for each unit of the
commodity from each consumer separately.
• The price of each unit is equal to its demand price so that the consumer is unable to enjoy
any consumer surplus.
• Such prices are charged by doctors, lawyers etc. In fact, the first degree price discrimination
manifests itself in the form of as many prices as many consumers.
•
(2) Second degree price discrimination:
• It involves charging consumers a different price for the amount or quantity consumed.
• The railway, airlines,electricity etc., charge the fares from customers in this way.
Degrees of Price Discrimination:

(3) Third degree price discrimination.

• In the third degree price discrimination, the monopolist divides the entire market into a few
sub-markets and charges different prices for the same commodity in different sub-markets.
The division here is among classes of consumers and not among individual consumers.
• Third degree price discrimination is possible only if the classes of consumers can be kept
separate.
• Secondly, the various groups of customers must have different elasticities of demand for his
commodity. The segment with a less elastic demand pays a higher price than the segment
with a more elastic demand.
• The consumer faces a single price in each category of consumers. He can purchase as much
as desired at that price. It is the most common type of price discrimination.
• For example, movie theaters, railways, typically charge lower prices to senior citizens,
students etc.
Dumping

• Dumping is a situation in which the price, a firm charges for its goods in a
foreign market is lower than either the price it charges in its home market or
the production cost. Dumping thus is the sale of surplus output of a firm on
foreign markets at below cost price. Dumping also occurs when a firm sells its
products at a higher price in the home market and at a lower price in the
foreign market.

• Reverse dumping: In the situation where there are some foreign producers
selling the good that has been dumped by the domestic firm through exports,
the foreign firms may resell the good back in the domestic market at a higher
price. This is called reverse dumping.

• Some countries have anti dumping laws in order to protect the domestic
producers from unfair foreign competition.
Types of dumping

a) Persistent Dumping: Also called International Price Discrimination, it is the continuous ability of the

domestic monopolistic firm to maximize returns by selling the good at a lower price abroad.

b) Predatory Dumping: It is a temporary arrangement of dumping where the domestic firm sells the output

abroad at a very low price even if it is making losses for a while. This is done to eventually drive out the

competitors in the foreign market and capture all profits.

c) Sporadic Dumping: This is the type of dumping in which firms dispose off excessive production

(inventories) that remains unsold in the domestic market, at a lower price in the foreign market.

d) Reciprocal Dumping (Two way trade): Two countries both having monopoly in a particular good facing

similar marginal cost dump the same good into the other country. Transportation costs are also the same

in the two countries.

Types of dumping
Importance and Impact of dumping

Homework