MONOPOLY
QUICK COMPARISON BETWEEN FOUR MARKETS
Key
characteristic s
Perfect Competition
Monopolistic Competition
Oligopoly Monopoly
No. of Sellers Large number
of sellers Many sellers Few sellers One single seller
Price decision (Price control)
Price taker
(no control over P)
Price taker (little control)
Price maker (some control)
Price maker (complete control) Type of
product Homogenous/
Identical Slightly
differentiated Differentiated Unique Barriers to
Entry No barriers/
Easy entry &
exit
No barriers/
Easy entry &
exit
Difficult of entry
& exit Completely blocked for entry
Type of SR profit
Supernormal/
normal/
subnormal prof
Supernormal/
normal/
subnormal proft
Supernormal/
normal/
subnormal proft
Supernormal/
normal/
subnormal proft
Type of LR
profit Normal proft Normal proft Supernormal
proft Supernormal
proft Demand curve Horizontal DD
curve, perfectly elastic demand, D=MR=AR=P
Downward sloping (elastic) P=AR=D>MR
Downward sloping or kinked D curve
Downward sloping (inelastic) P=AR=D>MR
MONOPOLY
A market structure characterized by a single seller, a unique product and impossible entry into the market.
CHARACTERISTICS
a) Single seller with many buyers
One frm provides the total supply of a product in a given market.
b) Unique product
It means there are no close substitutes for the monopolist’s product.
c) Firm is price maker
The monopolist frms have a power to control the market price. However the monopolist can only control price or quantity but not both.
Can change Qs to change price.
d) Impossible entry/blocked entry Among the barriers are:
Ownership of a scarce resources
Sole control of the entire supply of a
strategic input is one way a monopolist can prevent a new entering in the industry.
Legal barriers – protecting a frm from potential competitors. The result of
government regulations and laws, such as licenses, permits, franchises, patents and copyrights.
Economies of scale – As a frm becomes larger, its cost per unit of output is lower compared to a smaller competitor. In the long run, cost advantage forces the smaller frms to leave the industry.
Financial and technological barriers
e) Advertising is not important
Economies of Scale = Natural Monopoly
THE DEMAND OF MONOPOLIST FIRM
Since the monopolist is the only seller in the market, therefore the monopolist’s demand is the industry or market demand.
The monopoly is facing a negative sloping (downward sloping) demand curve,
meaning to increase QD must reduce price.
PRICE ELASTICITY AND MR
As noted earlier, since the demand curve
facing a monopoly frms is downward sloping, MR < P
MR > 0 when demand is elastic
MR = 0 when demand is unit elastic
MR < 0 when demand is inelastic
P ≠ MR but P > MR Monopoly will never produce output in the inelastic range of demand curve because here MR –ve & therefore profit ↓ Thus, it always charge a higher price & sell a smaller quantity.
MONOPOLY PRICE SETTING
There is a unique proft-maximizing price and output level for a monopoly frm.
It is optimal to produce at the level of output at which MR = MC and to
charge the price given by the demand curve at this output level.
Charging a higher (or lower) price results in lower profts.
SHORT-RUN EQUILIBRIUM
A monopolist maximizes proft by producing the quantity of output where MR = MC.
In short-run, monopolist can earns 3 types of profts:
Economic proft (Supernormal proft)
Zero economic proft (normal proft)
Economic loss (subnormal proft)
a) Economic Proft
(Supernormal Proft)
Economic proft is a situation where TR is greater than TC.
(TR >TC)
The conditions to attain economic proft are
MC = MR
P > ATC.
TR > TC
b) Normal Proft
Normal proft is a situation where TR equals TC. It is also known as minimum or zero proft.
The conditions to attain normal proft are:
MC = MR and
P = ATC.
TR = TC
c) Economic Loss
(Subnormal Proft)
A situation where TC is greater than TR.
The conditions to get loss are:
MC = MR and
P < ATC.
TR < TC
MONOPOLIST THAT SHUTS DOWN IN
THE SHORT RUN
LONG-RUN EQUILIBRIUM
In long run, a monopolist frm can earns economic proft.
The main factor is because there is no competition and more importantly
because of the assumption of barriers to enter the market.
PRICE DISCRIMINATION
Price discrimination can be
defned as a practice where a monopolist firm charges
different prices to different
customers for similar goods and services that are not justifed by cost differences.
PRICE DISCRIMINATION
In imperfectly competitive markets, frms may increase their profts by engaging in price discrimination (charging higher prices to those
customers with the most inelastic demand for the product).
Necessary conditions for price discrimination:
the frm must not be a price-taker
frms must be able to sort customers by their elasticity of demand
resale must not be possible
TYPES OF PRICE DISCRIMINATION
a) First degree price discrimination (Perfect price discrimination)
This type of price discrimination occurs when seller charges price according to
consumers’ willingness to pay i.e
maximum price consumer willing to pay.
Example: auction
b) Second degree price discrimination
Different prices are charged for different blocks (size of
purchase).
Examples:
1st 5 units = RM10 charged
2nd 5 units = RM9 charged
Examples are electricity and water supply, bulk photocopies.
c) Third degree price discrimination
Charging different prices in different markets which can be separated either geographically or conceptually.
Example: air travel
Condition for 3rd Degree Price Discrimination
a) Seller must be able to separate mkts &
resell of goods are not allowed.
c) Transport cost must be as low as possible.
c) Elasticity of demand must be different in different markets. The monopolist will charge a higher price when the demand is inelastic and a lower price when
demand is elastic.
EXAMPLE: AIR TRAVEL
COMPARING MONOPOLY AND PERFECT COMPETITION
- Perfect competition equilibrium output Pc : Qc
- optimum output where SS=DD.
Produced at minimum AC hence lower price.
- Monopoly equilibrium output
Pm : Qm.
higher price but less output
ACm ACc =
At output Qm : Price → Pm > MC
Monopoly does not achieve allocative
efficiency. i.e. underallocation of resources (restrict quantity to enjoy higher price)
At output Qc : Price → Pc = MC
Perfect competition achieve allocative efficiency since produce at minimum cost
Pm ≠ at minimum AC
no productive efficiency
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COMPARING MONOPOLY TO PERFECT COMPETITION
In perfect competition, economic proft is
relentlessly reduced to zero by entry of other frms
In monopoly, economic proft can continue indefnitely
But monopoly differs from perfect competition in another way
Can expect a monopoly market to have a higher price and lower output than an otherwise similar perfectly competitive market
By raising price and restricting output, new monopoly earns economic proft
Consumers lose in two ways
Pay more for output they buy
Due to higher prices they buy less output
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FIGURE 5(A/B): COMPARING MONOPOLY AND PERFECT
COMPETITION
100,000 E
$10
D S
1,000 MC ATC
d
$10
Quantity of Output Price
Unitper
(a) Competitive Market (b) Competitive Firm Dollars
Unitper
Quantity of Output 2. and each firm produces
1,000 units, where P = MC.
1. In this competitive market of 100 firms, equilibrium price is $10
3. When monopoly takes over, the old market supply
curve . . .
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FIGURE 5(C): COMPARING MONOPOLY AND PERFECT COMPETITION
100,000 Quantity of Output Price
Unitper
E 10
D (c) Monopoly
S = MC
60,000 MR
$15 F
6. with a higher price and lower market output than under perfect competition.
4. becomes the monopoly's MC curve.
5. The monopoly produces where MR = MC,
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COMPARING MONOPOLY TO PERFECT COMPETITION
Changeover from perfect competition to
monopoly benefts owners of monopoly and harms consumers of the product
Important proviso concerning this result
In comparing monopoly and perfect competition, price is higher and output is lower under monopoly if all else is equal
General conclusion
Monopolization of a competitive industry leads to two opposing effects
For any given technology of production, monopolization leads to higher prices and lower output
Changes in technology of production made possible under monopoly may lead to lower prices and higher output
Ultimate effect on price and quantity depends on relative strengths of two effects
ADVANTAGES OF MONOPOLY
a) Avoid wastage of resources
If there are too many frms, wasteful
competition will occur, especially when it involves the use of scarce resources.
b) Firm enjoys economies of scale
The frm is usually a large one and the frm can therefore enjoy economies of scale with cheaper cost.
c) Stability is ensured
The monopolistic frm is usually established.
The stability of the frm will in turn ensure national economic stability.
d) The use of modern and sophisticated machinery
The monopolist frm can afford to buy expensive machinery and this will ensure efficiency.
e) Research and development
The frm can undertake R & D in the form of innovation and invention.
f) Price discrimination beneft the poor
The poor will be charged lower price compared to the rich.
DISADVANTAGES OF MONOPOLY
a) Undesirable concentration of economic power
The monopolist usually charges a higher price compared to other frms.
b) No consumer sovereignty
The consumers are made powerless and have to accept whatever goods and
services produced by the monopolist.
c) Inequality of income
The monopolist can earn economic proft and this would increase their income, since consumers have to pay a higher price.
d) Absence of competition
The motivation to undertake R & D is almost absent because there is no rival frm to compete with.
e) Allocative inefficiency
Consumers have to pay more than the price of will result in the loss of consumer welfare.
f) Productive inefficiency
Resources are not fully utilized, i.e
production is carried out at less than the optimum point.
