Monopoly

1. 1. What is Monopoly?
Monopolyisthatsituationofmarketinwhichthereisasingle
sellerofaproduct,forexample:Thereisonlyonefirm
dealinginthesaleofcookinggasinaparticulartown.Hence,
monopolyisamarketsituationinwhichthereisonlyone
producerofacommoditywithnoclosesubstitutes.

2. 1.1 Definitions
-AccordingtoProf.Ferguson,“Apuremonopolyexistswhen
thereisonlyoneproducerinamarket.Thereareno
directcompetitors.”
-McConnelsays,“Pureorabsolutemonopolyexistswhena
singlefirmisthesoleproducerforaproductforwhich
therearenoclosesubstitutes.”

3. 1.2 Features
1.Oneseller&largenumberofbuyers:Undermonopolythereshouldbe
singleproducerofthecommodity.Thebuyersoftheproductareinlarge
number.Consequently,nobuyercaninfluencethepricebuttheseller
can.
2.Monopolyisalsoanindustry:Undermonopolysituation,thereisonly
onefirm&thedifferencebetweenfirm&industrydisappears.Thereisno
differencebetweenthestudyofafirmandindustry.
3.Restrictionsontheentryofnewfirms:Therearesomerestrictionson
theentryofnewfirmsintomonopolyindustry.Thereisnocompetitoroa
monopolyfirm.
4.Noclosesubstitutes:Thecommodityproducedbythefirmshouldhave
noclosesubstitute,otherwisethemonopolistwillnotbeableto
determinethepriceofhiscommodityasperhisdiscretion.
5.Pricemaker:Priceofthecommodityisfullyunderthecontrolofthe
monopolist.Incase,themonopolistincreasesthesupplyofthe
commodity,thepriceofitwillfall.Ifhereducesthesupply,thepriceofit
willrise.Amonopolistmayalsoindulgeinpricediscrimination.Inother
words,hemaychargedifferentpricesofthesameproductfromdifferent
buyers.

4. 2. Demand & revenue under
monopoly
Inamonopolysituationthereisnodifferencebetweenfirm&
industry.Accordingly,undermonopolysituation,firm‟s
demandcurvealsoconstitutesindustry‟sdemandcurve.
Demandcurveofthemonopolistisalsoaveragerevenue
(AR)curve.Itslopesdownward.Itmeansifthemonopolist
fixeshighprice,thedemandwillshrink.Onthecontrary,if
hefixeslowprice,thedemandwillexpand.Undermonopoly,
averagerevenue&marginalrevenuecurvesareseparate
fromoneanother.Bothslopedownwards.
FollowingfactscometolightasaresultofnegativeAR&MR:
i.Demandriseswithfallinprice(AR).Hence,byloweringthe
price,amonopolistcansellmoreunitsofthecommodity.
ii.ARisanothernameofpriceperunit,i.e.,P=AR.
iii.Withfallinprice,bothAR&MRfall,butfallingMRismore.
RateoffallinMRisusuallymorethanrateoffallinAR.
iv.ARisnever0,butMRmaybe0oreven-ve.

5. Fig.: Demand and revenue under monopoly

6. 3. Determination of price and
equilibrium under monopoly
Amonopolistwillsodeterminethepriceofaproductasto
getmaximumprofit.Amonopolistisinequilibrium
whenheproducesthatamountofoutputwhichyields
himmaximumtotalprofit.Amonopolistisalsoin
equilibriumintheshortperiodwhenheincursminimum
loss.Undermonopoly,price&equilibriumare
determinedby2differentapproaches:
1.TR&TCAnalysis
2.MR&MCAnalysis

7. 4. TR & TC curve analysis
Monopolistcanearnmaximumprofitbysellingthatamount
ofoutputatwhichdifferencebetweenTR&TCismaximum.
Byfixingdifferentpricesorbychangingthesupplyofthe
product,amonopolisttriestofindoutthelevelofoutputat
whichthedifferencebetweenTR&TCismaximum,i.e.,total
profitismaximum.Thatamountofoutputatwhicha
monopolistearnsmaximumprofitwillconstitutehis
equilibriumsituation.

8. Fig.: Total revenue & total cost curve analysis

9. 5. MR & MC analysis
In case of monopoly, one can know about price determination or
equilibrium position with the help of MR & MC analysis.
According to this analysis, a monopolist will be in equilibrium
when 2 conditions are fulfilled, i.e.,
1. MC=MR
2. MC curve cuts MR curve from below. A monopolist earns
maximum profit when he is in equilibrium.
Price & equilibrium determination under monopoly are studied
with reference to 2 time periods:
A. Short period
B. Long period

10. Fig.: Marginal revenue & marginal cost analysis

11. A. Price determination under short
period or short-run equilibrium
Short-run refers to that period in which time is so short that a monopolist cannot
change fixed factors like: machinery, plant etc. Monopolist can increase
his output in response to increase in demand by changing his variable
factors. Similarly, when demand decreases, the monopolist will reduce his
output by reducing variable factors & by slowing down the intensive use of
fixed factors. A monopolist will face any of the 3 situations in the short
period:
1. Super normal profit: If the price (AR) fixed by the monopolist in
equilibrium is more than his AC, then he will get super normal profits. The
monopolist will produce upto the extent where MC=MR. If the price of
equilibrium output is more than AC then the monopolist will earn super-
normal profit.
2. Normal profit: If in the short run equilibrium MC=MR, the monopolist
price AR=AC, then he will earn only normalprofit.
3. Minimum loss: In the short run, the monopolist may incur loss also. If in
the short-run price falls due to depression or fall in demand, the
monopolist may continue his production so long as the low price covers
his AVC. A monopolist in equilibrium, in the short period, may bear
minimum loss equivalent to fixed costs. In this situation, AR=AVC & the
monopolist bears the loss of fixed costs.

12. Fig.: Super normal profit Fig.: Normal profit

13. B. Determination of Long-
run or long-run equilibrium
Inthelongrun,themonopolistwillbeinequilibriumata
pointwherehislong-runmarginalcostisequaltomarginal
revenue.Inthelongrun,becauseofsufficientlylongperiod
atthedisposalofthemonopolyfirm,allcostscanbevaried&
supplycanbeincreasedinresponsetoincreaseindemand.

14. Fig.: Determination of long run price or long
run equilibrium

15. Monopolyequilibrium & law
of costs
i.Elasticityofdemand:Ifdemandisinelastic,themonopolistwillfixhigh
priceofhisproduct.Onthecontrary,ifthedemandiselastic,the
monopolistwillfixlowpriceperunit.Lowpricewillnotonlyextend
demand&increasethesales,alsomaximizehisprofits.
ii.Effectoflawsofcostsonmonopolypricedetermination:While
fixingtheprice,amonopolistalsotakesintoconsiderationcostof
production.
1)Diminishingcosts:Itmeansasproductionincreasesitscostperunit
goesondiminishing.
2)Increasingcosts:Itmeansasproductionincreases,thecostof
productionalsoincreases.
3)Constantcost:Itisasituationwhereincostofproductionremains
constant,whetherproductionismoreorless.

16. Price discrimination or
discriminating monopoly
Definitions:
InthewordsofKoutsoylannis,“Pricediscriminationexists
whenthesameproductissoldatdifferentpricestodifferent
buyers.”
-Dooley,“Discriminatorymonopolymeanschargingdifferent
ratesfromdifferentcustomersforthesamegoodorservice.”

17. Price & output determination or
equilibrium under discriminating
monopoly
Theaimofthemonopolistinresortingtopricediscriminationisto
increaseTR&profit.Analysisofpricedeterminationunderprice
discriminationcanbemadewithreferenceto2ormoremarket
conditions.Eachdiscriminatingmonopolist,inordertomaximizehis
profit,willproduceuptothatlevelwhereMR=MC.Inordertoget
maximumprofit,2conditionsmustbefulfilled:
1.GetsameMRinbothmarkets:IfweexpressMRofmarket„A‟as
MR1,&MRofmarket„B‟asMR2,thenMRofboththemarketsmustbe
same,i.e.,MR1=MR2.
2.EqualitybetweenMR&MC:Anotherconditionofequilibriumisthat
MRearnedineachmarketshouldbeequaltotheMCofthetotaloutput.
IfMRofmarket„A‟isexpressedasMR1&thatofmarket„B‟asMR2,&
marginalcostoftotaloutputasMC,thentheconditionofequilibriumwill
bewrittenas:MR1=MR2=MC.