Monopoly

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Monopoly

  1. 1. 1. What is Monopoly?Monopoly is that situation of market in which there is a singleseller of a product, for example: There is only one firmdealing in the sale of cooking gas in a particular town. Hence,monopoly is a market situation in which there is only oneproducer of a commodity with no close substitutes.
  2. 2. 1.1 Definitions-According to Prof. Ferguson, “A pure monopoly exists whenthere is only one producer in a market. There are nodirect competitors.”-Mc Connel says, “Pure or absolute monopoly exists when asingle firm is the sole producer for a product for whichthere are no close substitutes.”
  3. 3. 1.2 Features1. One seller & large number of buyers: Under monopoly there should besingle producer of the commodity. The buyers of the product are in largenumber. Consequently, no buyer can influence the price but the sellercan.2. Monopoly is also an industry: Under monopoly situation, there is onlyone firm & the difference between firm & industry disappears. There is nodifference between the study of a firm and industry.3. Restrictions on the entry of new firms: There are some restrictions onthe entry of new firms into monopoly industry. There is no competitor o amonopoly firm.4. No close substitutes: The commodity produced by the firm should haveno close substitute, otherwise the monopolist will not be able todetermine the price of his commodity as per his discretion.5. Price maker: Price of the commodity is fully under the control of themonopolist. In case, the monopolist increases the supply of thecommodity, the price of it will fall. If he reduces the supply, the price of itwill rise. A monopolist may also indulge in price discrimination. In otherwords, he may charge different prices of the same product from differentbuyers.
  4. 4. 2. Demand & revenue undermonopolyIn a monopoly situation there is no difference between firm &industry. Accordingly, under monopoly situation, firm‟sdemand curve also constitutes industry‟s demand curve.Demand curve of the monopolist is also average revenue(AR) curve. It slopes downward. It means if the monopolistfixes high price, the demand will shrink. On the contrary, ifhe fixes low price, the demand will expand. Under monopoly,average revenue & marginal revenue curves are separatefrom one another. Both slope downwards.Following facts come to light as a result of negative AR & MR:i. Demand rises with fall in price (AR). Hence, by lowering theprice, a monopolist can sell more units of the commodity.ii. AR is another name of price per unit, i.e., P=AR.iii. With fall in price, both AR & MR fall, but falling MR is more.Rate of fall in MR is usually more than rate of fall in AR.iv. AR is never 0, but MR may be 0 or even -ve.
  5. 5. Fig.: Demand and revenue under monopoly
  6. 6. 3. Determination of price andequilibrium under monopolyA monopolist will so determine the price of a product as toget maximum profit. A monopolist is in equilibriumwhen he produces that amount of output which yieldshim maximum total profit. A monopolist is also inequilibrium in the short period when he incurs minimumloss. Under monopoly, price & equilibrium aredetermined by 2 different approaches:1. TR & TC Analysis2. MR & MC Analysis
  7. 7. 4. TR & TC curve analysisMonopolist can earn maximum profit by selling that amountof output at which difference between TR & TC is maximum.By fixing different prices or by changing the supply of theproduct, a monopolist tries to find out the level of output atwhich the difference between TR & TC is maximum, i.e., totalprofit is maximum. That amount of output at which amonopolist earns maximum profit will constitute hisequilibrium situation.
  8. 8. Fig.: Total revenue & total cost curve analysis
  9. 9. 5. MR & MC analysisIn case of monopoly, one can know about price determination orequilibrium position with the help of MR & MC analysis.According to this analysis, a monopolist will be in equilibriumwhen 2 conditions are fulfilled, i.e.,1. MC=MR2. MC curve cuts MR curve from below. A monopolist earnsmaximum profit when he is in equilibrium.Price & equilibrium determination under monopoly are studiedwith reference to 2 time periods:A. Short periodB. Long period
  10. 10. Fig.: Marginal revenue & marginal cost analysis
  11. 11. A. Price determination under shortperiod or short-run equilibriumShort-run refers to that period in which time is so short that a monopolist cannotchange fixed factors like: machinery, plant etc. Monopolist can increasehis output in response to increase in demand by changing his variablefactors. Similarly, when demand decreases, the monopolist will reduce hisoutput by reducing variable factors & by slowing down the intensive use offixed factors. A monopolist will face any of the 3 situations in the shortperiod:1. Super normal profit: If the price (AR) fixed by the monopolist inequilibrium is more than his AC, then he will get super normal profits. Themonopolist will produce upto the extent where MC=MR. If the price ofequilibrium 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 monopolistprice AR=AC, then he will earn only normal profit.3. Minimum loss: In the short run, the monopolist may incur loss also. If inthe short-run price falls due to depression or fall in demand, themonopolist may continue his production so long as the low price covershis AVC. A monopolist in equilibrium, in the short period, may bearminimum loss equivalent to fixed costs. In this situation, AR=AVC & themonopolist bears the loss of fixed costs.
  12. 12. Fig.: Super normal profit Fig.: Normal profit
  13. 13. B. Determination of Long-run or long-run equilibriumIn the long run, the monopolist will be in equilibrium at apoint where his long-run marginal cost is equal to marginalrevenue. In the long run, because of sufficiently long periodat the disposal of the monopoly firm, all costs can be varied &supply can be increased in response to increase in demand.
  14. 14. Fig.: Determination of long run price or longrun equilibrium
  15. 15. Monopoly equilibrium & lawof costsi. Elasticity of demand: If demand is inelastic, the monopolist will fix highprice of his product. On the contrary, if the demand is elastic, themonopolist will fix low price per unit. Low price will not only extenddemand & increase the sales, also maximize his profits.ii. Effect of laws of costs on monopoly price determination: Whilefixing the price, a monopolist also takes into consideration cost ofproduction.1) Diminishing costs: It means as production increases its cost per unitgoes on diminishing.2) Increasing costs: It means as production increases, the cost ofproduction also increases.3) Constant cost: It is a situation wherein cost of production remainsconstant, whether production is more or less.
  16. 16. Price discrimination ordiscriminating monopolyDefinitions:In the words of Koutsoylannis,“Price discrimination existswhen the same product is sold at different prices to differentbuyers.”-Dooley,“Discriminatory monopoly means charging differentrates from different customers for the same good or service.”
  17. 17. Price & output determination orequilibrium under discriminatingmonopolyThe aim of the monopolist in resorting to price discrimination is toincrease TR & profit. Analysis of price determination under pricediscrimination can be made with reference to 2 or more marketconditions. Each discriminating monopolist, in order to maximize hisprofit, will produce upto that level where MR=MC. In order to getmaximum profit, 2 conditions must be fulfilled:1.Get same MR in both markets: If we express MR of market „A‟ asMR1, & MR of market „B‟ as MR2, then MR of both the markets must besame, i.e., MR1=MR2.2. Equality between MR & MC: Another condition of equilibrium is thatMR earned in each market should be equal to the MC of the total output.If MR of market „A‟ is expressed as MR1 & that of market „B‟ as MR2, &marginal cost of total output as MC, then the condition of equilibrium willbe written as: MR1=MR2=MC.

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