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1. Pricing in Product Market: A Case of
Monopoly Market Structure

2. Overview
 Define Monopoly
 Natural Monopoly, Bilateral Monopoly
 Emergence of Monopoly
 Natural Monopoly
 Bilateral Monopoly
 Production and Pricing Decisions
 A Rule of Thumb for Pricing
 Pricing in Monopoly Market
 Measuring Monopoly Power
 Effect of Tax on Monopoly
 Welfare Cost of Monopoly
 Public Policy and Monopoly

3. Monopoly
Derived from Greek Words: monos polein (alone to sell)
A market structure in which there is one seller who
either sets the price or the quantity but not both.
Exp: Enterprises supplying Public Utility Services – Water Supply &
Electricity (closely resemble)
[Gas Pipeline (Mahanagar Gas- Gas connection provided in building –Mumbai),
Public Transport: BEST BUS (Mumbai) Railways]

4. Monopoly ……
A firm is considered a monopoly if:
– Monopolist is the sole seller of its product.
– Not having close substitutes of its products. Why?
(Availability of substitute: with rise in price of monopoly product demand for
substitute will go up)
Exp: Coca Cola corp: Producer of ‘Coke’
Colgate-Palmolive: only produce of Colgate toothpaste but it is not a monopoly due
to availability of substitutes (Close up, Pepsodent etc.)
• The monopolist is the supply-side of the market and has complete
control over the amount offered for sale
• Monopolist controls price but must consider consumer demand

5. Monopolists are price setters:
They select their own price and supply the entire quantity
demanded.
Product has no close substitutes, so rise in price can not reduce
demand.
Prevalence of barriers to entry restricts other firms to enter the
market.
• Monopoly does not imply that there is a single Producer (as
monopolist need not produce own product).
• There is a SINGLE SELLER (of group of sellers) that sets the price.
Exp: OPEC- consists of 11 major producers that collectively set the
price of oil
Pure Monopoly: Rare in Practice

6. Monopoly
A Pure Monopoly exists when a
single firm is the only producer
or seller of a product that has no
close substitute. Entry into the
industry is difficult or
impossible. Firm is the industry
Pure Monopoly: Rare in Practice

7. Examples: Monopolies (Taxis in New York City)
• Case of Monopoly created by licensing (not pure monopoly)
-One can’t drive a cab without license (called Medallion).
- Licenses are limited in number, people having licenses got monopoly power to earn profit.
The number of taxicabs is set by law at 11,787.
No new taxi licenses have been issued for over half a century.
Until 1937- any qualified taxi driver could get the license by paying a nominal licensing fee.
Later limit on number of license issued imposed effectively fixing total supply of license.
Current owners of license can sell them to others who are keen to operate a taxicab.
Over time, Mismatch between supply and Demand: Rise in Price of Medallion.
(INCREASE in PRICE to even $50,000 from an initial licensing fee of $5)

8. The American Medical Association (AMA)
• Strongest and longest lasting Cartel
• AMA prevents individual doctors from reducing prices
• With Assistance from State Legislature AMA restricted supply of
doctors and therefore, restricted output of medical services.
• Flexner report (1910): Recommended reduction in
number of Medical Schools, implying fall in
doctor to population ratio .
• In contrast, demand for health care services increased due to
rise in per capita income and various insurance scheme.
• Outcome: Income of doctors went up.

9. Input Monopolies
• Monopolies through ownership of key resources
Aluminium Company of America (ALCOA) once controlled
most domestic bauxite deposits.
International Nickel Company once owned 90 per cent of
World’s Nickel
De Beers Consolidated Mines Ltd (South Africa)- Handles
about 80 per cent of World’s uncut Diamonds.

10. Why to Learn About Monopoly?
 A part of total domestic output is supplied
under monopoly condition
Helps to understand more common market
structures such as Monopolistic Competition
and Oligopoly.

11. Emergence of Monopoly
(Conditions that might give rise to Monopoly)
Ownership of Key Resource
Legal Barriers By Government
Large Economies of Scale
Barriers to Entry

12. Emergence of Monopoly
Barriers to Entry prevails in the
Market. Why?
(Implication: Imposition of Barrier to Entry ---
No competition-----Ensure growth of Profit)
– Monopolist can exercise monopoly power to
influence the market price (of its product)
[(Unlike in Perfect Competition, Monopoly is a price Setter not Price Taker
(set own price and supply entire quantity demanded)]

13. Emergence of Monopoly
Ownership of Strategic Raw Material
(Control over critical Inputs, exclusive knowledge of production technique):
If one firm controls supply of a critical input?
Other firms can’t enter the industry as not having access to it.
Exp: Role of Aluminum Company of America (ALCOA) in the production of
Aluminum through CONTROL OVER SUPPLY OF BAUXITE in the early
Twentieth Century
(SIGNED LONG TERM CONTRACTS WITH COMPANIES SUPPLYING
BAUXITE SO THAT BAUXITE CAN NOT BE SOLD TO ANYONE ELSE).

14. Economies of Scale
Firm having downward sloping Average Cost Curve.
HIGHER PRODUCTION LEADS TO LOWER UNIT COST OF
PRODUCTION.
New firms can not compete with the existing low cost
producers.
Exp: Electricity supply, Water, Gas, Transport services etc
(To have more than one firm implies overlapping
distribution systems and higher per unit cost).

15. Government-Created Monopolies
Patent and copyright laws are a major source of
government-created monopolies.
(countries grant an inventor sole control over the use of an
invention for certain number of years. India: 7 years)
– Xerox corporation for Photocopying
– Certain new pharmaceutical drugs
Governments also restrict entry by giving a single firm
the exclusive right to SELL a particular good in certain
markets.
– Local cable television
– Post Office
– License to Liquor Store

16. Emergence of Monopoly
• Entry Lags: Large gestation period prevents new firms in
entering the industry (Exp: Steel industry).
• Adoption of Limit Pricing Policy: Pricing policy aiming at
prevention of New entry.
(If price is very low, can other firms compete?)
• Limit Pricing along with Heavy advertising and continuous
product differentiation render entry unattractive.

17. Natural Monopoly
An industry is a natural monopoly when a single firm can supply a
good or service to an entire market at a LESSOR COST as compared
to what could have been provided by two or more firms.
A special type of Monopoly that arises from ECONOMIES of SCALE.
Efficient use of resources can be achieved if the entire market
supply is done by a SINGLE Enterprise.
COMPETITION WOULD LEAD TO WASTAGE OF SCARCE RESOURCES.
Exp: Public Utility Services
[Gas Pipeline (Mahanagar Gas-LPG connection in Apartments in Mumbai), Water
supply, Electricity

18. Bilateral Monopoly
• A market consisting of SINGLE SELLOR (monopolist) and
a SINGLE BUYER (Monopsonist)
• Exp: A single firm produces all copper in a country and the
metal is used by only one firm.
• Few Railway equipment (FAN, Battery) produced by a SINGLE
FIRM and purchased by Indian Railways
• Bilateral Monopoly rare for commodity market but common in
labor markets. Workers are organized (having union) and single
employer hires them.

19. Profit Maximization Condition for Monopoly: Short Run
• Profits will be maximized at the level of output where
marginal revenue equals marginal cost
(i) Necessary Condition for Profit Maximization
MR = MC
(ii) Sufficient Condition: MC cuts MR from Below

20. Total, Marginal, and Average Revenue
Revenue is zero when price is $6
-Nothing is sold
At lower prices, revenue increases as quantity sold increases
When demand is downward sloping, the price (average revenue) is greater than marginal
revenue
For sales to increase, price must fall

21. Average and Marginal
Revenue
Output1 2 3 4 5 6 70
1
2
3
$ per
unit of
output
4
5
6
7
Average Revenue (Demand)
Marginal
Revenue

22. Lost
profit
P1
Q1
Lost
profit
MC
AC
Quantity
$ per
unit of
output
D = AR
MR
P*
Q*
Monopolist’s Output
Decision
P2
Q2

23. Monopolist’s Output Decision
• At output levels below MR = MC, the decrease
in revenue is greater than the decrease in cost
(MR > MC)
• At output levels above MR = MC, the increase
in cost is greater than the decrease in revenue
(MR < MC)

24. Q
Q
C
MC
QQCCost
2
50)( 2





Q
Q
R
MR
QQQQPQR
QQPDemand
240
40)()(
40)(:
2






Monopoly: An Example
10
404
2402




Q
Q
QQ
MRMC
30)(
1040)(
40)(



QP
QP
QQP

25. Monopoly: An Example
• By setting marginal revenue equal to marginal
cost, profit is maximized at P = $30 and Q =
10
• This can be seen graphically by plotting cost,
revenue and profit
– Profit is initially negative when produce little or no
output
– Profit increase and q increase, maximized at
Q*=10

26. Quantity0 5 15 20
$
100
150
200
300
400
50
R
10
Profits
r
r'
c
c’
Example of Profit Maximization
C
When profits are
maximized, slope of
rr’ and cc’ are equal:
MR=MC

27. Profit
AR
MR
MC
AC
Example of Profit
Maximization
Quantity0 5 10 15 20
P=30
$/Q
10
20
40
AC=15
Profit = (P - AC) x Q
= ($30 - $15)(10) =
$150

28. Monopoly in Long run
• Profit maximizing rate of output and selling price is determined by
the equality between MC and MR
(MC=MR)
• Monopolists will NOT STAY IN BUSINESS if s/he makes LOSSES in the
long run.
• May earn SUPERNORMAL PROFIT (more than normal profit) even in
the long run due to entry barrier.
• Size of plant and degree of utilization of plant depends on market
demand.
May reach optimal scale (minimum point of LAC or remain suboptimal scale (falling part of
LAC) or surpass the optimal Scale (expand beyond the minimum LAC) depending on the
market conditions.

29. How to decide about Pricing in Monopoly Market: Thumb Rule for
Pricing






























P
Q
Q
PE
Q
P
P
Q
PP
Q
P
QPMR
T hus
d.3
.2


















d
d
E
PPMR
EQ
P
P
Q
1
.5
1
.4
Total Rev.(R)= PQ
MR= dR/dQ= PdQ/dQ + Q dp/dQ = P+Q.dp/dQ
In the absence of limited knowledge about AR and MR curves,
how to decide about Correct Price and Output?
Equilibrium Condition
Marginal Revenue=Marginal Cost

30. A Rule of Thumb for Pricing
 D
D
D
E
MC
P
EP
MCP
MC
E
PP
11
1
1









 MCMRwheremaximizedis
(P – MC)/P is the markup over MC as a percentage of price
The markup should equal the inverse of the elasticity of
demand
Price is expressed directly as the markup over marginal cost

31. A Rule of Thumb for Pricing
 
12$
75.
9
4
11
9
94
11
9











.
P
MCE
Assume
E
MC
P
d
d

32. Measuring Monopoly Power
• Why to Measure Monopoly Power?
• Monopolist is free to decide about Price and Quantity of
output.
• Implication: Production can be less than required amount
from Social point of view
• In case of Perfect Competition: Price =MC
• Monopoly: Price>MC
• -Rationale to assess the difference between Profit
Maximizing Price and Marginal Cost
• Methods to Measure Monopoly Power
– The Herfindahl Index
– Lerner Index
– Concentration Ratio

33. The Herfindahl Index
• Orris C Herfindahl: 1959
• Takes into entire size distribution of firm
• HI= ∑ Si 2 ; i= 1, 2….., n
n: number of firms in the industry
• Si: Market share of the ith firm (i=1,2…,n)
• Herfindahl Index lies between
0 and 1.
Depends on number of firms ‘n’ in the
industry and variance of market share.
If HI is small: Many firms of equal size
HI closer to 1: indicates a small number of
firms and/or very unequal shares- Greater
Monopoly Power.
• Ex: HI= (0.50)2 + (0.3)2….+(0.04)2
• = 0.3552
Firm Market Share
1 0.5
2 0.3
3 0.1
4 0.06
5 0.04
Total 1

34. Measuring Monopoly Power: Lerner Index
• The Lerner Index (Abba Lerner: 1934):
• L= (Price-MC)/P; 0<L<1
• The larger the value of L the greater the monopoly power
– L is expressed in terms of Ed
• L = (P - MC)/P = (AR-MR)/AR.
• (why? Profit Maximization condition MC=MR and Price =AR)
• =1-(MR/AR)=1 -1/Ed
• Ed is elasticity of demand for a firm, not the market
• In Perfect Competition Ed= infinity, 1/Ed=0--- Firm has no power
to raise price
• In Monopoly:
– If Ed= low, Firm has high degree of Monopoly power

35. Monopoly Power
• Monopoly power, however, does not guarantee
profits
• Profit depends on Average cost relative to price
• One firm may have more monopoly power but lower
profits due to high average costs

36. Thumb Rule for Pricing & Elasticity
• Pricing for any firm with monopoly power:
– If Ed is large, markup is small (firm has little monopoly
power)
– If Ed is small, markup is large (Considerable monopoly
power of the firm)
 dE
MC
P
11


37. D
MR
$/Q
Quantity
MC
Q*
P*
P*-MC
P*
MR
D
$/Q
Quantity
MC
Q*
P*-MC
The more elastic is
demand, the less the
markup.
Elasticity of Demand and Price Markup

38.  
MC.above11%-10aboutsetPrices.5
)(11.1
9.01011
.4
storesindividualfor103.
productSimilar2.
firmsSeveral1.
MC
MCMC
P
Ed




Markup Pricing: Supermarkets &
Convenience Stores
• Supermarkets

39. Markup Pricing: Supermarkets &
Convenience Stores
• Convenience Stores
 
1. Higher prices than supermarkets
2. Convenience differentiates them
3. 5
4. 1.25( )
1 1 5 0.8
5. Prices set about 25% above MC.
d
E
MC MC
P MC
 
  
 

40. Markup Pricing: Supermarkets & Convenience Stores
• Convenience stores have more monopoly
power, higher mark up but failed to make
larger profits. Why?
– Volume is far smaller and average fixed costs are
larger

41. Monopoly & Perfect Competition: A Comparison
Indicators Monopoly Perfect Competition
Goal of Firm Profit Maximization Profit Maximization
Product Homogenous or Heterogeneous
(Discriminating Monopoly change
the product slightly-different binding
of same book, different seats in an
aircraft/ train)
Homogeneous
Barriers to
Entry
Prevails Does not Prevail
(free entry and free exit)
Cost
Conditions
U-Shaped cost curves U-Shaped cost curves
Knowledge
about Market
Perfect Knowledge Perfect Knowledge
Price/Output
Decision
Either sets the price or output not
both
Price is given, decide about
output to be produced
Produce smaller output and sells at a higher price Output may be greater than that of

42. Regulation of Monopoly through Public Policy:
Effect of Tax
Under monopoly, price can sometimes rise by more than the amount of the
tax
• Imposition of Lump-sum tax (license fee, profit tax): Govt. can reduce or
even eliminate MONOPOLIST’s PROFIT without affecting the commodity
price or output (Salvatore:2006)
• Per Unit-Tax: Monopolist’s Profit declines.
– Feasible to shift part of the burden of the per-unit tax to consumers, in the
form of HIGHER PRICE and a SMALLER OUTPUT of the commodity.
• To determine the impact of a tax:
Let a specific tax ‘t’ Rs per unit is levied
New MC = MC + t

43. Quantity
Rs/Q
MC
D = AR
MR
Q0
P0 MC + tax
t
P
Increase in P:
P0 to P1 > tax
Q1
P1
Effect of Excise Tax on Monopolist
Impact of Tax: Lower
Quantity (Q1) & higher
Price (P1) as compared to
Pre-Tax level (Q0 and Po).

44. Effect of Excise Tax on Monopolist
• Amount of PRICE INCREASES with implementation of a TAX
depends on ELASTICITY OF DEMAND
• Price may or may not increase by more than the tax
• Overall Profits for monopolist will fall with a tax

45. Monopolies & Restrictive Trade Practices
• MRTP Act, 1969: To restrict and curb growth of monopoly power in the country
• MRTP Commission set up in 1970
• Govt. imposed restrictions on entry of large business houses in a number of
industries, set up a large number of industries in the business sector, and
encouraged small and medium industries.
• MRTP Act sought to achieve
– Prevention of concentration of economic power
– Prohibition of monopolistic and Restrictive and Unfair Trade Practices
Since 1991, the focus shifted from controlling Monopolies to Promoting Competition.
Why?

46. MRTP Act……
In a liberalised and globalised economy free and fair competition is the basic
requirements for economic success.
In order to achieve ECONOMIES of SCALE for ensuring Higher PRODUCTIVITY and
Competitive advantage in the International Market, MRTP Act was reviewed.
Need to make economic laws that curb practices adversely affecting competition
Competition Act 2002 was introduced in INDIA

47. Constituents of MRTP Act
• Monopolistic Trade Practices:
A Trade practice which can have the effect of Maintaining the price of goods or charges for
the services at an unreasonable level by limiting, reducing or otherwise controlling
Production, supply or distribution of goods
Restrictive Trade Practice:
Trade practices which has the effect of Preventing, Distorting or Restricting Competition in any
manner.
-Tends to obstruct the flow of Capital or resources into the stream of Production
- Tends to Bring about Manipulation of Prices-----Imposition of Unjustified costs or restrictions
on the Consumers.
Unfair Trade Practices (incorporated in 1984)
To promote sale adopt certain strategy which causes loss or injury to the Consumers
Make False representations and Misleading Advertisement regarding goods and services
Selling or supplying sub-Standard, unsafe, hazardous products
Hoarding, Destroying or refusing to sell in order to push up the price level
Publication of any advertisement for sale or supply at bargain price (of goods or services that
are not intended to be offered for sale or supply at the bargain price)

48. Competition Act, 2002
• MRTP Lost relevance in the libearlised scenario
• Only Large companies can survive in the new competitive Market and therefore,
size should not be the cosntraint.
• Focus shifted from CURBING Monopolies to Promoting Comeptition
• A Committee set up (S V S Raghavan)
• OBJECTIVE:
• Prevent Practices having adverse effect on COMPETITION
• To PROMOTE and SUSTAIN Competition in the Market
• To PROTECT interest of CONSUMERS at a large
Prohibition of Anti-Competitive Agreements: No Entreprise.. Shall enter into an
agreement in respect of production, supply etc. …which can affect COMPETITION
Prohibition of Abuse of Dominant Position: NO entreprise shall abuse its dominant
position. Misuse of Dominant Position is prohibited not Dominant Position
Regulation of Combinations (Merger or acquisition): No entreprise shall enter into a
combination which has adverse effect on COMPETITION

49. The Welfare Cost of Monopoly: Issues for Discussion
A monopoly leads to an inefficient allocation of
resources, leading to a failure to maximize total
economic well-being.
The monopolist produces less than the socially
efficient quantity of output.

50. Sum up…….
What did we discuss?
Pure Monopoly: Single seller of a product with no
close substitutes who either sets the
price or the quantity but not both.
Monopoly: Aims at Maximization of Profit
Equilibrium condition: MC=MR and MC cuts MR from
below
Distinction between Monopoly & Perfect Competition:
Monopoly produces lesser quantity and charges higher price as
compared to competitive firm.
Maximization of welfare necessitates regulation of monopoly.

51. Thanks