Monopoly

Monopoly
 Pure monopoly is the form of market organisation in which there is a
single seller of a commodity for which there are no close substitutes
and there are barriers to entry
 The firm is the industry and faces the negatively sloped industry
demand curve for the commodity
 The monopolist must lower its price to sell more of the commodity
 Under monopoly, and the curve lies below the demand
curve

Sources of Monopoly
 Ownership of strategic raw materials: Complete or large control over
necessary inputs for production causes some companies to be the
sole power in an industry, as competitors cannot form due to the lack
of inputs
 Exclusive knowledge of production techniques
 Patent: A patent typically confers the right to exclusive benefit from all
exchanges involving the invention to which it applies. Patent rights for
a product or for a production process leads to monopoly.
 Government licensing: Government or local authorities can grant
licenses for firms in certain areas so they gain exclusive rights of
operations.
 Imposition of foreign trade barriers to exclude foreign competitors

Sources of Monopoly
 Economies of Scale: If the LAC is downward sloping, it is rational to
have only a single producer in the market. This is called a natural
monopoly, as every additional competitor makes production costlier
and more wasteful. This mainly because of limited size of the market
– technology to have economies of scale require only single plant
(e.g., Electricity, communication, transportation etc.) – an example of
natural monopoly.
 Limit-pricing policy: Limit pricing involves reducing
the price sufficiently to deter entry – implementing such policy along
with heavy advertising or continuous product differentiation make
entry unattractive.

Sources of Monopoly
For an effective limit pricing, the
monopolist needs to decrease the
price to the point where a new firm
will not be able to make any profit
on entering the market. By reducing
the price to , the new firm
sacrifices supernormal profit in the
short-run. But, the price is low
enough to discourage a new firm
entering. At , a new firm faces
average costs higher than the
market price

Features of Monopoly
 Lack of close substitutes: One firm produces a good without any close substitutes.
 Barriers to entry: There are significant barriers to entry set up by the monopolist
because of any of the sources of the monopoly.
 There are no close competitors in the market for that product.
 The monopolist decides the price of the product since it has the market power. This
makes the monopolist a price maker.
 Because of the special characteristics of monopoly, the monopolist is able to make
super normal profit.
 Price discrimination: According to the market situation, the monopolist is able to set
price. In an elastic market, the monopolist will sell at a lower price to sell high
quantity of output. Likewise, in a relatively inelastic market, the firm will be able to
set a high price.

Short run Equilibrium
Profit maximisation is the primary objective of any firm. For a monopolist two
conditions need to be satisfied for maximising profit.
 𝑀𝐶 is equal to the 𝑀𝑅
 The slope of 𝑀𝐶 is greater than the slope of the 𝑀𝑅 at the point intersection.

 The equilibrium of the monopolist is defined
by point 𝜀, at which the MC intersects the MR
curve from below, where the slope of the MC
is greater than MR.
 At this point both the conditions for
equilibrium (profit maximisation) are fulfilled.
 The equilibrium price is 𝑃 and equilibrium
quantity is 𝑋 .
 At this level, the monopolist is able to make
excess profits equal to the shaded area
𝐴𝑃 𝐶𝐵.
 At this level, price is higher than marginal
revenue.

 For a monopolist, the firm can set price and
output unlike pure competition.
 Given the downward-sloping demand curve,
the two decisions are interdependent.
 The monopolist will either set his price and
sell the amount that the market will take at
it
 ..or he will produce the output defined by the
intersection of 𝑀𝐶 and 𝑀𝑅, which will be
sold at the corresponding price, 𝑃
 The monopolist cannot decide
independently both the quantity and the
price at which he wants to sell it.

Long run Equilibrium
 In the long run the monopolist has the time to expand his plant, or to use his existing
plant at any level which will maximise his profit.
 With entry blocked, however, it is not necessary for the monopolist to reach an optimal
scale (that is to build up his plant until he reaches the minimum point of the 𝐿𝐴𝐶).
 It is also to be noted that, the firm may not use his plant at optimum capacity.
 However, the monopolist will not stay in business if he makes losses in the long run.
 Size of the plant and the degree of utilisation of any given plant size depend entirely on
the market demand
 He may reach the optimal scale (minimum point of LAC)
 The monopolist remains at suboptimal scale (falling par of his LAC) or surpass the
optimal scale (expand beyond the minimum LAC) depending on the market conditions.

Long run Equilibrium
 In the long run, a monopolist will remain
in business only if he or she can make a
profit by producing the best level of
output in the long run is given by the
point where the 𝐿𝑀𝐶 curve intersects the
𝑀𝑅 curve from below (𝑋 ).
 The appropriate scale of plant is the
one whose 𝑆𝐴𝐶 curve is tangent to
the 𝐿𝐴𝐶 curve at the best level of
output.
 The difference between price and
average cost explains the volume of
profit.
 at long run equilibrium
𝑆𝑀𝐶 = 𝐿𝑀𝐶 = 𝑀𝑅

Price Discrimination
 Price discrimination is the practice of charging a different price for the same good or
service.
 The product is basically the same, but it may have slight differences
E.g., different location of seats in a theatre, different classes of seats in an
aircraft etc.
 i.e., a monopolist produces identical products produced at the same cost, selling at
different prices, depending on the preference of the buyers, their income, their
location and the ease of availability of substitutes.
 It is also common to charge different prices for the same product at different time
periods.
 Three types of price discrimination – first-degree, second-degree, and third-degree
price discrimination.

Types of Price Discrimination
First degree price discrimination
charging whatever the market will bear
Second degree price discrimination
quantity discounts or versioning
Third degree price discrimination
separate markets and customer groups

Price Discrimination of the First Degree
 Price discrimination of the first degree is also known as perfect price discrimination.
 This type of price discrimination occurs when the monopolist is able to sell each
separate unit of the product at a different price.
 It is based on the sellers ability to determine exactly how much each and every
customer is willing to pay for a good.
 Different consumers have different preferences and levels of purchasing power and
thus the amount they would be willing to pay for a good often exceeds a single
competitive price.
 This difference between what a consumer is willing to pay and the price actually paid
is known as consumers surplus.
 Thus the firm is able to charge the maximum possible price for each unit which
enables the firm to capture all available consumer surplus for itself.

Price Discrimination of the First Degree
 The seller will take the time to bargain
with the customer about the price that
customer is willing to pay
 Some buyers willing to pay a higher
price other buyers a lower price
 The firm will sell a quantity of output
' 𝑄 ∗' up to the point where the price
of the last unit sold just covers the
marginal costs of production.
 The difference between the price
charged on each unit and the average
costs of producing ' Q*' units of
output will be the firm's profits.

Price Discrimination of the Second Degree
 Second-degree price discrimination means charging a different price for different
quantities, such as quantity discounts for bulk purchases
 The seller charges a higher per-unit price for fewer units sold and a lower per-unit price
for larger quantities purchased.
 The seller is attempting to extract some of the consumer's surplus value as profits with
residual surplus remaining with the consumer over and above the actual price paid
 The firm will produce a level of output where the price charged just covers the marginal
costs of production.

Price Discrimination of the Second Degree
 The figure shows a firm charging three different
prices for the same product.
 The price 𝑃 is charged per unit if the buyer chooses
to buy 𝑄 units of the good.
 A lower price 𝑃 is charged for a greater
quantity 𝑄 and the price 𝑃 is charged for the
quantity 𝑄∗
(the level of output such that 𝑃

Price Discrimination of the Third Degree
 Third-degree price discrimination means charging a different price to different
consumer groups.
E.g.,
 Rail travellers can be subdivided into commuter (season ticket) and casual travellers
 Cinema goers can be subdivided into adults and children
 Splitting the market into peak and off-peak use

Price Discrimination of the Third Degree
 The increase in total revenue is achieved by
taking away part of the consumers’ surplus.
 𝐷𝐷’ is the demand curve.
 If the monopolist sold all 𝑂𝑋 at 𝑃 he would
received 𝑂𝑋𝐴𝑃
 The consumers would have a surplus
of 𝑃𝐴𝐷.
 Assume that the monopolist sells 𝑂𝑋 at the
price 𝑃 and the remaining quantity of 𝑋 𝑋 at
the price P; then the total revenue will be
0𝑋 + 𝐶𝑃 + 𝑋 𝑋𝐴𝐵 = 𝑂𝑋𝐴𝑃 + 𝑃𝐵𝐶𝑃

Price and output determination under discriminating monopoly
 The very objective of the monopolist to apply price discrimination is to obtain an
increase in his total revenue and his profits.
 By selling the quantity defined by the equation of his 𝑀𝐶 and 𝑀𝑅 at different prices
the monopolist realises a higher total revenue and hence a higher profit too.
 Assume that the monopolist will sell his product in two segregated markets, each of
them having a demand curve with different elasticity.

 The demand curve 𝐷 has higher price
elasticity than 𝐷 at any given price.
 The total demand curve is the horizontal
summation of 𝐷 and 𝐷 .
 The aggregate marginal revenue curve is the
horizontal summation of 𝑀𝑅 and 𝑀𝑅
 𝑀𝐶 is the marginal cost curve.
 The price discriminating monopolist has to
decide
(a)The total output that he must produce
(b) How much to sell in each market and at
what prices, so as to maximise his profits.

MC=MR
ε1 ε2
ε
P
C
P2
P
P1
F’ C
D A
E
MC
D = D1 + D2
X1 X2
X X
MR = MR1 + MR2
MR1
MR2
0
B

 The total quantity to be produced is defined by
the point of intersection of the 𝑀𝐶 and the
aggregate 𝑀𝑅 curve of the monopolist.
 The two curves intersect at point 𝜀 and the
total output the firm must produce is 0𝑋.
 If the monopolist charges a uniform price, then
the price will be 𝑃 and his total revenue would
be 0𝑋𝐴𝑃
 His profit would be the difference between this
revenue and the cost for producing 0𝑋
 On the other hand, if the monopolist charges
different prices in the two markets, he can
achieve higher profit.
MC=MR
ε1 ε2
ε
P
C
P2
P
P1
F’ C
D A
E
MC
D = D1 + D2
X1 X2
X X
MR = MR1 + MR2
MR1
MR2
0
B

 In each market he must equate the
(corresponding) 𝑀𝑅 curve with the 𝑀𝐶.
 Marginal cost is the same for the whole
quantity produced.
 The marginal revenue in each market differs
due to the difference in the elasticity of the two
demand curves.
 The profit in each market is maximised by
equating 𝑀𝐶 to the corresponding 𝑀𝑅:
 In the first market profit is maximised when
𝑀𝑅 = 𝑀𝐶
 In the second market profit is maximised when
𝑀𝑅 = 𝑀𝐶
MC=MR
ε1 ε2
ε
P
C
P2
P
P1
F’ C
D A
E
MC
D = D1 + D2
X1 X2
X X
MR = MR1 + MR2
MR1
MR2
0
B

 The total profit is maximised when the monopolist equates
the common MC to the individual marginal revenues
𝑀𝐶 = 𝑀𝑅 = 𝑀𝑅
 The determination of prices quantities
Draw a line perpendicular to the price axis from the
equilibrium point 𝜀.
𝑀𝐶 = 𝑀𝑅 = 𝑀𝑅
 From 𝜀 and 𝜀 we draw vertical lines to the quantity axis
and we extend them upwards until then meet the demand
curves 𝐷 and 𝐷 respectively.
 In the first market the monopolist will sell 0𝑋 at price 𝑃 ,
and the second market the monopolist will sell 0𝑋 at the
price 𝑃 .
0𝑋 + 0𝑋 = 0𝑋
With price discrimination the total revenue is
𝑃 0𝑋 + 𝑃 0𝑋 = 0𝑃 𝐹𝑋 + 0𝑃 𝐸𝑋
MC=MR
ε1 ε2
ε
P
C
P2
P
P1
F’ C
D A
E
MC
D = D1 + D2
X1 X2
X X
MR = MR1 + MR2
MR1
MR2
0
B

Comparing
𝑃 0𝑋 + 𝑃 0𝑋 = 0𝑃 𝐹𝑋 + 0𝑃 𝐸𝑋
with the revenue from the unique price 𝑃 we
have
Revenue from 𝑃:
𝑅 = 𝑂𝑋𝐴𝑃 = 𝑂𝑋 𝐷𝑃 + 𝑋 𝑋𝐵𝐶 + 𝐶𝐵𝐴𝐷
Revenue from 𝑃 and 𝑃 :
𝑅 = 𝑂𝑋 𝐹𝑃 + 0𝑋 𝐸𝑃
.. but
𝑂𝑋 𝐹𝑃 = 𝑋 𝑋𝐵𝐶
and
0𝑋 𝐸𝑃 = 𝑂𝑋 𝐷𝑃 + 𝑃𝐷𝐸𝑃
MC=MR
ε1 ε2
ε
P
C
P2
P
P1
F’ C
D A
E
MC
D = D1 + D2
X1 X2
X X
MR = MR1 + MR2
MR1
MR2
0
B

Therefore
𝑅 = 𝑋 𝑋𝐵𝐶 + 𝑂𝑋 𝐷𝑃 + 𝑃𝐷𝐸𝑃
𝑅 − 𝑅
= 𝑋 𝑋𝐵𝐶 + 𝑂𝑋 𝐷𝑃 + 𝑃𝐷𝐸𝑃 − [𝑂𝑋 𝐷𝑃 + 𝑋 𝑋𝐵𝐶
+ 𝐶𝐵𝐴𝐷]
= 𝑃𝐷𝐸𝑃 − 𝐶𝐵𝐴𝐷
Since 𝐶𝐵𝐴𝐷 < 𝑃𝐷𝐸𝑃 ; 𝑅 > 𝑅
MC=MR
ε1 ε2
ε
P
C
P2
P
P1
F’ C
D A
E
MC
D = D1 + D2
X1 X2
X X
MR = MR1 + MR2
MR1
MR2
0
B

Dumping
 Dumping is yet another form of price discrimination
 When a monopolist sells products at higher price in the home market
and lower prices in the international market, it is called dumping
 The monopolist does so mainly for managing excess inventory with a
view to maximise his profits
 Dumping is done in case of international trade in which a firm exports
its products at a price lower than the price it charges in its own
country

Dumping
A monopolist has following motives for dumping
 To dispose an excess stock produced due to wrong
judgment of demand
 To develop new trade relations with countries
 To benefit from economies of scale

Dumping
 𝐴𝑅 is Average revenue in home market
 𝑀𝑅 = marginal revenue in home market
 𝐴𝑅 = 𝑀𝑅 which is equal to Foreign
market demand curve
 𝑃 = Price in home market (monopoly
price)
 𝑃 = Price in world market (competitive
price)

Dumping
 Price in world market (competitive price).
The figure represents two markets faced by
a monopolist.
 One is home market and the other one is
foreign (world) market.
 There is an assumption that, the monopolist
is having monopoly in the domestic market
 In the world market the firm is facing perfect
competition
 The monopolist, by definition is at
equilibrium when 𝑀𝐶 = 𝑀𝑅

Dumping
 the monopolist is at equilibrium at point 𝐸,
where 𝑀𝐶 = 𝑀𝑅.
 The quantity of output, the firm can sell is
𝑄 .
 Out of which 𝑂𝑄 quantity of output is sold
at 𝑃 price in the home country
 𝑄 𝑄 output in the world market at 𝑃
price
 Here the price charged in the foreign
country is comparatively higher than that of
the domestic country.

Monopsony
 A monopsony is a market condition in which there is only
one buyer, the monopsonist
 Monopsony also has imperfect market conditions as in the
case of monopoly
 A single buyer dominates a monopsonised market.

Bilateral Monopoly
 Bilateral monopoly is a market consisting of a single seller
(monopolist) and a single buyer (monopsonist).
 The equilibrium in such a market cannot be determined by the
traditional tools of demand and supply.
 non-economic factors like bargaining power, skill and other strategies
of the participant firms have also to be considered.
 These non-economic factors are considered as exogenously
determined.

Bilateral Monopoly
 The equilibrium of the monopolist
(producer) is defined at the level where
𝑀𝐶 = 𝑀𝑅
 He is able maximise profit if he produces
𝑋 quantity of output and sell it at 𝑃
price.
 But it is not possible as he sells the
product in a market where there are no
large number of buyers. Instead there is
only one buyer.
Consider such a market where there is a monopolist and a monopsonist. Both firms are assumed to
maximise their profit.
P1
P*
P2
e
ME
MC
MR
X0
X2 X1
X*
b
D
e1
a
P
C

Bilateral Monopoly
 The buyer (monopsonist) also tries to
maximise his profit.
 𝑀𝐶 curve of the producer (monopolist)
is the supply curve of the buyer.
 As the monopsonist increases his
purchases, the price he will have to pay
rises
 The 𝑀𝐶(= 𝑆) curve shows the quantity
that the seller (monopolist) is willing to
supply at various prices.
P1
P*
P2
e
ME
MC
MR
X0
X2 X1
X*
b
D
e1
a
P
C

Bilateral Monopoly
 The increase in the expenditure of the
buyer (his marginal outlay or marginal
expenditure) caused by the increases in
his purchases is shown by the curve 𝑀𝐸
 The product is considered as an input or
an equipment for the buyer
 𝑀𝐸 is the marginal cost of the input for
the monopsonist (buyer).
 In order to maximise his profit, he would
like to purchase additional units of 𝑋 until
his marginal outlay is equal to his price as
determined by the demand curve 𝐷𝐷
 The equilibrium of the monopsonist is
shown by point 𝑒
P1
P*
P2
e
ME
MC
MR
X0
X2 X1
X*
b
D
e1
a
P
C

Bilateral Monopoly
 The equilibrium of the monopsonist is
shown by point 𝑒
 That is, he would like to purchase 𝑋 units
of the input at a price 𝑃 , determined by
point 𝑎 on the supply curve 𝑀𝐶(= 𝑆).
 The monopsonist buys from a monopolist,
who wants to charge 𝑃 price.
 The buyer wants to pay only 𝑃 while the
seller wants to charge 𝑃
 Thus, there is an indeterminacy in the
market.
 The two firms, eventually will be settled
somewhere in the range between 𝑃 and
𝑃 , (𝑃 ≤ 𝑃 ≤ 𝑃 ), depending on the
bargaining skill and power of the firms.
P1
P*
P2
e
ME
MC
MR
X0
X2 X1
X*
b
D
e1
a
P
C

Determining the Social Cost of Monopoly
 Under perfect competition allocation of resources is optimum and therefore social
welfare is maximum
 Under monopoly resources are misallocated causing loss of social welfare.
 When an industry is monopolised, price rises above and output falls below the
competitive level
 The monopolist gains at the expense of consumers, for they have to pay a price
higher than marginal cost of production.
 Those who continue to buy the product at the higher price suffer a loss, but this loss
is exactly offset by the additional revenue that the monopolist obtains by charging
the higher price.
 This results in loss of consumers’ welfare.

 To measure welfare gain or loss some economists have used the
concept of consumer’s surplus
 Consumer’s surplus is price which consumers are prepared to pay for
a commodity over and above what they actually pay for it.
 Other consumers, who are deflected by the higher price to substitute
goods, suffer a loss, that is not offset by gains to the monopolist.
 This is the "deadweight loss" from monopoly is the social cost of
monopoly.

 Under perfect competition 𝐴𝐶 = 𝑀𝐶 = 𝑃
 Competitive price is 0𝑃 and output is
0𝑄
 𝑃 = 𝑀𝐶
 Consumers Surplus; 𝑇𝐾𝑃
 For monopolist 𝑀𝐶 = 𝑀𝑅
 Monopoly Price is 0𝑃 ; and Output is 0𝑀
 The Monopoly profit is 𝑃 𝐿𝐸𝑃
 The consumer's surplus is reduced to
𝑇𝐿𝑃
Pc
Pm
L
K
E
0
M Q
MR
AC = MC
D
Monopoly gain
Dead Weight Loss
T
P
X
C

 Consumer’s surplus: 𝑇𝐿𝑃
 Loss of consumer’s surplus: 𝑃 𝐾𝐿𝑃
 Monopolist Profit: 𝑃 𝐿𝐸𝑃
 𝑃 𝐾𝐿𝑃 > 𝑃 𝐿𝐸𝑃
 𝑃 𝐾𝐿𝑃 − 𝑃 𝐿𝐸𝑃 = 𝐿𝐾𝐸
 Loss of Consumer’s surplus
 𝑃 𝐿𝐸𝑃 (profit by monopolist at the expense of
the consumers)
 𝐿𝐾𝐸 (Allocative inefficiency caused by the
monopolist by reducing output of the product
and raising its price
 𝐿𝐾𝐸 – Dead-weight loss of welfare –
 Social cost of Monopoly
Pc
Pm
L
K
E
0
M Q
MR
AC = MC
D
Monopoly gain
Dead Weight Loss
T
P
X
C

 For the consumer, the value of the
product is more than the ‘opportunity
cost’ – or the marginal cost
 For an additional unit of 𝑀𝑄 consumer is
willing to pay more than the 𝑀𝐶
 This is the additional consumer surplus
 This additional consumer surplus is the
area 𝐿𝐾𝐸, if the output is extended to 0𝑄
 But monopolist would not extend his
output as maximise his profit at
0𝑀output as 𝑀𝐶 > 𝑀𝑅
 Thus 𝐿𝐾𝐸 is the net loss of consumer
welfare
Pc
Pm
L
K
E
0
M Q
MR
AC = MC
D
Monopoly gain
Dead Weight Loss
T
P
X
C

 𝐿𝐾𝐸 is the area where no one else is
gaining.
 Suppose, if we distribute the monopolist
profit among consumers, the loss
represented by the area 𝐿𝐾𝐸 remains as
it is – showing allocative inefficiency of
monopoly.
 Thus it is called Dead-weight LossPc
Pm
L
K
E
0
M Q
MR
AC = MC
D
Monopoly gain
Dead Weight Loss
T
P
X
C

Regulation of Monopoly
 Monopolies derive their market power from barriers to entry
 Natural monopolies arise in industries with large economies of scale, i.e., high entry
cost. (MES exceeds market demand) – Only one firm survives.
 The Minimum Efficient Scale (MES) is the lowest scale necessary for achieving
economies of scale.
 The minimum efficient scale can only be achieved at very high levels of output
relative to the whole industry – not many firms can survive
 Natural monopoly arises when the market size is small relative to the optimal size of
plant, in which the market cannot support more than one optimally-sized firm.
 It may be cheaper for one firm to produce all of the industry output than for many
small firms to produce some fraction thereof.

Why monopolies need to be regulated?
 The monopolist does not produce at full capacity – charges and high price and
produce less output
 As there is no rival competitor, they make supernormal profit – increase inequality in
income distribution
 Increase the producers surplus at the expense of both consumers and society
 Deadweight loss lead to inefficiency in the allocation of resources
 Monopolies often don't produce a product that would be most desirable by society,
because they do not have to worry about competition
 As they reduce the economic wealth of society in many ways.
 Hence, governments regulate monopolies with the objective of benefiting societies

Methods to control Monopoly
 Regulation through taxation – specific tax or lumpsum tax
 Removing or lowering barriers to entry through antitrust laws so that
other firms can enter the market to compete;
 Regulating the prices that the monopoly can charge
 Regulating the price that the private monopolist is allowed to charge – or the
levels of different prices, if price discrimination is followed
 Operating the monopoly as a public enterprise.
 Government intervention – undertaking operation of the plant
 Here the government has the role to set price/prices

Determination of price and output under regulated monopoly
 The price will be set below the profit-maximising
𝑃 , where 𝑀𝐶 = 𝑀𝑅
 At 𝑃 price – excess profit (exploitation of the
buyers)
 Hence regulation is needed
How?
1. The government may set price at the level of
the 𝑀𝐶 (= 𝑃), at price 𝑃 , leads to higher level
of output at 𝑋 , by allowing certain level of
excess profit.
2. The government may set price equal to 𝐴𝐶
= 𝑃 , at price 𝑃 , leads to more output at 𝑋 ,
but with only normal profit – a fair return
P
C
D
MC
AC
PM
P1
P2
0
XM
MR
X1 X2
D
X
P = MC
P = AC
Ajit Sinha

Government – Regulated Monopoly
 The government may apply a price discrimination scheme
 This solution has wide applications in public utilities like electricity, gas, railways,
communications and other government-regulated monopolies.
 The purpose of regulation is to improve resource allocation
 In certain cases government will regulate a monopoly by actually owning it
 these monopolies are operated by bureaucrats, so they have little incentive to operate the business
efficiently or to provide good service to the taxpayer
 the bureaucrats act as a special interest group who seeks to enrich themselves at taxpayers'
expense (high salaries and lush pensions)
 Effective government intervention and a fair price discrimination are essential for
ensuring equity and redistribution of income, and of economic allocation or
resources.

Monopoly

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