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Monopoly Dr. Kishor Bhanushali Faculty – Economics IBS-Ahmedabad

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Monopoly is a market structure in which there is a single seller, there are no close substitutes for the commodity it produces and there are barriers to entry The distinction between the firm and industry disappear under conditions of monopoly The cross elasticity of demand between the product of the monopolists and the products of other producers must be very low Main causes that lead to monopoly Ownership of strategic raw materials or exclusive knowledge of production techniques Patent rights for the product or production process Government licensing Size of the market Pricing policy of existing firms

Average and Marginal Revenue P = a – bQ

R = aQ – bQ2 MR = ∂R --∂Q = a – 2bQ Slope of the demand curve is –b and that of MR curve is -2b

P

AR & MR

AR (D) MR 0 The slope of MR Curve is double the slope of demand curve

Quantity

Price Output Determination under Monopoly Y

MC

Revenue & Cost

P

P’ Profit

T

L

AC

Price output analysis in the case of monopoly is also an analysis of the equilibrium of the firm and industry under monopoly

E AR MR

0

M

Output

Few Properties of Equilibrium under Monopoly 1. Like a perfectly competitive firms operating in the short run, the monopolists either earn excess profit or incurs losses or only normal profit. 2. The monopolist can also produced at the minimum points if the AC curve, though he will not earn normal profit at that point. He will earn more than normal profit 3. Like perfect competition, monopolists can earn even negative profits. In the long run monopolists will either earn normal profits or more than normal profits. But a perfectly competitive firm in the long run earns only normal profits and neither more nor less 4. Under prefect competition, price = MR = MC, while under monopoly MR=MC. Under monopoly, price>MR. hence under monopoly, price >MC 5. If the MC curve is a horizontal straight line, equilibrium of the firm under perfect competition remains indeterminate. However this is not the case under monopoly. Even if the MC curve is horizontal, the equilibrium level of output is determined 6. Monopolist does not operate on that portion of the demand curve which is inelastic i.e. where the elasticity of demand is less than unity

Price Discrimination When a monopolists charges different prices form different buyers for the same good, he is known as a discriminating monopolist Price discrimination is not possible under perfect competition because every one knows the price at which the good is being bought and sold Two conditions must be fulfilled for price discrimination to be possible (1) Markets must be divided into submarkets with different price elasticities (2) there must be effective separation of the submarkets so that no reselling can take place from a low priced market to a high price market Types of Price Discrimination (a) Personal (b) local (c) according to trade or use

When Price Discrimination is Possible When consumers have certain preference or prejudices Nature of good – direct services When consumers are separated by distances or tariff barriers Government regulations – Railways, Electricity Ignorance of the consumers Same service for different purposes Special orders Possible only in imperfect competition

Types of Price Discrimination First-degree discrimination involves charging of maximum prices possible for each unit of output Second degree price discrimination, instead of setting different prices for each units, involve the pricing based on the quantities of output purchased by individual consumers Third degree price discrimination involves the separating the consumers or markets in terms of their price elasticity of demand

When Price Discrimination if Profitable Price discrimination is profitable only if elasticity of demand in one market is different from elasticity of demand in the other Marginal Cost of Total Output = Combined Marginal Revenue Marginal Revenue in Market A = Marginal Revenue in Market B = Marginal Cost

In order to maximize profit the monopolist will distribute his output in the two market in such a way that the MR is the same in both the markets as is equal to the MC. So long as MR1>MR2 it will be profitable for the monopolist to shift one unit from second market to the first market as it increase his total revenue

Equilibrium of a Discriminating Monopolist P, AR. MR

P, AR. MR

P, AR. MR

MC

P2 E

P1 AR

AR 0

Q1

MR

MR

MR Q1

0

Q2

Q2

Q 0

Q = Q1+Q2

Effect of a Shift in the Demand on Monopoly In a perfectly competitive market, the demand curve is downward sloping and the supply curve is upward rising, and upward shift of demand curve will increase the equilibrium price and the equilibrium level of output However in the case of monopoly, an upward shift of the demand curve. MC curve remaining the same, will increase the equilibrium output but the effect on equilibrium price is indeterminate. It may increase, decrease or remain constant depending on the extent of shift in the demand curve and the change in the elasticity

Effect of Shift in Cost In the case of increase in the fixed cost, there will be no impact on the equilibrium prices and output, since the fixed cost when differentiated, in other words, when fixed cost increases, it will have no impact on the MC curve. Hence the equilibrium will remain the same. In the case of increase in the variable cost the MC curve will shift to the left. i.e. in the upwards direction. Given the MR curve this will lead to an increase in the equilibrium price and a decrease in the equilibrium level of output. The extent by which the price will rise and the quantity will decrease depends on the slope of the MR curve.

Imposition of Lump Sum Tax Under Monopoly Imposition of Lump Sum Tax will reduce the excess profit of the monopolist because it will increase its fixed total cost. However the MC curve of the monopolist will not be affected, and hence the equilibrium in the monopoly market will remain the same even in the long run (Provided that lump sum tax does not exceed the supernormal profits of the monopolist)

Imposition of Profit Tax Under Monopoly Imposition of a profit tax on the profit of the monopolist are the same as in the case of the lump sum tax. The profit reduces the subnormal profit, but the equilibrium in the market is not affected, so long as the profit tax does not bite into the normal profits of the monopolists.

Imposition of Specific Sales Tax Under Monopoly The imposition of specific tax will shift the MC curve of the monopolist upward, which will result in a change in his equilibrium; in the new position the prices will be higher and the quantity smaller as compared with the initial equilibrium. This is the same qualitative prediction with the model of perfect competition

Measure of Monopoly Power By monopoly power we mean the amount of discretion which a producer or a seller enjoys in regard to the framing of his price and output policies Monopoly power indicates the degree of control which a seller or producer yields over the price and output of his product It also indicates the deviation form perfect competition. Prof. Lerner’s Measure: the difference between price and MC indicates the deviation from perfect competition. Greater the difference the greater is the degree of monopoly power Monopoly Power = P – MC P

Prof. Triffin: Cross Elasticity of Demand as a measure Lower is the value of cross price elasticity of demand, the greater will be the degree of monopoly power and vice versa Rothchild’s Index of degree of monopoly power shows how far a particular firm controls the market for a particular good.