LESSON NO: 10

9-May-12

Pure Monopoly
Monopoly a market with a single firm. Produces and sells a commodity that has no close

substitutes, The firm = industry, no competition. Barriers to entry. The firm is a Price Maker it is free to fix its own price. AR curve or Demand curve is downward sloping, the firm can sell more, but only at a lower price. MR lies below AR.

Emergence of Monopolies
Natural Monopoly: Large scale production (e.g. electricity, railways) high fixed costs, no room for second producer. 2. Geographical Monopoly: raw materials available in certain areas only (jute in Bengal, basmati rice in Himalayan foothills) 3. Patents and copyrights: Microsoft, or IBM, medicines, book publishing, scientific discoveries and inventions. 4. Government Monopoly: Government may give franchise to certain companies. Called de jure monopoly. 5. Raw material control: such as diamonds by De beers in S. Africa.
1.
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Profit maximisation in Monopoly

Monopolist faces a downward sloping D-

curve (AR) Let the cost curves be usual U-shaped curves. Profit maximising conditions apply:
MC = MR, MC

If the monopolist decides how much to produce and sell, the D-curve shows the P at which it should be sold
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Profit maximisation Short Run

C,R
SMC SAC Profit maximising Q = Q1, where MC = MR, MC. Price = OP and TR = P X Q = Op x OQ1 = OPRQ1. TC = AC X Q = OC1 X OQ1 = OC1CQ1. Abnormal profits = C1PRC

P Abnormal Profits C1

C m

AR = D 0 Q1 MR Q 5

Long Run Equilibrium

In the long run, the monopolist experiences Returns to

Scale, and increases production. But he can still control his price. Hence he can still make abnormal profits. These profits attract new competitors, But the monopolist can create barriers to entry, and prevent new competition.
Pre empting licences, Buying copy rights and patents, Mergers with smaller firms. Economics of scale
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Long Run equilibrium - Monopoly and PC

CR
LRMC LRAC

Pm

R Monopoly: Abnormal Profits

ARpc = MRpc LRAC = AR, Normal Profit in PC ARm

C1

C m

C2

Qm

Qpc
MRm

Monopoly Firm 1. Single firm, Price Maker 2. Downward sloping AR curve, MR < AR 3. Higher P, and lower Q 4. Short run Abnormal profits 5. Long run: Abnormal profits 6. Long run: Firm produces at less than efficient level, LAC not minimum 7. Long run: P > MC, so consumers are exploited

Perfect competition Firm 1. Large number of firms, Price taker 2. Straight line AR parallel to X axis, AR = MR 3. Lower P, higher Q 4. Short run Abnormal profits possible 5. Long run: Normal profits 6. Long run: Firm produces at minimum LAC, efficient firm 7. Long run: P = MC, no exploitation of consumers.

Monopoly Power
Lerners Index (Li) is a measure of the exercise of

monopoly power.

Li = (P MC) P E.g. P = Rs.10, and MC = Rs.5, then Li = (10 5)/10 = 5/10 = 50%. If MC = Rs.5, and P = Rs.15, then Li = (15 5)/15 = 10/15 or 66%, So this firm has greater control over the market. In PC Comp. Li = 0 because P = MC, so P MC = 0.
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Price Discrimination

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Price Discrimination
Price discrimination: practice of monopolists of

charging different prices to different consumers for the same or similar commodities, without significant differences in the costs. Monopolist wants to take away or reduce consumers surplus. This is possible when there are different buyers who cannot communicate with each other, Or when it is not possible for buyers to trade with each other.
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Price Discrimination
Based on: a) Geographical distances: prices of text books in USA > prices in India or Europe, b) Income differences: Medical services, higher for rich, and lower for poorer citizens. c) Different age groups: less for senior citizens, children, more for others (e.g. railways) d) Quality: e.g. hard bound books more expensive than paper back. e) Time: Peak time airline tickets > off time tickets, or early bird tickets.
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First degree Price Discrimination

The monopolist takes

away the entire consumer surplus. Charges the highest possible price. Highly luxurious goods e.g. Rolls Royce, or collectors items such as rare paintings, etc. Take it or leave it policy

P1

No consumers surplus.

D 0 Q1 13 Q

Second degree Price Discrimination

Here the firm charges different rates for different

users of the same commodity by dividing consumers into different categories:

Timings (e.g. railway/airline tickets cheaper for

night travel, or during non-peak timings). Age: lower charges for senior citizens or for children below 14 years. Perceived quality: hard bound books costlier than paper back.

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Second degree Price Discrimination

Time: premier rates higher for new films, or

concerts, lower rates as time passes. Position: lower rates for front seats in a theatre, or economy class , 2nd class in trains. As compared to first class or AC.

People in different categories cannot buy at lower rates and sell to others at higher rates. Some but not all of consumers surplus is taken away by the monopolist.
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Second degree Price Discrimination

Each unit (e.g. ticket) sold

at a different price. TR of 3 units = 500 + 400 + 300 = 1200 If MC = MR gives P = 300. Uniform price Then TR = 300 X 3 = 900 With price discrimination, the firm earns 300 Rs more, without any extra cost.

P1 = 500 P2 = 400

MC

P3 = 300

D =MR 0 Q1 Q2 Q3

Q The blue triangles show that the monopolist cannot take away the entire consumers surplus 16

Third Degree Price Discrimination

When there are two or more different markets. Separated from each other in terms of space, time, or income levels. (e.g. in posh areas, and in low income areas, premier tickets)

The elasticity of demand is different in each market.

The high income market has less elastic demand,

The low income market has more elastic demand.

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Third Degree Price Discrimination

P P P

PB
PB T

AC = MC

ARa 0 QA MRa 0 QB MRb

ARb 0 QA+QB MONOPOLIST FIRM MR a+b 18

MARKET A

MARKET B

Third degree Price Discrimination

There are two unconnected markets A and B Market A has inelastic D curve, Market B has elastic D

curve. The monopolist produces the commodity with constant costs (MC = AC). At the firm level, profit maximising Q is determined at T = QA+QB. He sells QB in Market B at price PB, and QA in Market A at price PA. QA < QB, while PA > PB. Market with more elastic D, has lower P, market with inelastic demand has higher P. Thus the monopolist can make more profits by selling in two different markets at two different prices.
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Control of Monopoly
Monopoly is discouraged by Governments, as it

leads to exploitation of consumers. Anti Monopoly Laws, Laws to encourage Competition (MRTP Act, and Competition Act 2002 in India), Anti Restrictive Practices Acts, passed in many countries. Or the Government can tax away the extra profits of monopolists through both direct profit taxes, or through indirect taxes, and use the tax revenue for other welfare purposes.
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Questions
1.

Short Answer Questions: 1. What are the main features of Monopoly? 2. What are the factors that lead to the emergence of Monopoly? 3. What is meant by barriers to entry? What type of barriers can be put up by a monopoly firm? 4. What is Monopoly Power and how is it measured? 5. What are the methods used by Governments to regulate monopoly?
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2. Essay Questions: 1. Depict the long run equilibrium of a Monopoly Firm. How does it differ from a firm in P.C? 2. What is Price Discrimination? Explain the different types of price discrimination that can be carried out by a monopolist. 3. Why is monopoly considered to be less efficient than perfect competition? Give reasons for your answer.

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