08-10-2021

Price-output Equilibrium under Monopoly

Monopolist, like a perfectly competitive firm tries to maximize

profits.

A monopolist however faces a downward slopping demand curve (or

AR) and his marginal revenue curve lies below it.

In order to maximize profit, the monopolist will go on producing

additional units of output as long as marginal revenue exceeds
marginal cost.

❑ The firm is in equilibrium at point ‘E’ where

MR=MC, and MC cuts the MR from below.

❑ Hence, the equilibrium price and quantity

determined for the firm is OP and OM
respectively.

❑ Given the average cost (AC) curve, the

monopolist is earning PH profit per unit.

❑ The total profit (super-normal) is equal to

the area PHTS.

1
 08-10-2021

However, it is not guaranteed that the monopolist will always earn abnormal or
supernormal profit.

Depending on his cost situation, he may earn normal profit or incur losses.

The social cost of monopoly

To compare the perfect competitive price and
monopolist price, assume the industry is
operating under constant cost conditions, so
that the LAC is horizontal straight line and the
LMC coincides with it, which is also happens
to be the supply curve of the industry.
Introduce an industry demand curve ‘D’
under perfect competition. Industry supply
and demand determines the industry price at
$3 and sells 6 units.
Now if the market suddenly handed over to a
single private firm, who behaves like a
monopolist.

Taking D as his demand curve, will equate his MC curve (which he faces as the industry
used to face earlier) with his MR at point M, and fixes up the price at $6 and sells 3
units instead of 6, and earn monopoly super normal profit equal to the area RMCF.

2
 08-10-2021

Now, the consumer surplus shrunk to LFR from LCE during perfect competition time. A
part of the earlier consumer surplus, is being transferred to the monopolist as profits,
and the other part equal to the area REM is a deadweight loss on the society.

Numeric Example: Monopolist Profit & Tax

P = 100 – 2q
C = 50 + 20q
a) Find out the profit maximizing price and output of the monopolist
firm
b) Analyse the impact of a sales tax of Rs. 8 per unit on the monopolist
profit

3
 08-10-2021

Price Discrimination
❑Price discrimination is an important feature of monopoly market.

❑It refers to the practice of selling the identical goods at different

prices to different buyers. This is a simple and direct case of price
discrimination.

❑This kind of price discrimination may not be possible everywhere.

In such situations, the monopolist slightly differentiate the product
and charge different prices successfully.

❑Thus, price discrimination is an act of selling varieties of the same

good at price which are not proportional to their marginal costs.

A.C. Pigou has distinguished the following three types of price

discriminations.

1. Price discrimination of the first degree: When the monopolist is able to sell
each separate unit of the output at different prices. This involves maximum
exploitation and called perfect price discrimination.

2. Price Discrimination of the Second degree: When seller charges different

prices to different group/class of customers, the price discrimination of the
second degree is said to be exist. For example a physician charges lower fee to
a poor customer and a higher fee to a rich customer.

3. Price Discrimination of the Third degree: When the seller divides his
buyers into two or more sub markets and charges different price in each sub
market. For example, when a producer sells his product at higher price in the
home market and at a lower price abroad.

4
 08-10-2021

When is Price discrimination Possible & Profitable?

Two fundamental conditions are necessary for the price discrimination

to become possible.
First, when goods cannot be transferred from one market to the other.

Second, when buyers cannot move themselves from the dearer market to the
cheaper market.

Price discrimination to become profitable :

The markets are to be divided in such a way that the elasticity of demand in the
two markets differ, so that higher price can be charged in the relatively inelastic
market.

International price discrimination and dumping

5
 08-10-2021

Numeric Example of a Discriminating monopolist

Given the following demand functions of a discriminating monopolist
and the composite cost function, answer the questions that follow:
P1 = 17 – 2q1
P2 = 25 – 3q2
C = 2 + q1 + q2
a) Find out the equilibrium prices the monopolist would charge in two
different markets and total profit.
b) Find the price elasticity of demand in each market.

Multi-plant Monopolist
A multi-plant monopolist will minimize the total cost of producing the best level of output in the
short run. He equates his output in each plant in such a way that the last unit he produced in each
plant is equal to the MR he would get by selling his output in the common market.

6
 08-10-2021

Numeric example of a multi-plant monopolist

Find out the profit of a multi-plant monopolist firm facing the following
demand and cost functions:
X = 200 – 2p (or P = 100 – X/2)
C1 = 10X1
C2 = 0.25X22