Economics Optional | Rohit Sehrawat

Monopoly

Monopoly versus Competition

Marginal revenue for monopolies is very different from marginal revenue for
competitive firms. When a monopoly increases the amount it sells, this action
has two effects on total revenue (P 3 Q):
1. The output effect: More output is sold, so Q is higher, which tends to
increase total revenue.
2. The price effect: The price falls, so P is lower, which tends to decrease
total revenue.
Because a competitive firm can sell all it wants at the market price, there is no
price effect. When it increases production by 1 unit, it receives the market
price for that unit, and it does not receive any less for the units it was already
selling. That is, because the competitive firm is a price taker, its marginal
revenue equals the price of its good. By contrast, when a monopoly increases
production by 1 unit, it must reduce the price it charges for every unit it sells,
and this cut in price reduces revenue on the units it was already selling. As a
result, a monopoly’s marginal revenue is less than its price.

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Profit Maximization for a Monopolist

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Sources of
Monoploy Power

Technical Barrier Legal Barrier

Monopoly arises due to barriers to entry, which can be technical barrier or legal
barrier.
A primary technical barrier is that production of good may exhibit decreasing
AC & MC over wide range of output. The technology of production is such that
relatively large-scale firms are low-cost producers. In this situation one firm may
find it profitable to drive others out of industry by reducing price (natural
monopoly).
Note: - Generally natural monopoly arise in those Industries where fixed cost of
production is very high and economics of scale are realized up to large scale of
output.

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In the case of natural monopoly price is generally regulated by regulatory

agency. However, problem for regulatory agency is that at what level price
should be determined. If regulatory agency tries to fix efficient price = P = MC
then there will be continuous loss for monopolist.
Monopolists can operate in loss provided it is subsidized by government
therefore price should be at least equal to average cost which include normal
rate of return on capital.
Another technical barrier is special knowledge of Low-cost production
technique. In addition, monopoly arises due to legal barrier which could be
created by giving patent right, copy right or exclusive distribution right.

Technical note
𝑻𝑹 = 𝑷 ⋅ 𝑸
𝝏(𝑷𝑸)
𝑴𝑹 =
𝝏𝑸
𝝏𝑷
𝑴𝑹 = 𝑷 + 𝑸 ⋅
𝝏𝑸
𝝏𝑷
1. Perfect competition: where =𝟎
𝝏𝑸

𝑴𝑹 = 𝑷 + 𝑸(𝟎)
𝑴𝑹 = 𝑷
Profit maximization implies MR=MC=P

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𝝏𝑷
2. Where 𝝏𝑸 ≠ 𝟎

𝑻𝑹 = 𝑷 ⋅ 𝑸

𝝏(𝑷𝑸)
𝑴𝑹 =
𝝏𝑸
𝝏𝑷
𝑴𝑹 = 𝑷 + 𝑸 ⋅ 𝝏𝑸 ….. (1)

While
𝝏𝑸 𝑷
𝒆𝑷 = − 𝝏𝑷 ⋅ 𝑸

𝟏 𝝏𝑷 𝑸
= − 𝝏𝑸 ⋅ 𝑷
𝒆𝑷

𝝏𝑷 −𝟏 𝑷
Therefore 𝝏𝑸 = ⋅𝑸 ……. (2)
𝒆𝑷

From (1) and (2)

−𝟏 𝑷
𝑴𝑹 = 𝑷 + 𝑸 ( ⋅ )
𝒆 𝑸

𝑷
𝑴𝑹 = 𝑷 −
𝒆

𝟏
𝑴𝑹 = 𝑨𝑹 (𝟏 − )
𝒆

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1. If e = 1 = MR = 0 MR = MC
2. If e > 1 = MR > 0 +ve = +ve
3. If e < 1 = MR < 0
A monopolist always operates in elastic region of DD curve. This is because for
𝜫 maximization. Monopolists will always produce that much output where MR =
MC. Since MC is always positive so it requires that MR must also be positive but
𝟏
MR can be positive only when 𝒆𝒅 > 1 because: MR = (𝑷 − 𝒆)

When DD curve is rectangular hyperbola then price elasticity of demand at every

point on DD = 𝒆𝒅 = 1 & therefore MR = 0, so MR will coincide with x-axis. Since
MC is always positive. So, monopolists will not produce any output. From this
it follows that monopolists always operate in the elastic region of demand curve.
Lerner index of Monopoly power
MR = P (1 – 1/e) at profit max MR = MC
P (1 – 1/e) = MC
P – P/e = MC
P – MC = P/e
Therefore, Lerner Index is:
𝑷 − 𝑴𝑪 𝟏
=
𝑷 𝒆

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Lerner index of monopoly power measures the extent to which price charged by
monopolists can exceed MC. It varies inversely with price elasticity of demand
(Ed). It means grater will be Ed – less will be monopoly power.
Index of monopoly power also measures markup pricing which means to what
extent price of product can exceed MC, which is a measure of 𝜫 margin. We
must note that under perfect competition where P = MC there will be no
monopoly power enjoyed by a firm.

Multi-plant Monopolists

Multiplant Monopolist

Plant-1 Plant-2
TC1=f(Q1) TC1=f(Q2)
MC1=? MC2=?
MC1=MR MC2=MR

Therefore, 𝑴𝑪𝟏 = 𝑴𝑪𝟐

If 𝑴𝑪𝟏 > 𝑴𝑪𝟐 ⇒ 𝑸𝟐 should be increased
If 𝑴𝑪𝟏 < 𝑴𝑪𝟐 ⇒ 𝑸𝟏 should be increased
In the case of Multi-plant monopolists we assume that monopolists produces a
homogenous product in different plants, each with different cost structure in
such situations monopolists has to make 2 decisions.

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1. How much output to produce & at what price to sell it to maximize 𝜫.

2. How to allocate the production of optimal output between two plants.
To maximize 𝜫, MC of each plant must be equated to MR therefore MC1 = MC2
= MR. This is because if MC will be different then monopolists will continue to
reallocate it production.
If MC1 > MC2 then monopolists will produce more output in Plant -2. So, output
will be continued to be reallocated so that MC of each plant becomes equal to
common MR.

Numerical:
Q = 200 – 2p
𝑻𝑪𝟏 = 𝟏𝟎𝑸𝟏

𝑻𝑪𝟐 = 𝟎. 𝟐𝟓𝑸𝟐𝟐

Find 𝜫 maximizing price charged and quantity produced by Multi-plant

Monopolist.

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