Price and Output Under Pure Monopoly

1. Pure Monopoly
a. It is the form of the market organization in which a single firm sells a commodity for
which there are no close substitution
b. The monopolist represents the industry and faces the industry’s negative sloped
demand curve
c. A monopolist can earn profits in the long run because entry into the industry is
blocked or very difficult
d. The monopolist has complete control over price
e. Source
i. A firm may own or control the entire supply of a raw material required in
the production of a commodity, or the firm may possess some unique
managerial talent
ii. A firm may own a patent for the exclusive right to produce a commodity or
to use a particular production process.
iii. Economies of scale may operate over a sufficiently large range of outputs so
as to leave a single firm supplying the entire market
1. Such a firm is called a natural monopoly
iv. Some monopolies are created by the government franchise itself.
2. Market Demand Curve

a. MR > 0, when D is elastic

b. MR = 0, when D is unitary elastic
c. MR < 0, when D is inelastic
MR = P (1 + 1/ η)
d. For any value of |η| < infinity, MR < P, and MR curve will be below Demand curve
 e. The monopolist will never operate over the inelastic portion of the demand curve
3. Short-Run Equilibrium
a. Total Approach
i. Monopolist’s TR curve is not a straight line, and is an inverted U
1. Because Monopolist has to lower the price to sell the additional
units of the commodity

ii. At maximum profit

1. TR and STC curve are parallel
2. TP curve reaches its highest point
iii. The monopolist maximized profits at an output level smaller than the one at
which TR is maximum
b. Marginal Approach
i. Maximum Total Profit
1. Marginal revenue = marginal cost
c. Profit maximization or loss minimization
i. Monopolist will continue to produce in the short-run as long as price
exceeds the average variable cost

ii. At P = AVC, the monopolist would be indifferent between producing or

shutting down because in either case it would incur a loss equal to its total
fixed costs. (Shutdown point)
 d. Short Run Marginal Cost and Supply
i. No supply curve, as monopolist could supply the same quantity of a
commodity at different prices depending upon the price elasticity of the
demand

4. Long-Run Equilibrium
a. Profit maximization
i. When monopolist’s long run marginal cost curve intersects the marginal
revenue curve from below
ii. The most efficient plant is the one that allows the monopolist to produce
the best level of output at the lowest possible cost
 iii. Does not necessarily produce at the lowest point of its LAC curve
iv. A monopolist may earn long-run profits
v. As P > LAC
1. There is distributional inefficiency.
vi. As LAC ≠ LMC
1. LAC is not at a minimum, so there is Production Inefficiency.
vii. As P > LMC
1. There is allocative inefficiency.
b. Comparison with Perfect competition

5. Profit Maximization by the Multiplant Monopolist

a. Short-Run

i. Minimize the total cost in short run when the marginal cost of the last unit
of the commodity produced in each plant is equal to the marginal revenue
from selling the combined output
b. Long-Run Equilibrium
6. Price Discrimination
a. It refers to the charging of different prices for different quantities of a commodity or
in different markets which are not justified by cost differences.
b. Charging different prices for different quantities
i. First-Degree (perfect) price discrimination
1. If a monopolist could sell each unit of a commodity separately and
charge the highest price each consumer would be willing to pay for
the commodity rather than go without it, the monopolist would be
able to extract the entire consumers’ surplus from consumers

2. To practice this, the monopolist must

a. Know the exact shape of each consumer’s demand curve
and be able to charge the highest price that each and every
consumer would pay for each unit of the commodity
 b. Be able to prevent arbitrage, or someone purchasing many
units of the commodity at decreasing prices and reselling
some of the units to others at higher prices.
ii. Second-degree (multipart) price discrimination
1. It refers to the charging of a uniform price per unit for a specific
quantity of the commodity, a lower price per unit for an additional
batch or block of the commodity, and so on.
2. The monopolist will be able to extract part, but not all of consumers’
surplus
3. Often practiced by public utilities, such as electrical power
companies
c. Charging different prices in different markets
i. Third-degree price discrimination

1. To maximize profit, monopolist must produce the best level of

output and sell that output in the two markets in such a way that
the marginal revenue of the last unit sold in each market is the same
a. This will require the monopolist to sell the commodity at a
higher price in the market with the less elastic demand.
2. Conditions
a. The firm must have some monopoly power
b. The firm must be able to keep the two market separate so
as to avoid arbitrage
c. The price elasticity of demand for the commodity or service
must be different in the two markets
7. Analysis
a. Per-Unit Tax
i. A per-unit excise tax will fall entirely on consumers if the industry is
perfectly competitive and will fall only partly on consumers under
monopoly, if both the monopolist and the perfectly competitive industry
operate under constant costs