MODULE BASIC MICROECONOMICS

CHAPTER 8: MONOPOLY

Objectives:
1. Enumerate the characteristics of a monopoly.
2. Explain how market prices and outputs are determined in both
short run and long run under monopolistic market.
3. Illustrate how the short-run and the long-run equilibrium are
achieved in a monopolistic market.
4. Compute for marginal revenue, marginal costs, and profits with
given data on price and output.
5. Recognize how short-run profit maximization is achieved under
total curves and per unit curves approaches.
6. List the merits and shortfalls of the monopoly.

INTRODUCTION

Monopoly - is a specific type of economic market structure. A monopoly exists when a specific
person or enterprise is the only supplier of a particular good. As a result, monopolies are
characterized by a lack of competition within the market producing a good or service.

Pure Monopoly – refers to the form of market organization in which there is single firm producing
a commodity or a service for which there are no close substitutes. Thus the firm is the industry
and faces a negatively sloped industry demand curve for the commodity or service.
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THE DEMAND CURVE

The difference between a pure monopolistic and a purely competitive seller lies in the
demand side of the market. In our previous discussion, we recall that the purely competitive seller
faces a perfectly elastic demand schedule. The competitive firm can sell as much or as little as it
wants at the going market price.

The monopolist’s demand curve is different. Because the pure monopolist is the industry,
its demand curve is the industry demand curve. The industry demand curve is not perfectly elastic
but negatively sloped. As a result, if the monopolist wants to sell more of the commodity or service,
he must lower its price. Thus, for the monopolist, MR > P and his MR curve lie below his demand
curve.

Short-run Equilibrium:

Total Revenue – Total Cost Approach

Given the market price of a product, the monopolistic is faced with the following questions:

1. At what point would I be losing?

2. At what point would I be break even?

3. At what point would I maximize profit?

One of the approaches in answering these questions would be through the total revenue
– total cost approach. The monopolist would be losing so long as his costs exceed his revenues.
The break-even point is arrived at when total revenues equal total costs.

Revenues minus cost is equal to profits. As long as revenues are greater than costs, the
monopolists acquire profits; if costs are greater than revenues, even a monopolist would be
incurring losses. Maximum profit is achieved when the positive difference between the total
revenue and total cost is greatest. The equilibrium output of a monopolist is the output at which
total profits are maximized.

Profit Maximization: Total Curve

As in the case of pure competition, the rules for profit maximization are the same for pure
monopoly.

Total profit becomes positive when total revenue exceeds total cost. When the firm
continues to produce after the break-even point, the firm attains positive profit.

Table 20: Revenue and Cost Data of a Pure Monopolist (Hypothetical Data)

Price Total Marginal Total Marginal

Quantity Average Profit
Cost Revenue Revenue Cost Cost
₱80.00 - - - ₱60.00 - - ₱-60
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70.00 1 ₱70.00 ₱70.00 80.00 ₱20.00 ₱80.00 10.00
60.00 2 120.00 50.00 90.00 10.00 45.00 30.00
55.00 2.5 137.50 40.00 100.00 20.00 40.00 37.00
50.00 3 150.00 30.00 120.00 40.00 40.00 30.00
40.00 4 160.00 10.00 200.00 80.00 50.00 -40.00
30.00 5 150.00 -10.00 350.00 150.00 70.00 -200.00

COMMON MISCONCEPTIONS ABOUT MONOPOLISTIC ECONOMY

It is commonly believed that because a monopolistic can manipulate price and output, he
will therefore charge the highest price he can get. This is not a correct assumption. Any price
charged by a monopolist above that price will give him lower profits. As discussed earlier,
maximum profit is attained at the point where marginal revenue equals marginal cost.
Because the demand curve facing purely competitive firm is perfectly elastic, there is a
temptation to assume that the demand curve faced by a monopolistic is inelastic. A monopolist
will always want to produce in the elastic range of its demand curve. If we recall the concept of
elasticity, lowering price within the inelastic range of the curve would result to lower total revenue.
The monopolist will always want to avoid price and output combination in the inelastic segment
of its demand curve. At any point within this range, marginal cost is positive. At the output at which
marginal cost equals marginal revenue, marginal revenue is must also be positive. If the marginal
revenue is positive, then the elasticity of demand must be greater than one.

We also have to emphasize that monopoly does not guarantee economic profits. It is true
that in all likelihood, economic profits are greater for a monopolist than for producers in a purely
competitive market. In the short-run the monopolist may incur losses. If this happens, the concern
of the monopolist is to minimize losses. Losses will be minimized if the monopolist produces at
the point where the short-run marginal cost equals marginal revenue.

The Long Run

As we have taken up before, the entry of new firms into an industry characterized by pure
competition is easy in the long run. Entry into a monopolistic industry, however, is difficult and is
often blocked either by natural or artificial forces.

One of the barriers to entry into a monopolistic industry is the question of size or
economies of scale. Capitalization of monopolistic industries usually runs in millions or billions of
pesos. The production and eventual distribution of energy for example, is a very expensive
proposition.

The monopolist may also lock entry in several ways. The discovery, production, and
control of the sources of a raw material are the cases in point. A country or company might have
control of strategic raw materials like aluminium, bauxite uranium, and would thus exercise
monopolistic control over these materials.
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Another reason could be that a firm may become a monopolistic because it is awarded a
market franchise by the government. The firm is granted the exclusive privilege to produce a given
good or service in a particular area. In exchange for this right, the firm agrees to allow the
government to regulate certain aspects of its behaviour, pricing, policies, and other operational
policies. We have several examples to illustrate this point. In the field of energy, the case of
MERALCO is a classic example; in transportation, we have the Light Rail Transit (LRT); in trading,
we had the National Sugar Trading Association (NASUTRA).

Size of Plant Adjustment

Since entry into the industry under monopoly is blocked, the monopolistic adjusts the long-
run output by means of size of plant adjustments. We will just explain two possibilities here. First,
the relationship between the monopolist’s market and long-run average cost may be such that a
plant smaller than the most efficient size will be built. Second, the relationship may be such that
the most efficient size of plant will be appropriate.

Less Than Most Efficient Size of Plant

Any change in the size of plant or in the rate of output of short-run average cost will
decrease profits.

Situations like these happen when the market is not large enough to expand the plant
sufficiently to take advantage of all economies size. The size of plant used will have excess
capacity, Medium-sized towns often operate plants smaller than the most efficient size less than
the most efficient rates of output. In addition to this the relatively small local market for electricity
limits the generating plant to size too small to use the most efficient generating equipment and
techniques. This is the reason why most small-and-medium-sized electric plants outside the
jurisdiction of MERALCO charge higher rates than MERALCO. Also, it is for this reason, why
consumers in the outlying areas near Metro Manila want to be integrated into the services of
MERALCO.

Most Efficient Size of Plant

The size of plant considered the most efficient size of plant if the monopolist market and
cost curves are such that the marginal revenue curve hits the minimum point of the long-run
average cost (LAC) curve.

Price Discrimination

Price discrimination is widely practiced in our economy. The sales representative who must
communicate important information to the company headquarters has to use the more long-
distance telephone service (if it is available from the area he is calling from). Electric utilities
frequently segment their markets by end-users. The industrial users are charged higher rates
compared with the ordinary home users.

In some cases, a monopolist may find it possible and profitable to separate two markets
and to charge different price for the product in each of the markets. For example moviegoers are
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charged different prices although they see the same movie; orchestra tickets are paid lower rates
compared with balcony tickets. Appliances in Metro Manila are comparatively lower compared
with the prices in the provinces, for example.

There are several reason why price discriminations occurs. First, the monopolist can keep
the markets apart. Second, for price discrimination to be effective and profitable, the elasticities
of demand at each price level must differ among the markets.

Regulation of Monopoly

As we have learned, there is a tendency for a monopolist to maximize profits and being
the only market, a monopolist normally would not think too much of consumer’s welfare. If
monopolies were not regulated, the cost of energy would be costing much more than ever.

Public welfare dictates that the government should take more active role in the regulation
of monopolies. Monopolies cannot just left alone by the government in the same ways as other
industries in more competitive models are left alone.

There are two parties involved here: the monopolist who tends to maximize profits; and
the consumers who must be protected by the government and be given a fair deal by the
monopolist. Thus, the economic problem involved here is the determination of the rate that will
induce the monopolist to furnish the amount of product consistent with his cost and with the need
and demands of the consumers.

THE WELFARE EFFECTS OF PURE MONOPOLY

We can now compare two markets; a market characterized by pure competition; and one
characterized by pre monopoly. Obviously, from the point of view of producers, a monopolistic
market would be preferred. A monopolist does not have to contend with any competitor, has
considerable control over price decisions, and therefore has more chances of maximizing profit.
Given these factors, what welfare considerations are in store for the consumers? The following
discussion will answer this question.

Short-run Output Restriction

If all industries were initially purely competitive and were in long-run equilibrium,
monopolization of one or more of them would reduce consumers’ welfare. As we have seen in
our previous discussion on pure competition, equilibrium price is reached where price equals cost
of production or the lowest point of the average cost curve.

Inefficiency of the Firm

In addition to the welfare impact of output restriction, the monopolistic firm ordinarily will
not use resources at their peak potential efficiency. The purely competitive firm in long-run
equilibrium uses the most efficient size of plant at the most efficient rate of output. The size of
plant and the output that maximize the monopolist’s long-run profits are not necessarily the most
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efficient ones. However, if monopoly is to be compared with pure competition on this point, the
comparison is legitimate only for the industries in which pure competition can exist.

In an industry with a limited market relative to the most efficient size of plant, monopoly
may result in lower cost or greater efficiency than would occur if there were many firms, each with
a considerably less than most efficient size of plant.

Sales Promotion

It may be to the advantage of the monopolist to engage in sales promotion activities of this
kind. The monopolist may use sales promotion to enlarge his market, that is, to shift his demand
curve to the right. These monopolies advertise for several reasons: to enlarge their respective
markets; to promote goodwill or good public relations with the consumers; and to make the public
aware that their companies exist and are doing good service to the public.

If a monopolist can convince the public that consumption of his product is highly desirable
or even indispensable, elasticity of demand at various prices may be decreased. All of these sales
promotions imply cost to the company. The welfare effect of all these efforts will inevitably be
reflected in additional cost to the company, which will ultimately be passed on to the consumers
in the form of higher prices.

MONOPOLIES IN THE PHILIPPINE SETTING

From previous discussions, the loss of consumer’s welfare where monopolies exist is
suggested. Can this situation take place in our country?

We have had unpleasant experiences with monopolies in the Philippines. Consumers

have been complaining about the abuses committed by monopolies in the Philippines. Pressures
have been exerted by the concerned citizens and consumers’ union to make these monopolies
conscious not only of monopoly profits but also of public welfare.

We are obviously moving away from centralization, monopolies, and regulations. We

have taken steps to deregulate the coconut industry by allowing among other things, all oil millers
to export their products to overseas markets.

Our experience under a more centralized economic set-up, which apparently became
expedient under an authoritarian regime while it lasted, has obviously not worked in our best
interest. This is the reason we are falling back to our original position of promoting free enterprise.

But even in normal times, we had problems with monopolies in areas where they are
deemed necessary and practical or their type of operations can just be justified by the prevailing
circumstances. There is nothing wrong with the monopolies, especially in public utilities like
power, water, telecommunications, and the like provided management and those who work for
such enterprises remember their real role in the economy and why they are granted exclusive
franchise in their areas of operation.
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In the final analysis, it is probably management that must be blamed for perpetuating a
policy that forgets and even makes a mockery of public service and puts more emphasis on profit
even if it has to be punitive and thereby creates public distrust and ill will.

A STUDY IN MONOPOLIES

We have already shown theoretically how monopolies reduce consumer’s welfare in the
form of higher prices and lesser goods available to the consumers. We also mentioned ordinarily
a monopolistic firm will not use resources at their peak potential because of absence of
competitors. Because of this a monopolistic can afford to be inefficient and can still rake in higher
than average profits.

A well-documented study made by a group of economist at the University of the

Philippines, School of Economics came up with the conclusion that the presence of numerous
monopolies in the economy represents an enormous drag on productive capacity.

The government has mandated the existence of many private monopolies, and is in itself
a monopolist in some sectors of the economy (e.g., through the National Food Authority).

The study added that except where there are valid economic reasons for maintaining them
(and these must be publicly demonstrable), monopolies are economically harmful, and the trend
toward greater economic concentration should be discourage. Existing monopolies and other
privileges, especially those which exist only by virtue of presidential decrees or letters of
instructions, should as a rule be abolished and re-established, if at all, only after a lengthy public
discussion and study.

SUMMARY

Purely Competitive vs. Pure Monopolist

Perfectly elastic demand – Negatively sloped

Price taker – Price maker

Large number of sellers – Single seller

Easy to enter in the market – Difficult to enter the market

Questions faced by a monopolist.

1. At what point would I maximize profit?

2. At what point would I break even?
3. At what point would I maximize profit?

A monopolist:
1. Cannot manipulate price and output.
2. Will always want to produce in the elastic range of its demand curve.
3. Will always want to avoid price and output combinations.
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4. Would prefer price-output combinations within the elastic segment of the demand curve.
5. Does not guarantee economic profits.

Barriers to entry into a monopolistic industry:

1. Question of size or economies of scale.
2. Discovery, production, and control of the sources of raw materials.
3. Patent ownership and research.
4. Market franchise was awarded by the government.

A monopolist adjusts the long-run output by:

1. Means of plant size adjustments.
2. Price discrimination.
3. Regulation of monopoly

For more knowledge, please follow the link provided;

https://www.youtube.com/watch?v=1UxA6JzoT-4
https://www.youtube.com/watch?v=aef0W1Uaizk
https://www.youtube.com/watch?v=aef0W1Uaizk