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Chapter 10
Chapter 10
Monopoly
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Lecture plan
Objectives
Introduction
Features
Types of Monopoly
Demand and MR Curve
Price and Output Decisions in Short Run
Price and Output Decisions in Long Run
Supply Curve of Monopolist
Multiplant Monopolist
Price Discrimination
Price and Output Decisions of Discriminating
Monopolist
Economic Inefficiency of Monopolist
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Objectives
3
Introduction
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Price and Output Decisions in Short Run
The monopolist cannot set Price, AR>AC
both price and quantity at its Revenue, MC
own will. Cost
B AC
In order to maximize profit a PE
monopoly firm follows the rule
of MR=MC when MC is rising. A
A monopoly firm may earn E AR
supernormal profit or normal MR
profit or even subnormal profit
O QE
in the short run. Quantity
The negative slope of the
demand curve is instrumental Firm maximizes profit where
for chances of monopoly (i) MR=MC (ii) MC cuts MR from
profits in the short run. below, at point E.
In the short run, the firm would Equilibrium price=OPE, Output= OQE
reap the benefits of supplying Total revenue =OPEBQE
a product which not only is
unique, but also has negligible Total cost = OAEQE
cross elasticity.
Supernormal profit= AEBPE,
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since price (AR) > AC
Price and Output Decisions in Short Run
Price,
Revenue, AR=AC Price, AR<AC
Cost Revenue,
MC Cost MC AC
AC
A B
PE B PE C
E
E AR
AR MR
MR
O QE O QE Quantity
Quantity
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Supply Curve of Monopoly Firm
A monopolist is a price maker
The firm itself sets the price of the product it sells,
instead of taking the price as given.
It equates MC with MR for profit maximization,
but unlike perfect competition, it does not
equate its price to MR.
Supply of the good by the monopolist at a given
price would be determined by both the market
demand and the MC curve.
As such, there is no defined supply curve for a
monopolist.
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Multi Plant Monopoly
A monopolist may produce a homogeneous product in different
plants.
different cost functions but the same demand function for the entire
market.
hence the same AR and MR curves for the entire market.
A multi plant monopolist has to take two decisions:
how much to produce and what price to sell at, so as to maximize its profit
how to allocate the profit maximizing output between the plants.
Assuming that a monopoly firm produces in two plants, A and B.
Profit maximising output will be at MR= MCA= MCB
If MCA< MCB, it would increase production in A, (lower MC) and
reduce production in B (higher MC), till the equality is satisfied.
The firm produces till MCA and MCB are individually equal to MR,
which is same for both plants.
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Multi Plant Monopoly
• Monopoly firm may produce a homogeneous
product in different plants
– firm has different cost functions from multiple plants,
(MC = MCA+MCB)
– faces the same demand function for the entire market.
• Firm has to decide
– The profit maximizing output and price; (MC=MR)
– Allocation of the profit maximizing output between the
plants (MR = MCA+MCB)
• Firm will produce more in the plant with lower
cost than in the one with higher cost
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Multi Plant Monopoly
Panel a Panel b Panel c
MC MCB
Price, AC MCA ACA
Revenue, ACB
Cost
B B1 B2
P P=A
R
E AR E1 E2 MR=MCA = MCB
MR
O O QA O
Q Quantity QB
P E1
P1
P1 E1
P2 A1 E2
E E3 E
P3 P
A2 A1
D=MR D D
O O O
Q Quantity Q1 Q2 Q3 Q1 Q
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First degree Second degree Third degree
Price and Output Decisions of Discriminating
Monopolist
Assume that the firm can segregate the market on basis of price elasticity of
demand: M1 with high price elasticity and M2 with low price elasticity.
The rule is:
Lower price and more supply in the market with high price elasticity
Higher price and less supply in the market with low price elasticity.
The firm will charge lower price in the market M 1 and higher price in the
market M2 and it would supply more to the market M1 and less to the market
M2.
Firm would determine the profit maximizing output at MC=MR while MC is
increasing.
The upper portion of the AR curve refers to the less elastic demand and the
lower portion to highly elastic demand.
The MR curve corresponds to the AR curve.
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Price and Output Decisions of Discriminating
Monopolist
Price,
Revenue, Firm Market 1 Market 2
Cost
MC
P2 E2
P1 E1
P E
MC=MR1=MR2
MR1 AR1
MR2 AR2
MR AR
O Q1 O Q2
O Q Quantity
In the market M1 the optimum output is OQ1 and price is OP1
In the market M2 the optimum output is OQ2 and price is OP2
OQ1> OQ2 and OP1< OP2
Price discrimination leads to greater profits.
OPEQ is less than the area given by total area of OP1E1Q1+OP2E2Q2.
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Economic Inefficiency of Monopoly
A monopoly firm operates at less than optimum output and charges
a higher price.
Monopoly does not allow optimum use of all the factors of
production, thereby allowing loss of output and creating excess
capacity in the economy
Considered as a loss of social welfare, hence authorities make
regulations to check and prevent monopoly practices.
Also termed as deadweight loss to the economy, since this increase
in output is actually possible under perfect competition.
Compare two firms, one under perfect competition, and the other
under monopoly to explain the condition; assuming that both the
firms earn normal profits.
The firm under perfect competition faces a horizontal demand curve
(DC), whereas the monopoly firm faces a downward sloping curve
DM, which is less elastic.
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Economic Inefficiency of Monopoly
The monopolist produces an output QM(<QC), and sells at price PM(>PC) (Fig 1)
OQC-OQM (i.e. QMQC), is regarded as excess capacity.
Perfectly competitive firm allows maximum consumer surplus (PCDB) (Fig 2).
Monopoly takes away PCPMAE from consumers to the firm.
AEB is neither part of firm’s income nor of consumer surplus; hence is the deadweight
loss or economic inefficiency due to monopoly.
Price,
Revenue,
Cost LAC
D
EM PM A
PM
EC B
PC PC E MC=AC=MRP=A
DC RP
DM ARM
MRM
O QM
O QM QC QC Quantity
Quantity
Fig 1: Excess Capacity Fig 2: Deadweight Loss 22
Summary
A monopoly is that form of market in which a single seller sells a product (or
service) which has no substitute.
Pure monopoly is where there is absolutely no substitute of the product, and
the entire market is under control of a single firm.
A monopoly has a single seller, sells a single product (pure monopoly) and
decides on its own price and output, based on individual demand and cost
conditions and is hence regarded as a price maker.
In monopoly the firm and the industry are one and the same.
Barriers to entry are the major sources (or reasons) of monopoly power and
may include restriction by law, control over key raw materials, specialized
know how restricted through patents or licences, small market and
economies of scale.
A monopoly firm has a normal demand curve with a negative slope. The
demand curve is highly price inelastic because there is no close substitute.
A monopolist firm may earn supernormal profit, or normal profit, or may even
incur loss in the short run, but would not incur loss in the long run.
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Summary
The monopolist being a price maker does not have any supply curve.
A multi plant monopolist decides on how much to produce and what price to
sell at so as to maximize its profit on the basis of the principle of
marginalism.
When a seller discriminates among buyers on basis of the price charged for
the same good (or service), such a practice is called price discrimination.
Price discrimination can be done on personal basis (demographical, paying
capacity or need), on the basis of geography, on the basis of time or
purpose of use.
The discriminating firm will charge a higher price and supply less to the
market having higher price elasticity and a lower price and supply more in
the market having lower price elasticity.
Monopoly runs at less than optimum level of output and generates excess
capacity in the economic system, which in turn results in deadweight loss
that adds neither to consumer surplus, nor to seller’s profit.
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