Market structure

Monopoly
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Aims & Objectives

After studying this lesson, you will be able to understand:

 A Monopoly market structure

Monopoly
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Features of monopoly
 There is a single seller
 The product does not have close substitutes.
 Monopolist is a price maker
 There are legal/technical /economic barriers to entry
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Why Monopolies Arise

• The fundamental cause of monopoly is barriers to entry.
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Why Monopolies Arise?

• Barriers to entry have three sources:
• Ownership of a key resource.
 This tends to be rare. De Beers which once controlled 80% of the
world’s diamond market is an example
• The government gives a single firm the exclusive right to produce
some good.
 Patents, Copyrights and Government Licensing.
• Costs of production make a single producer more efficient than a
large number of producers.
 Natural Monopolies (example: railways, telecommunications,
water services, electricity, mail delivery)
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Monopoly versus Competition

• A monopoly firm is the only producer while a perfectly competitive
firm is one of many firms
• A monopoly firm has a downward sloping demand curve while a
perfectly competitive firm faces a horizontal demand curve
• A monopolist is a price maker and a competitive producer is a price
taker
• A monopolist sells more at lower price while competitive seller sells
as much or as little at same price
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Demand Curves for Competitive and Monopoly

Firms
(a) A Competitive Firm’s (b) A Monopolist’s
Demand Curve Demand Curve
Price Price

Demand

Demand

Quantity of
0 Quantity of 0 Output
Output
Note: Monopoly demand is the industry
(market) demand and is therefore downward
sloping
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A Monopoly’s Revenue
• Total Revenue: P x Q = TR

• Average Revenue: TR/Q = AR = P

• Marginal Revenue: dTR/dQ = MR = d(PQ)/dQ= P + QdP/dQ

where, d denotes a small change
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A Monopoly’s Marginal Revenue

• A monopolist’s marginal revenue is always less than the price of its
good.

MR = d(PQ)/dQ= P + QdP/dQ < P

= P [1 + 1/(dQ/dP * P/Q)]
= P [1 -1/e]
Where ‘e’ is the price elasticity of demand

 The demand curve is downward sloping.

 When a monopoly drops the price to sell one more unit, the
revenue received from previously sold units also decreases.
Demand and MR curve of a Monopolist

Price
Revenue

AR / Dd

O MR quantity

11
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Profit-Maximization for a Monopoly...

2. ...and then the demand
Costs and curve shows the price 1. The intersection of
Revenue consistent with this the marginal-revenue
quantity. curve and the marginal-
cost curve determines
B MC the profit-maximizing
quantity...
price

AC
A

AR/Dd

MR
0 QMAX Quantity
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Profit-Maximization for a Monopoly

Costs and
Revenue

MC
price

Profit AC

AR/Dd

MR
0 QMAX Quantity
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Comparing Monopoly and Competition

• For a competitive firm, price equals marginal cost.
P = MR = MC
• For a monopoly firm, price exceeds marginal cost.
P > MR = MC
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Economic Effects of Monopoly

Pure competition is efficient
Monopoly is inefficient

S=MC MC
Pm b
P=MC= d
Pc Pc c
Minimum
ATC a

D D
MR
Qc Qm Qc

(a) (b)
Purely Competitive Market Pure Monopoly

LO3 10-15
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Monopoly Power
• This the power of a firm to change the price of its product
through an adjustment in its output
• The degree of monopoly power, L, called Lerner’s index of
monopoly power is measured as

L = P – MC /P
• In case of perfect competition P = MC, hence L= 0
• Higher the price elasticity of demand of consumers, lower is L
• Lower the price elasticity of demand of consumers, higher is L
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Regulated Monopoly
• This occurs where a natural monopoly or economies of scale make one firm desirable. This
is in turn may affect the consumers/economy’s interest adversely . In such cases, the
government may choose to intervene on a case-by-case basis. Example: As a result of
changes in technology and deregulation in the local telephone and the electricity-providers
industry, some states are allowing new entrants to compete in previously regulated
markets.

• In those markets that are still regulated, a regulatory commission may attempt to establish
the legal price for the monopolist that is equal to marginal cost at the quantity of output
chosen. This is called the “socially optimal price.”

• Though P = MC is most efficient but may result in losses for the monopoly firm, at which
point the government would have to subsidize the firm for it to survive. The Regulators often
choose a price equal to average cost rather than marginal cost, so that the monopoly firm
can achieve a “fair return” and avoid losses. (Recall that average cost includes an
allowance for a normal or “fair” profit)

• Output produced is less than the output at the socially optimal price, but it is greater than
the output of an unregulated monopoly.
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Regulated Monopoly

Monopoly
Price
Price and Costs (Dollars)

Pm Fair-Return
Price
Socially
a f Optimal
Pf Price
ATC

Pr r MC
MR D
b
0
Qm Qf Qr
Quantity

LO5 10-18
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Price Discrimination
• Price discrimination is the practice of selling the same good at
different prices to different customers, even though the costs for
producing for the two customers are the same. In order to do this,
the firm must have market power.
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Price Discrimination
• Two important effects of price discrimination:
 It can increase the monopolist’s profits.
 It can reduce deadweight loss.
• But in order to price discriminate, the firm must
 Be able to separate the customers on the basis of willingness
to pay.
 Prevent the customers from reselling the product.
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Types of Price discrimination

• First degree- the practice of charging maximum possible price that
the consumers are willing to pay for each of the successive units of
the product. Example: applies to any market where discounts from
posted prices are normal like professional services, homes.

• Second Degree- this occurs if the monopolist can divide the buyers
of his product into different groups each having a different range of
demand prices and charge from each group a price that equals the
minimum demand price of that group. Example: electric companies
charging block rates

• Third Degree- here the monopolist divides his market into different
sub markets and charges for the product in different sub markets
different prices. Example: charging of different rates for an insured
patient and uninsured patient
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Case study: De Beers’ Diamonds: Are Monopolies forever

• De Beers Consolidated Mines of South Africa has been one of the

world’s strongest monopolies. It produces about 45 percent of all
rough-cut diamonds in the world and buys for resale many of the
diamonds produced elsewhere, for a total of about 55 percent of the
world’s diamonds.

• Its behavior and results fit the monopoly model just discussed. It
sells a limited quantity of diamonds that will yield an “appropriate”
monopoly price. The “appropriate” price is well over production
costs and has earned substantial economic profits.
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Qs: How has De Beers controlled the production of mines it doesn’t

own?

• It convinces producers that “single-channel” monopoly marketing is

in their best interests.
• Mines that don’t use De Beers may find the market flooded from De
Beers stockpiles of the particular kind of diamond they produce,
which causes price declines and loss of profits.
• Finally, De Beers purchases and stockpiles diamonds produced by
independents.
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Threats and problems face De Beers’

monopoly power.
• New diamond discoveries have resulted in more diamonds outside
their control.
• Russia, which has been a part of De Beers’ monopoly, has agreed to
sell progressively larger quantities directly to the world market
rather than through De Beers.
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Way ahead for De Beers

• In mid-2000, De Beers abandoned its attempt to control the supply
of diamonds.
• The company is transforming itself into a company that sells
“premium” diamonds and luxury goods under the De Beers label.
• De Beers plans to reduce its stockpile of diamonds and increase the
demand for diamonds through advertising.
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Thank You