Imperfect Market

Monopoly
 Monopoly
Meaning
‘Mono’ means a single and ‘poly’ means seller. So it is a market structure
characterized by a single seller of a ‘unique’ product and a large number of
buyers.

Most of the public utilities in the past were run as government monopolies[public
corporations].

There are various factors which result into the generation of monopolies.
An absolute monopoly would have a 100% of the market.

From legal perspectives a firm controlling 25% of the market share is called a
‘legal monopoly’ and a firm controlling 40% and above is called a ‘dominant
monopoly.’
Monopoly

• Monopoly exists when an industry is in the hands of a single

producer. In other words, it is that market form in which a
single producer controls the whole supply of a single
commodity which has no close substitutes and there are
barriers to entry.
• The single producer may be an individual owner or a group
of partners or a joint stock company or any other
combination of producers.
 MONOPOLY
CHARACTERISTICS:
SINGLE FIRM [NO COMPETITORS]
POWER [LACK OF SUBSTITUTE]: The firm
produces a ‘Unique Product.’
BARRIES TO ENTRY:
Economies of scale [see Natural Monopoly].
It can produce a range of products.
Lower costs for established firm: through a
large-scale operation.
 MONOPOLY
CHARACTERISTICS
BARRIES TO ENTRY:
Control over key inputs.
Control over outlets.
Legal protection: patent, copyright.
Mergers and takeovers.
Aggressive practices.

The firm is assumed to be a short-run profit maximizing

entity.
The firm faces a downward sloping demand curve which
is highly inelastic because of the lack of close
substitutes.
The firm is a price setter.
The firm makes abnormal profits even in the long-run.
Reasons for the existence of monopoly
• Legal barrier to entry of new firms
• Ownership of natural resources
• Ownership of outlets
• Transport costs
• Tariff
• Existence of good will
• Mergers
• Economies of scale
• Optimum scale of plant
Monopoly

Equilibrium
MONOPOLY
EQUILIBRIUM PRICE & OUTPUT
The firm’s/ industry’s demand curve is downward
sloping.
Demand is likely to be relatively inelastic.
The firm is a ‘price maker’.
Profit is maximised where MC = MR and MC cuts
MR from below.
Supernormal profits can be earned in the long-run
[barriers to entry].
Monopoly
AR and MR curves
Average and marginal revenue under monopoly
£

AR

MR

O Q
 Monopoly
As shown in the previous slide the AR and MR curves facing the
monopolists are not the same.

Since the monopolist faces a downward sloping market demand

curve it can sell more at a lower price. Therefore MR is less than AR
in monopoly. This is so because price must be lowered to sell an
extra unit
When the price is lowered it is applicable to all units and not only to
current units. Therefore the rate of fall of MR is higher/double than
the rate of fall of AR. So the slope of MR is higher than the slope of
AR.
Thus AR is greater than MR.
Monopoly
Equilibrium Approach
 Monopoly: Equilibrium Approach
As per the neo-classical theory, the firm is assumed to a short-run
profit maximizer.
As discussed previously in perfect competition there are two
approaches.

• Total revenue and total cost approach

• Marginal cost and marginal revenue approach.

In the following slide we focus on the second approach. Under this

approach MC must be equal to MR and MC must cut MR from below.
Profit maximising under monopoly
£ MC
Profit maximised
at output of Qm
(where MC = MR)

As seen in the slide the

equilibrium takes place
at ‘C’
where MC is equal to MR
and MC cuts MR from
Below.
Thus the output OQm is
the equilibrium output.
C

MR

O Qm Q
Profit maximising under monopoly
£ MC
Total profit/
Super normal profit AC

P/AR E

AC F

AR

MR

O Qm Q
 Profit Maximization under Monopoly
As per the marginal principle, equilibrium takes place at point ‘c’
where MC is equal to ‘MR’ and ‘MC’ cuts ‘MR’ from below.
Thus the firm produces equilibrium output OQm and sells it at a
price of OAR[OP] per unit.
The cost per unit of output incurred by the firm is OAC.
The total revenue received by the firm is OPEQm and the total cost
incurred by the firm is OACFQm.
The abnormal profit received by the firm is represented by the
rectangle ACFEP.
The firm continues to earn abnormal profit even in the long-run.
 Monopoly: Long-run Equilibrium
The monopolist continues to earn abnormal profit in the long-run
too.

The firm deploys the resources for r&d and this permits the firm to
gain dynamic efficiency through technological advancement.

Thus through this the firm is able to produce better quality products
and sell it at a lower price. This benefits consumers in the long-run.
The following slide shows the long-run equilibrium.
 Long-run Equilibrium with Excess Capacity

As shown in the slide the

firm is not using the
plant optimally. It means
that it is not operating at
the point ‘b’ which is the
minimum point on LAC.
So the excess capacity is
indicated by Eb.
The firm is earning
supernormal profit.

So though the firm achieves super normal profit in the long-run, it is not productively
and allocatively efficient because Price is not equal to marginal cost and it is not
operating at the lowest point on LAC where LAC=LMC.
MONOPOLY
MONOPOLY AND THE PUBLIC INTEREST

DISADVANTAGES
HIGHER PRICES AND LOWER OUTPUT
THAN PC IN THE SHORT-RUN
The monopolist will produce Q1 at a price
of P1, whereas…………..
Equilibrium of industry under perfect competition and monopoly:
with the same MC curve
£ MC

Monopoly

P1 E

C AR = D

MR

O Q1 Q
MONOPOLY
MONOPOLY AND THE PUBLIC INTEREST

………… under perfect competition the output

is Q2 at price P2.
Equilibrium of industry under perfect competition and monopoly:
with the same MC curve
£ MC ( = supply under
perfect competition)

Comparison with
P1
Perfect competition
E

P2 F

C AR = D

MR

O Q1 Q2 Q
MONOPOLY
MONOPOLY AND THE PUBLIC INTEREST

DISADVANTAGES
HIGHER PRICES AND LOWER OUTPUT THAN
UNDER PERFECT COMPETITION IN THE LONG-
RUN
Barriers to entry protect monopolists supernormal
profit.

HIGHER COST CURVES

Owing to inefficiency [lack of competitive
pressure].
MONOPOLY
MONOPOLY AND THE PUBLIC INTEREST

ADVANTAGES
ECONOMIES OF SCALE
The slide below shows the monopolist
having lower costs than the perfectly
competitive firms. The monopolist
produces more and sells at a lower price.
Equilibrium of industry under perfect competition and monopoly:
with different MC curves
£ MC ( = supply)perfect competition

MCmonopoly

P2 E

Higher price (P2) under

P1 x
F
perfect competition

AR = D
C

MR

O Q2 Q1 Q
MONOPOLY
MONOPOLY AND THE PUBLIC INTEREST

ADVANTAGES
LOWER COSTS [MORE R&D]

INNOVATION & NEW PRODUCTS

Capital may move towards the development of
new products to establish long-run monopolies.