Market

Market Structure:
Structure:
Monopoly
Monopoly
 MONOPOLY
• Single seller that produces a product with no
close substitutes

• Market and firm demand curve slopes downward.

• Is at the opposite extreme of perfect

competition. Monopolist is a price maker as
against perfect competitor who is price taker

• Entry prohibited or difficult

• Opportunity for economic profit in LR.

• The ability of a monopolist to raise its price
above the competitive level by reducing output is
known as market power.
Under perfect
competition, the price
and quantity are
determined by supply
and demand. Here,
the equilibrium is at C,
where the price is PC
and the quantity is QC.
A monopolist reduces
the quantity supplied
to QM, and moves up
the demand curve
from C to M, raising
the price to P .
 Why Do Monopolies Exist?
• A monopolist has market power and as a result
will charge higher prices and produce less output
than a competitive industry
•This generates profit for the monopolist in the
short run and long run
• Profits will not persist in the long run unless there
is a barrier to entry.
•This can take the form of
 control of natural resources or inputs
 economies of scale
 technological superiority (https://www.youtube.com/watch?v=2kJDTzFtUr4)
 legal restrictions imposed by governments,
including patents and copyrights
China’ Dominance (%) on Strategic Metals and Technologies for
Clean Energy Transition
Economies of Scale and Natural Monopoly
• A monopoly created and sustained by economies
of scale is called a natural monopoly.
• It arises when economies of scale provide a large
cost advantage to having all of an industry’s
output produced by a single firm.
• Under such circumstances, average total cost is
declining over the output range relevant for the
industry.
• This creates a barrier to entry because an
established monopolist has lower average total
cost than any smaller firm.
 Economies
of Scale
Create
Natural
Monopoly

Firm’s AC curve declines over the range of output at which price is

greater than or equal to average total cost. This gives the firm
economies of scale over the entire range of output at which the
firm would at least break even in the long run. As a result, a given
quantity of output is produced more cheaply by one large firm than
by two or more smaller firms. 7
 Monopoly
Short-Run Equilibrium
• Demand curve for the firm is the market
demand curve

• Firm produces a quantity (Q*) where marginal

revenue (MR) is equal to marginal cost (MC)

• When D is linear, slope of MR is twice the

slope of D
[P=a-bQ, TR = PQ = (a-bQ)Q, MR = d(TR)/dQ=a – 2bQ]
 Profit maximising under monopoly
Rs MC

a
Pm

D
MR
O Qm Q
 Profit maximising under monopoly
Rs MC
AC

a
PM

Profit
AC
b

D
MR
O Qm Q
 Lessens Learnt
• As the only seller, a monopolist faces the market
demand curve

• Profit maximizing output is determined by equating

marginal revenue with marginal cost

• A monopolist could also incur losses in the SR,

depending on the height of the AC curve at the best
level of output. If AC > P, monopolist incurs a loss
and may remain in business in SR as long as P>AVC

• If entry by other firms is difficult, the monopolist

can earn economic profit even in the long run
• Production is not likely to take place at the lowest
point in LAC curve, unlike perfect competition in LR
Computing Profit Maximizing Price & Output

• Cost equation of monopolist; TC = 500+20Q2

• Demand equation is P=400 – 20Q
• Total revenue is TR = 400Q – 20Q2
• What are profit maximizing price & output?

• Soln:
• MR = d(TR)/dQ = 400 - 40Q
• MC = d(TC)/dQ = 40Q
• MR = MC; Q = 5 & P = Rs. 300
 Monopoly and Public Policy

• By reducing output and raising price above

marginal cost, a monopolist captures some of
the consumer surplus as profit and causes
deadweight loss

• To avoid deadweight loss, government policy

attempts to prevent monopoly behavior.

• When monopolies are “created” rather than

natural, governments should act to prevent
them from forming and break up existing ones.
 Monopoly Causes Inefficiency
Panel (a) depicts a perfectly competitive industry: output is QC and market price, PC , is
equal is to MC Since price is exactly equal to each producer’s cost of production per
unit, there is no producer surplus.
surplus Total surplus is therefore equal to consumer surplus,
the entire shaded area.
Panel (b) depicts the industry under monopoly: the monopolist decreases output to QM
and charges PM. Consumer surplus (blue area) has shrunk because a portion of it is has
been captured as profit (green area). Total surplus falls: the deadweight loss (orange
area) represents the value of mutually beneficial transactions that do not occur because
of monopoly behavior.
Here, we assume AC and MC are constant for all output level 14
 Dealing with Natural Monopoly
• Breaking up a monopoly that isn’t natural
can be a good idea
• But it’s not so clear whether a natural
monopoly, one in which large producers have
lower average total costs than small producers,
should be broken up, because this would raise
average total cost

• Yet even in the case of a natural monopoly, a

profit-maximizing monopolist acts in a way that
causes inefficiency—it charges consumers a price
that is higher than marginal cost, and therefore
prevents some potentially beneficial transactions.
 Dealing with Natural Monopoly

• What can public policy do about this?

• A common response is price regulation

• A price ceiling imposed on a monopolist
• Price deregulation and impose competition
wherever possible
•Wire & energy business
• There always remains the option of doing
nothing !!!
 Regulated and Unregulated Natural Monopoly
In panel (a), if the monopolist is allowed to charge PM, it makes a profit, shown by
the green area; consumer surplus is shown by the blue area. If it is regulated and
must charge the lower price PR, output increases from QM to QR, and consumer
surplus increases.

Panel (b) shows what happens when the monopolist must charge a price equal to
average total cost, the price PR*. Output expands to QR*, and consumer surplus is
now the entire blue area. The monopolist makes zero profit. This is the greatest
consumer surplus possible when the monopolist is allowed to at least break even,
making PR* the best regulated price.
• Income redistribution from consumer to
monopolist in the form of profit does not
necessarily represent a loss in society

• Monopolist could use this for R & D

• Some resources will be transferred to the

production of other products, which are
valued less by the society
– Employment for players and artists

• Two major negative consequences of

monopoly are
– Technical Inefficiency
– Rent Seeking
 Technical Inefficiency & Rent Seeking
Price, cost
Per unit

Pm
Economic
Profit

Rent Seeking

Tech Inefficiency A
Pc
D

MR
Qm Qc Quantity per
period
 Technical Inefficiency
• Objective of a firm’s manager is to maximize
profit
• A necessary condition for profit maximization is
cost minimization
• A monopoly, earning supernormal profit and
insulated from competition, may not keen on
cost minimization because
– Manager, who is salaried and not a stockholder, may
not give significant effort
– Faulty labour contract, which consider number of
hours work, not efficiency
– Everybody wants leisure
 Rent Seeking

• Rent-seeking is an attempt to obtain economic

rent by manipulating the social or political
environment in which economic activities occur,
rather than by creating new wealth
– For example, spending money on political lobbying in
order to be given a share of wealth that has already
been created
– Monopoly producer often pays a pert of its profit to
maintain its monopoly status

• Rent seeking behavior does not increase the

amount of goods and services produced and
also results in deadweight loss
 Case Study: Price of Caviar
• In Soviet era, Bureau of Fisheries made decisions about
sales of caviar
• In a typical year, out of 2000 tons of cavier, only 150 tons
were allowed to export
• The caviar which was available in $5 in Russia could
easily have been sold in $500 - $1000 in US
• Monopoly arrangement caused substantial redistribution
of income from US to USSR
• After breaking up of USSR in 1991, increase competition
in caviar mkt as fisheries are now under the control of
Russia and Kazakhstan.
• Fisherman in Caspian sea bypass government and
establish their own export business

• Price of caviar dropped by 20% in one year

• The Organization of the Petroleum Exporting Countries (OPEC) was
formed on September 14, 1960 in Baghdad, Iraq. The current membership
is comprised of five founding members plus six others: Algeria, Indonesia,
Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab
Emirates and Venezuela. OPEC’s stated mission is Ato bring stability and
harmony to the oil market by adjusting their oil output to help ensure a
balance between supply and demand.@ At least twice a year, OPEC
members meet to adjust OPEC’s output level in light of anticipated oil
market developments. OPEC's eleven members collectively supply about
40 per cent of the world's oil output and possess more than three-quarters
of the world's total proven crude oil reserves. To demonstrate the
deadweight loss from monopoly problem, imagine that market supply and
demand conditions for crude oil are:

• QS = 2P (Market Supply)
• QD = 180 - 4P (Market Demand)
where Q is barrels of oil per day (in millions) and P is the market price of
oil.
• Graph and calculate the equilibrium price/output solution. How much
consumer surplus, producer surplus, and social welfare is produced
at this activity level?
• Use the graph to help you ascertain the amount of consumer surplus
transferred to the monopoly producer following a change from a
competitive market to a monopoly market.
• The competitive market equilibrium price-output
combination is a market price of $30 with an
equilibrium output of 60 (million) barrels per day.

• Consumer Surplus =
2 [60 *($45 - $30)] = $450 (million) per day
• Producer Surplus =
2 [60 *($30 - $0)] = $900 (million) per day

• Social Welfare = Consumer Surplus + Producer

Surplus
$450 (million) + $900 (million)
= $1,350 (million) per day
• The amount of deadweight loss from monopoly suffered by the
monopoly producer is given by the triangle bounded by BCD.

• Producer Deadweight Loss

= 2 [(60 - 45) * ($30 - $22.50)]
= $56.25 (million) per day
• The creation of a monopoly also results in a significant
transfer from consumer surplus to producer surplus.
• In the figure, this amount is shown as the area in the rectangle
bordered by PCMPMAB:
• Transfer to Producer Surplus
= 45 * ($33.75 - $30)
= $168.75 (million) per day
 Example: SEBs Monopoly
OPERATIONAL REASONS FOR PRODUCTIVITY GAP – GENERATION
Index :US = 100 • Higher • Less
capital availability
• Poor quality • High ash work-in of gas
• Low capacity utilisation coal progress
content
• Inefficient deployment of • Shortage of coal
manpower coal 100
• Overengineering 5
• Construction overruns 86 5
4
80 1 2
3
3
India
India 7
average
average
== 34%
34% 13

30

27

SEBs Excess Poor Lack of Lack of Best Supply Lack of Lack of India Supp- High Plant US
man- OFT* viable scale practice rela- viable infrast- poten- lier growth mix average
power invest- India tions invest- ructure tial relat- rates
ments ments ions
*Organisation of functions and tasks
Source:Planning Commission; CEA; EIA; ASI; Interviews; McKinsey analysis
 Example: SEBs Monopoly
OPERATIONAL REASONS FOR PRODUCTION GAP – T&D
Index :US = 100 100

• Outdated meter
• Under- reading
• Thefts investment in • Theft technology
• Inefficient substations, • Excessive 58
deployments capacitors etc. hierarchy
of manpower

42
2
33 5
2
India
India 6
average
average
== 4%
4% 22
4
1

SEBs Excess Poor Lack of Best Excess Poor Lack of India Low per US
man- OFT* viable practice man- OFT* viable poten- capita average
power invest- India power invest- tial consump-
ments ments tion

*Organisation of functions and tasks

Source: CEA; CMIE; ASI; Planning Commission; EIA; Interviews; McKinsey analysis
 Rise of Private Monopolists

• Google, Facebook, Amazon - The rise of

the mega-corporations | DW Documentary
https://www.youtube.com/watch?v=Dy8ogOaKk4Y&t=258s

• India’s New Economy Can’t Be a Monopoly

Board
https://www.bloombergquint.com/opinion/adani-joins-ambani-in-carving-up-
india-s-post-covid-monopoly-board

– “Airports are natural monopolies. To have one private owner

controlling eight or more — a fresh batch of six will soon go
under the hammer — can’t possibly be great news for airlines,
fliers, or businesses operating from the premises” - Bloomberg
 MONOPOLY

• Disadvantages of monopoly
– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
– X-inefficiency
• Advantages of monopoly
– economies of scale
– profits can be used for investment
 Economic & Normal Profit

• In economics, the term profit has two related but

distinct meanings.
– Normal profit represents the total opportunity costs
(both explicit and implicit) of a venture to an
entrepreneur or investor. Normal profits are basically
earning what is required to keep you in the business.
Any less than that, and you would go do something
else
– Economic profit (also abnormal, pure, supernormal or
excess profit, as the case may be monopoly or
oligopoly profit, or simply profit) is the difference
between a firm's total revenue and all costs, including
normal profit.