MONOPOLY

• LESSON OBJECTIVES
• Explain the term, ‘MONOPOLY.
• Describe the assumed characteristics of a monopoly.
• the implications for the demand (average revenue)
curve and the marginal revenue curve and the
relationships between them.
• Explain with a diagram and analyse the efficiency of
the price and output decisions of a firm in a
monopoly market with respect to allocative and
productive efficiency.
 Meaning of Monopoly
• The term ‘monopoly’ means ‘single seller. When
there is a single firm producing a good or service
for the entire market, it is called a pure monopoly.
The firm is therefore the entire industry.
• In the real world, a monopolistic industry may
consist of one firm that dominates the market
with a very large market share. For example,
DeBeers Company of South Africa controls over
80% of diamond sales, and is considered to be a
monopoly.
 MONPOLY POWER
• Monopoly lies at the opposite extreme of market structures to
perfect competition.
• As a single seller, the monopolist faces no competition from other
firms and it has substantial market power (the ability to control price).
• Yet a pure monopoly is quite rare in the real world. Like perfect
competition, it is studied because of the insights it offers into the
ability of firms to exercise market power, also known as monopoly
power. Monopoly power arises whenever a firm faces a demand
curve that is downward-sloping. As we will see throughout the rest of
this chapter, firms in all market structures except perfect competition
face a downward-sloping demand curve, and therefore have varying
degrees of monopoly power, or the ability to influence the price at
which they sell their output.
 CHARACTERISTICS OF A MONOPOLY
• The model of monopoly rests on the
following assumptions:
• There is a single seller or dominant firm in the
market.
• There are no close substitutes.
• There are significant barriers to entry.
 barrier to entry.
• Anything that prevents other firms from
entering the industry is called a barrier to
entry.
• There are several kinds of barriers to entry.
These are described below.
 1.Economies of scale
• Economies of scale occur when a firm’s average costs of
production fall as output increases.
• These mean that large firms can set their prices below
those of any potential new entrant firms to the market,
and still make a supernormal profit.
• For example, a large supermarket such as Tesco will be
able to negotiate a much cheaper price per unit when
buying dairy products from farmers in terms of a bulk-
buying discount, than a much smaller, independent
convenience store. This acts as a deterrent for new firms
to enter the market.
 2. Branding

• Branding involves the creation by a firm of a unique image and name of

a product. It works through advertising campaigns that try to influence
consumer tastes in favour of the product, attempting to establish
consumer loyalty.
• If branding of a product is successful, many consumers will be convinced
of the product’s superiority, and will be unwilling to switch to substitute
products, even though these may be qualitatively very similar. Branding
may work as a barrier to entry by making it difficult for new firms to enter
a market that is dominated by a successful brand. Note that branding
need not lead to a monopoly (it is a method used by firms in monopolistic
competition and oligopoly, as we will discover below), but it does have the
effect of limiting the number of new competitor firms that enter a market.
Examples of branding include brand-name items (such as NIKE®, Adidas®,
CocaCola®, etc.)
 3. Control of essential resources

• Monopolies can arise from ownership or control

of an essential resource.
• A classic example of an international monopoly
is DeBeers, the South African diamond firm, that
mines roughly 50% of the world’s diamonds and
purchases about 80% of diamonds sold on open
markets. Whereas it is not the sole diamond
supplier, its large market share allows it to have
a significant control over the price of diamonds..
 4. Legal barriers
• These include patents, copyrights and
trademarks and essentially give a single firm or
individual the right to have a monopoly over a
new product, process or other intellectual
property either forever or over a given time. For
example, the British inventor James Dyson holds
many patents over his original designs for a
range of household appliances, most notably
vacuum cleaners, which cannot legally be copied.
 5. Aggressive tactics

• If a monopolist is confronted with the

possibility of a new entrant into the industry, it
can create entry barriers by cutting its price,
advertising aggressively, threatening a
takeover of the potential entrant, or any other
behaviour that can dissuade a new firm from
entering the market.
 Sunk costs
• Sunk costs are the costs that cannot easily be recovered if
a firm is unsuccessful in a market and has to exit, i.e. these
financial commitments are essentially lost, or ‘sunk’.
• Such costs may include spending on specialist market
research or specialist equipment that could not easily be
sold to another firm.
• For example, an oil company may have to spend many
millions of pounds on detecting resources of crude oil
before it begins to extract any. The threat of losing this
money acts as a deterrent to new firms considering
entering a market.
 • The demand curve facing
The demand curve facing
the monopolist the monopolist
Since the pure monopolist is the
entire industry, the demand
curve it faces is the industry or
market demand curve, which is
downward-sloping. This is the
most important difference
between the monopolist and the
perfectly competitive firm, which
faces perfectly elastic demand at
the price level determined in the
market.
The two demand curves shown in
Figure beside indicate that the
perfectly competitive firm is a
price-taker with
zero market power, while the
monopolist is a price-maker with
a significant degree of market
power.
 The demand curve facing the monopolist

• All firms under market structures other than

perfect competition are to varying degrees price-
makers, as they all face downward-sloping
demand curves. Of these, the monopolist has the
greatest degree of market power, or the ability to
influence price, because it is the sole or dominant
firm in the industry. However, whereas the
monopolist has a large control over price, this
control is limited by the position of the market
demand curve
 CONTINUATION
• . Given the demand curve in Figure (b), when it chooses
how much output to produce, say Q1, it simultaneously
determines the price at which the good can be sold, or
P1. It could not possibly sell output Q1 at a price such as
P2, since the price–quantity combination P2 and Q1 is at
a point a lying off the demand curve. The monopolist can
sell its output at price P2 if it wants to, but will only be
able to sell quantity Q2 at that price. In other words, the
monopolist cannot make independent decisions on both
price and quantity; it can only choose price–quantity
combinations that are on the market demand curve.
 The monopolist’s revenue curves

• In perfect competition where the firm is a price-

taker, the market-determined price is constant for
all output, leading to the perfectly elastic
(horizontal) demand curve. But when a firm faces a
downward-sloping demand curve, price is no longer
constant for all output: more output can only be
sold at a lower price.
• Table1. provides the same data for a monopolist’s
total, marginal and average revenues, and the
diagrams in Figure 3 plot these data.
 • The monopolist’s revenue schedule

EXPLANATION
Looking at Table 1 and Figure 3, we
may note the following:
• As price (P) falls, output (Q) increases
because of the downward-sloping
demand curve). Total revenue (TR),
obtained by Q × P, at first increases,
reaches a maximum at six and seven
units of output, and then begins to fall.

• Marginal revenue, showing the

change in total revenue resulting from
a change in output, falls continuously;
MR is equal to zero when total
revenue is at its maximum (at seven
units of output), and becomes
negative when total revenue falls.

• Average revenue (column 5 of Table

1 ) is equal to price (see column 2):
 • Revenue curves in monopoly
EXPLANATION
Since TR = P × Q, and AR = TR
Q,
it follows that P is equal to AR.
• The AR and P curves
represent the demand curve
facing the firm.
• The MR curve lies below the
demand curve. The reason is
that, unlike in perfect
competition, where MR = P,
here the firm must lower its
price in order to sell more
output. The lower price is
charged not only for the last
unit of output but all the
previous units of output sold