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Monopoly

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Monopoly- assumptions

One seller Many buyers Entry and exit into the market: very

difficult or prohibited Monopolist usually produce unique

product with no close substitute

Sources of monopoly Principal cause of monopoly is barrier to entry. Barriers to entry may arise from various

sources. When a firm can produce a good at a price

lower than any other firm can then monopoly arises. We call this Natural Monopoly.

Monopoly may also arise when a firm has exclusive ownership of a factor of production.

Government may create monopoly through legal system (copyright, patent).

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Shape of the monopoly market demand curve

Downward sloping Slope of the curve depends on the

elasticity of demand for the monopoly product

However, monopoly demand curve is never horizontal

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Pricing under Monopoly

The basic question is- “can the monopolist charge any price for his product?”

The answer is- “yes, it can.” But, the point of consideration is-

“how much can he sell his product at that price?”

It depends on the elasticity of demand for his product.

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Note on the relationship between demand and marginal revenue

Marginal revenue and demand are very closely linked. If we look at the marginal revenue, we get an idea about the demand.

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Demand vs. Marginal RevenueSuppose we have a demand equation:Q = C – a.PWhere, Q is quantity demanded, P is price, a and C are parameters.Rearranging the equation we get:P = (C/a) - (1/a).QMultiplying both sides by Q we get:PQ = (C/a).Q - Q2/aTR = (C/a).Q - Q2/aSo, the marginal revenue is:MR = (C/a) - (2/a).Q

The slope of the MR curve is just double of the demand curve. This means the MR curve is twice as steep as the demand curve. This also means that the demand curve will always lie above the MR curve.

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Demand and MR curves

D

MR

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Pricing under monopolyQ P TR MR TC AC MC Profit

0 180 0   100     -100

1 170 170 170 155.7 155.70 55.7 14.3

2 160 320 150 205.6 102.80 49.9 114.4

3 150 450 130 253.9 84.63 48.3 196.1

4 140 560 110 304.8 76.20 50.9 255.2

5 130 650 90 362.5 72.50 57.7 287.5

6 120 720 70 431.2 71.87 68.7 288.8

7 110 770 50 515.1 73.59 83.9 254.9

8 100 800 30 618.4 77.30 103.3 181.6

9 90 810 10 745.3 82.81 126.9 64.7

10 80 800 -10 900 90.00 154.7 -100

11 70 770 -30 1086.7 98.79 186.7 -316.7

12 60 720 -50 1309.6 109.13 222.9 -589.6

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The optimum price level for the monopolist

D

MR

Where?MC

P*

Q*

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Superiority of Perfect Competition over Monopoly

In Perfect Competition-

Consumers maximize surplus No deadweight loss More output No technical inefficiency No rent-seeking

Whereas, in Monopoly all the opposite statements are true.

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Perfect Comp. vs. Monopoly

MR

MR=AR

D

MC

Q* Qp

P

P*Deadweight loss

Consumer’s surplus

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Task Suppose the total cost for a

monopolist is given by-

TC = 500 + 20.Q2 andDemand equation is given by- P = 400 – 20.QWhat are the profit maximizing price and quantity?

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Solution hints

Profit maximizing happens where MC = MR

To get MR we need to have TR To get TR multiply P by Q. [TR = P.Q] Arrange the table to get MC and MR Find out the desired values from the

table

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SolutionQ TC TR MC MR Profit

1 520 380     -140

2 580 720 60 340 140

3 680 1020 100 300 340

4 820 1280 140 260 460

5 1000 1500 180 220 500

6 1220 1680 220 180 460

7 1480 1820 260 140 340

8 1780 1920 300 100 140

9 2120 1980 340 60 -140

10 2500 2000 380 20 -500

11 2920 1980 420 -20 -940

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Monopolistic Competition

MonopolyPerfect Competition

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Definition

Monopolistic competition is a market structure in which:

Number of buyers and sellers is large Entry and exit are easy Products are differentiated Non-price competition exists

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Product Differentiation

Product differentiation implies that the products are different enough that the producing firms exercise a “mini-monopoly” over their product.

The firms compete more on product differentiation than on price.

Entering firms produce close substitutes, not an identical or standardized product.

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Many Sellers

When there are many sellers, they do not take into account rivals’ reactions.

The existence of many sellers makes collusion difficult.

Monopolistically competitive firms act independently.

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Non-price competition

A key instrument for survival Indicates competition that do not

involve price setting decisions Examples are: advertising, sells

promotion, free gifts Helps to avoid price war

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Profit Maximization in a Monopolistic Market

MC

AC

D

MR

Q

P