PD Monopoly

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PRICE DETERMINATIONMonopoly


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Elasticity of demand is zero or negative

The industry is a single firm industry

Firm and industry are identical in a monopoly

Equilibrium of a firm means equilibrium of theindustry

Pricing decision in a monopoly are based onRevenue and Cost.


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A firm under monopoly faces a downward slopingdemand curve or average revenue curve.

Further, in monopoly, since average revenue falls asmore units of output are sold, the marginal revenueis less than the average revenue.

In other words, under monopoly the MR curve lies

below the AR curve.


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The Equilibrium level in monopoly is that level ofoutput in which marginal revenue equals marginalcost.

The producer will continue producer as long asmarginal revenue exceeds the marginal cost.

At the point where MR is equal to MC the profit will

be maximum and beyond this point the producer willstop producing.


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It can be seen from the diagram that up till OMoutput, marginal revenue is greater than

marginal cost, but beyond OM the marginalrevenue is less than marginal cost.

Therefore, the monopolist will be in equilibrium

at output OM where marginal revenue is equal tomarginal cost and the profits are the greatest.

The corresponding price in the diagram is MP or

OP. It can be seen from the diagram at outputOM, while MP is the average revenue, ML is theaverage cost, therefore, PL is the profit per unit.


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Now the total profit is equal to PL (profit perunit) multiply by OM (total output).

n the short run, the monopolist has to keepan eye on the variable cost, otherwise he willstop producing.

In the long run, the monopolist can changethe size of plant in response to a change indemand. In the long run, he will make

adjustment in the amount of the factors, fixedand variable, so that MR equals not only toshort run MC but also long run MC.


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COMPARISON OF PRICE DETERMINATION UNDER PERFECT COMPETITION ANDMONOPOLY:The key points of comparison of price determination under Perfect Competition andMonopoly is as below: Perfect Competition Monopoly

(i) The demand curve or average revenue curve is perfectly elastic and is a horizontal straight line.(i) The demand curve or average revenue curve is relatively elastic and a downward

sloping from left to right.

(ii) The firm is in equilibrium at the level of output where MC is equal to MR. Since in perfectcompetition MR is equal to AR or price, therefore, when MC is equal to MR, it is also equal to ARor price at the equlibrium position, i.e., MC=MR=AR (Price) (ii) The firm is in equilibrium atthe level of output where MC is equal to MR.

(iii) In equilibrium position, the price charged by the firm equals to MC. (iii) In equilibriumposition, the price charged by the firm is above MC.

(iv) The firm is in long-run equilibrium at the minimum point of the long-run AC curve. (iv) Thefirm is in long-run equilibrium at the point where AC curve is still declining and has not reachedthe minimum point.

(v) The firm is in equilibrium at the level of output at which MC curve is rising, and is cutting MRcurve from below. (v) The firm is in equilibrium at the level of output at which MR curve is slopingdownwards, and MC curve is cutting it from below or above. (See figure 1)

(vi) In the long run, the firm is earning normal profit. There may be super normal profit in the shortrun but they will be swept away in the long run, as new firms entered into the industry. (vi) Thefirm can earn abnormal or supernormal profit even in the long run, as there is no competitor in theindustry.

(vii) Price can be set lower at greater output in case of constant-cost and decreasing-costindustries. (vii) Price is set higher and output smaller by the monopolist. (See Figure 2)


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Discrimination?

While discussing price determination under monopoly, itis assumed that a monopolist charges only one price forhis product from all the customers in the market.

But it often so happens that a monopolist, by virtue of hismonopolistic position, may manage to sell the samecommodity at different prices to different customers or indifferent markets.

The practice on the part of the monopolist to sell theidentical goods at the same time to different buyers atdifferent prices when the price difference is not Justifiedby difference in costs in called price discrimination.


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Types and Examples ofPrice Discrimination

(1)Price discrimination. It is persona!, when separate price is chargedfrom each buyer according to the intensity of his desire oraccording to the size of his pocket. For instance, a doctor maycharge more from a rich person for an operation and very little orno money at all from a poor man for the similaroperation.

(2).Trade discrimination. It may take place when a monopolist charges

different prices according to the uses to which the commodity is put.For example, an electricity company may charge low rate for electriccurrent used in an industrial concern than for the electricity used forthe domestic purpose.


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Conditions of Price Discrimination:

1. Segregation by price. There should be nopossibility, of transferring a unit of commoditysupplied from the low priced to the high priced

market. For instance, a rich patient cannot send apoor man to the doctor for his medical cheek up at acheaper rate for him. Similarly, if you want to send akilogram of gold by train to a relative of yours, youcannot get it converted into coal or iron simplybecause these metals are transported at a cheaperrate.


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2. Segregation by market. Another essential characteristicof price discrimination is that there should be nopossibility of transferring one unit of demand from thehigh priced to the low priced market. For instance, a

banana market is divided on the basis of wealth. Thepoor are supplied bananas at a concessional rate in onemarket. The rich people will not like to become poor inorder to get the commodity at a cheaper rate. A

monopolist will maximize his total revenue by equalizingmarginal revenue from all the markets.


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3. Segregation by demand. Pricediscrimination can be possible if there isdifference in the elasticity of demand indifferent markets. If the demand for a certaincommodity is elastic in a particular market,the monopolist will charge lower prices. But if

the demand is inelastic, the monopolist willfix higher prices for his product.


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Degrees of Price

Discrimination

(1) First degree price discrimination. The monopolistcharges a different price equal to the maximum amountfor each unit of the commodity from each consumerseparately i.e. he charges the highest price in such a

way that those willing to buy can buy at least one unit.The price of each unit is equal to its demand price sothat the consumer is unable to enjoy any consumersurplus (the difference between what consumers arewilling to pay for a good or service and what they

actually pay i.e. the market price.) After extracting thehighest price, the price is lowered so that the secondunit of consumer is extracted of consumer surplus.ENTIRE CONSUMER SURPLUS IS EXTRACTED.


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(2).Second degree price discrimination. Here the monopolist divideshis market into different groups of customers and charges eachgroup the highest price which the marginal consumer belongingto that group is willing to pay. The railway, airlines etc., charge thefares from customers in this way. In this degree, a major part ofthe consumer surplus is extracted rather than the whole of it. The

prospective consumers are divided into categories (like rich,middle, poor etc.) This degree is possible only when

(i). Number of consumers is large

(ii). Demand curve for all consumers is identical

(iii). Single rate is applicable for a large number

of consumers.

Example: Electricity usage charges for various categories .


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(3) Third degree price discrimination. In the third degree

price discrimination, the monopolist divides the entiremarket into a few sub-markets and charges differentprices for the same commodity in different sub-markets. He determines the MR and MC curves for allsub markets. The division here is among classes ofconsumers and not among individual consumers. Third

degree price discrimination is possible only if theclasses of consumers can be kept separate. Secondly,the various groups of customers must have differentelasticities of demand for his commodity. The segmentwith a less elastic demand pays a higher price than the

segment with a more elastic demand. The consumerfaces a single price in each category of consumers. Hecan purchase as much as desired at that price. It is themost common type of price discrimination. Forexample, movie theaters, railways, typically chargelower prices to senior citizens, students etc.


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PRICE DETERMINATION :

OLIGOPOLY

Oligopoly falls between two extreme marketstructures, perfect competition and monopoly.

Oligopoly occurs when a few firms dominate the

market for a good or service. This implies that whenthere are a small number of competing firms, theirmarketing decisions exhibit strong mutualinterdependence.

By mutual interdependence we mean that a firm'saction say of setting the price has a noticeable effecton its rival firms and they are likely to react in thesome way. Each firm considers the possible reaction

of rivals to its price and product developmentdecisions.


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Explanation of Price and Output DeterminationUnder Oligopoly:

There is not a single theory which satisfactorilyexplains the pricing and output decisions underoligopoly. The reasons are:

(i) The number of firms, dominating the market vary.Sometimes there are only two or three firms whichdominate the entire market (Tight oligopoly). Atanother time there may be 7 to 10 firms which

capture 80% of the market (loose oligopoly).

(ii) The goods produced under oligopoly may or maynot be standardized.


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(iii) The firms under oligopoly sometime cooperate witheach other in the fixing of price and output of goods. Atanother time, they prefer to act independently.

(iv) There are situations also where barriers to entry arevery strong in oligopoly and at another time, they arequite loose.

(v) A firm under oligopoly cannot predict with certainly the

reaction of the rival firms, if it increases or decreases theprices and output of its goods. Keeping in view the widerange of diversity of market situations, a number ofmodels have been developed explaining the behaviour ofthe oligopolistic firms.

CLASSIFICATION OF


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CLASSIFICATION OFOLIGOPOLY

a) Duopoly: If there are two giant firms in an industry it iscalled duopoly. Duopoly is further classified as below:

(i) Perfect or Pure Duopoly: If the duopolists in anindustry are producing identical products it is calledperfect or pure duopoly.

(ii) Imperfect or Impure Duopoly: If the duopolists in anindustry are producing differentiated products it iscalled imperfect or impure duopoly.


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(b) Oligopoly: If there are more than two firms in anindustry and each firm takes consideration thereactions of the rival firms in formulating its own

price policy it is called oligopoly. Oligopoly is furtherclassified as below: (i) Perfect or PureOligopoly: If the oligopolists in an industry areproducing identical products it is called perfect orpure oligopoly.(ii) Imperfect or ImpureOligopoly: If the oligopolists in an industry areproducing differentiated products it is calledimperfect or impure oligopoly.

PD Monopoly

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