MONOPOLY

A firm is a monopoly if it is the sole seller of its product and if its product does not have any close
substitutes

Characteristics :

1 One firm: One seller and large no of buyers, there is only one firm that dominates the entire supply of
a particular product or services.

2 One good: no close substitute

3 High Barrier to entry: high start up cost, control over essential resources, govt. regulations and
economies of scale.

4 Monopoly is Price maker( independent pricing policy) they have market power

5 Price discrimination

6 Monopoly is also an industry

The fundamental cause of monopoly is barriers to entry: A monopoly remains the only seller in its
market because other firms cannot enter the market and compete with it. Barriers to entry, in turn,
have three main sources.

 Monopoly resources: A key resource required for production is owned by a single firm e.g
diamond, oil producing countries
 Government regulation: The government gives a single firm the exclusive right to produce some
good or service.(patents, copy right). The patent and copyright laws are two important
examples. When a pharmaceutical company discovers a new drug, it can apply to the
government for a patent. If the government deems the drug to be truly original, it approves the
patent, which gives the company the exclusive right to manufacture and sell the drug
 Natural monopolies(The production process): A single firm can produce output at a lower
cost than can a larger number of firms. An example of a natural monopoly is the distribution of
water. To provide water to residents of a town, a firm must build a network of pipes throughout
the town. If two or more firms were to compete in the provision of this service, each firm would
have to pay the fixed cost of building a network. Thus, the average total cost of water is lowest if
a single firm serves the entire market. It arises when there is economies of scale.
How Monopolies Make Production and Pricing Decisions

The key difference between a competitive firm and a monopoly is the monopoly’s ability to influence
the price of its output. A monopoly is the sole producer in its market, it can alter the price of its good by
adjusting the quantity it supplies to the market. One way to view this difference between a competitive
firm and a monopoly is to consider the demand curve that each firm faces. A competitive firm can sell as
much or as little as it wants at this price, the competitive firm faces a horizontal demand curve. A
monopoly is the sole producer in its market, its demand curve is the market demand curve. Thus, the
monopolist’s demand curve slopes downward.

A Monopoly’s Revenue: A monopolists Marginal revenue is always less than the price of its good. The
demand curve is downward sloping so when a monopoly drops the price to sell one more unit, the
revenue received from previously sold units also decreases .

Marginal revenue for monopolies is very different from marginal revenue for competitive firms. When a
monopoly increases the amount it sells, this action has two effects on total revenue (P x Q):

• The output effect: More output is sold, so Q is higher, which tends to increase total revenue.

• The price effect: The price falls, so P is lower, which tends to decrease total revenue.
. Figure 3 graphs the demand curve and the marginal-revenue curve for a monopoly firm. (Because the
firm’s price equals its average revenue, the demand curve is also the average-revenue curve.) These two
curves always start at the same point on the vertical axis because the marginal revenue of the first unit
sold equals the price of the good. But, the monopolist’s marginal revenue on all units after the first is
less than the price of the good. Thus, a monopoly’s marginal-revenue curve lies below its demand curve.
You can see in Figure 3 (as well as in Table 1) that marginal revenue can even become negative. Marginal
revenue is negative when the price effect on revenue is greater than the output effect. In this case,
when the firm produces an extra unit of output, the price falls by enough to cause the firm’s total
revenue to decline, even though the firm is selling more units.
Profit maximization (firm equilibrium) under monopoly:

A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal
cost.

MC=MR

MC cuts MR from below

Figure 4 graphs the demand curve, the marginal-revenue curve, and the cost curves for a monopoly
firm. Suppose, first, that the firm is producing at a low level of output, such as Q1. In this case, marginal
cost is less than marginal revenue. If the firm increased production by 1 unit, the additional revenue
would exceed the additional costs, and profit would rise. Thus, when marginal cost is less than marginal
revenue, the firm can increase profit by producing more units. If the firm increased production by 1
unit, the additional revenue would exceed the additional costs, and profit would rise. Thus, if marginal
cost is greater than marginal revenue, the firm can raise profit by reducing production. Thus, the
monopolist’s profit-maximizing quantity of output is determined by the intersection of the marginal-
revenue curve and the marginal-cost curve. In Figure 4, this intersection occurs at point A.

In case of perfect competition, Price equals to marginal cost

P=MR=MC

In case of monopoly price exceeds marginal cost.

P>MR =MC
A Monopoly’s Profit

Profit = TR - TC.

Profit = (TR/Q - TC/Q) x Q.

TR/Q is average revenue, which equals the price, P, and TC/Q is average total cost, ATC. Therefore,

Profit = (P - ATC) x Q

SUPER NORMAL PROFIT([Link]) NORMAL PROFIT(AR=AC)

Price discrimination is the business practice of selling the same good at different prices to differ ent
customers. . For a firm to price discriminate, it must have some market power, so it is not possible in
case of perfect competition.

The first and most obvious lesson is that price discrimination is a rational strategy for a profit-maximizing
monopolist. That is, by charging different prices to different customers, a monopolist can increase its
profit. In essence, a price- discriminating monopolist charges each customer a price closer to her
willingness to pay than is possible with a single price.

The second lesson is that price discrimination requires the ability to separate customers according to
their willingness to pay. In our example, customers were separated geographically. But sometimes
monopolists choose other differences, such as age or income, to distinguish among customers.

The third lesson from our parable is the most surprising: Price discrimination can raise economic
welfare. When price discriminates, all readers get the book and the outcome is efficient. Thus, price
discrimination can eliminate the inefficiency inherent in monopoly pricing.

Perfect price discrimination describes a situation in which the monopolist knows exactly each
customer’s willingness to pay and can charge each customer a different price. In this case, the
monopolist charges each customer exactly her willingness to pay, and the monopolist gets the entire
surplus in every transaction.

Examples of Price Discrimination:

Movie Tickets

Airline Prices

Discount Coupons

Financial aid

Public Policy toward Monopolies

Increasing Competition with Antitrust Laws

Regulation

Public Ownership