Monopoly

Single seller has control over the entire market supply.

No substitutes hence no alternatives for buyers.

It is a complete negation of competition. Price maker. Downward sloping demand curve. Entry barriers. A monopolist fixes the price as well as

quantity of output to be sold in the market.

1. Demand CurveThe demand curve of a monopoly firm is negatively sloped. The demand curve also reflects the AR curve of the firm, as AR is always equal to the price. The negative slope of demand curve under monopoly indicates that firm must reduce the price of the product if it wants to sell more.

2. MR CurveMR curve is also downward sloping curve

under monopoly. This curve also starts from the same point from where AR curve of the firm starts. However MR curve always lies below AR curve indicating that MR is always less than AR. Falling AR implies that MR should be falling faster than AR.

3. Relation between AR and MR(i) Initially both curves start from the same point and are downward sloping.(ii) MR curve always lie below AR curve indicating that MR is always less than AR at all levels of output.(iii) Although MR shares its intercept with AR or say demand curve, but its slope is double the slope of AR curve.(iv) AR is always positive but MR may be positive, zero or negative.

In the fig below, MR is zero at OQ level of output though AR is positive at that level. If firm produces more than OQ, MR becomes negative, but again AR remains positive.

The firm obviously attempts to maximize profits. In such a situation, the monopolist has to make two decisions :

I) To determine the price for his product.II) To determine the equilibrium level of

output.Both these decisions are interdependent.

If one is decided, the other one is implied.

The monopolist chooses between the above 2 decisions. He is unable to decide on both.

The monopolist, since is interested in profit maximization, follows the behavioral rule of MR=MC.

The demand curve in such a case is downward sloping.

MR curve lies below AR and the rate of fall in MR is twice of AR.

He produces that level of output at which : SMC= SMR SMC cuts SMR from below.At this output level, price is set in relation to

the demand position (AR curve)

At a level of output where MR=MC, the profits of a monopoly firm depend on the levels of AR and AC.

i) Economic profit: AR>ACii)Normal profit : AR=ACiii)Losses : AR<AC

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For a monopoly, the distinction between the long and short run is not as important

If a monopoly is insulated from competition by high barriers that block new entry, economic profit can persist in the long run

However, short-run profit is no guarantee of long-run profit

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A monopolist that earns economic profit in the short-run may find that profit can be increased in the long run by adjusting the scale of the firm

Conversely, a monopoly that suffers a loss in the short run may be able to eliminate that loss in the long run by adjusting to a more efficient size

Profit maximization is reached at LMR= LMC.

The firm has the flexibility to expand and to enhance profits depending upon conditions like:

a) Size of the market b)Expected economic profit. c)risk of inviting legal restrictions.

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A monopolist can sometimes increase economic profit by charging higher prices to customers who value the product more

The practice of charging difference prices to different customers when the price differences are not justified by differences in cost is called price discrimination

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ConditionsThe demand curve for the firm’s product

must slope downward the firm has some market power and control over price

There are at least two groups of consumers for the product, each with a different price elasticity of demand

The producer must be able, at little cost, to charge each group a different price for essentially the same product

The producer must be able to prevent those who pay the lower price from reselling the product to those who pay the higher price

First degree where the monopolist charges different prices to different buyers for each different unit of the same product.

Second degree where the monopolist sells blocks of output at different prices.

Third degree when different prices are set in different markets having different demand elasticities

Market size of the product is small. Monopolist is able to know the price

each consumer is willing to pay. He sets the price in such a way that he

is able to extract the consumer surplus at all levels of pricing.

The entire consumer surplus is converted into producer surplus.

The monopolist intends to extract major part of consumer surplus rather than whole of it.

The number of consumers are large. Demand curve of all consumers are identical. The potential buyers are divided into blocks

as per their financial status. Price rationing can be possible as in case of

utility services like telephone, electricity etc. A single rate is applicable for large number of

buyers.

Second Degree

Most common type of monopolist price discrimination.

Firm divides its total output into many sub markets and sets different prices in each of these markets basis demand elasticities.

The practice of discriminatory monopoly pricing in the area of foreign trade.

Implies different prices in the domestic and foreign markets.

Depends upon demand elasticities in different markets.