Monopoly

MonopolyOpposite of PCOccurs when output of entire

industry is produced and sold by a single firm referred to as Monopolist

Characteristics of Pure Monopoly

Single supplier – the firm and the industry are the same.

No close substitutes – the product is unique and unlike any others.

Price maker – the firm has considerable control over price since it controls the total quantity supplied.

Blocked entry – barriers to entry exist because there is no immediate competition.

Example railways in Pakistan , PTCL was once a monopoly

Barriers to EntryEconomies of ScaleLegal Barriers to Entry

◦Patents[ gives right to a firm to produce a product for a given time period]

◦Licenses[ govt gives licenses e.g. TV channels]

Ownership or Control of Essential Resources [e.g. gas reserves]

Price Maker

Monopoly Price-Setting Strategies◦ For a monopoly firm to determine the quantity

it sells, it must choose the appropriate price. ◦ There are two types of monopoly price-setting

strategies:◦ A single-price monopoly is a firm that must

sell each unit of its output for the same price to all its customers.

◦ Price discrimination is the practice of selling different units of a good or service for different prices.

PROFIT DETERMINATIONCOMPARING COSTS AND REVENUES

Single price monopolist

A single price Monopolist

Cost and Demand curveThe cost curves[ AVC, ATC] of

monopolist are U shaped just like PC firms, because cost depend on law of DR not market structure

Monopoly firm is sole the supplier so it faces downward sloping demand, tradeoff between D and P

A single price MonopolistAverage RevenueWhen monopoly charges same price

over all units sold, AR is identical to price.

The market demand curve is also firm AR curve

AR= TR/Q= [P x Q]/Q so Q cancels out and

hence AR= P for single price monopoly

A single price MonopolistPrice and Marginal Revenue

◦MR from sale of additional unit of production will be below demand curve

◦Since the demand curve is negatively sloped hence the prices must be lowered on all units to sell an extra unit.

0 1 2 3 4 5 6

$142

132

122

112

102

92

82

Price and Marginal RevenueMarginal Revenue is Less Than Price

D

• A Monopolist isSelling 3 Units at$142

• To Sell More (4), Price Must BeLowered to $132

• All Customers Must Pay the SamePrice

• TR Increases $132 Minus $30 (3x$10)

Gain = $132

Loss = $30

0 1 2 3 4 5 6

$142

132

122

112

102

92

82

Price and Marginal RevenueMarginal Revenue is Less Than Price

D

• A Monopolist isSelling 3 Units at$142

• To Sell More (4), Price Must BeLowered to $132

• All Customers Must Pay the SamePrice

• TR Increases $132 Minus $30 (3x$10)

• $102 Becomes a Point on the MR Curve

• Try Other Prices toDetermine Other MR Points

Gain = $132

Loss = $30

The Constructed Marginal Revenue CurveMust Always Be Less Than the Price

MR

Total, Average and Marginal Revenue

PriceP=AR

Quantity Total RevenueTR= T x Q

Marginal Revenues

9.1 9 81.9

9 10 90 8.1

8.9 11 97.9 7.9

Price elasticity and MRAs noted earlier, since the

demand curve facing a monopoly firms is downward sloping, MR < P

MR > 0 when demand is elasticMR = 0 when demand is unit

elasticMR < 0 when demand is inelastic

$200

150

100

50

0

$750

500

250

0

2 4 6 8 10 12 14 16 18

2 4 6 8 10 12 14 16 18

Pri

ce

Tota

l R

even

ue

Monopoly Revenue and CostsDemand, Marginal Revenue, and Total Revenue for a

Pure MonopolistElastic Inelastic

Demand and Marginal Revenue Curves

Total-Revenue Curve

DMR

TR

SR Monopoly equilibrium Two rules apply 1. Produce or Not [ if monopolist

cannot cover SR variable costs then shut down]

2. If the firm does produce then MC = MR, the monopolist is maximizing profit.

MC= MRBecause MR< P for a monopoly

then MR=MC< PWhen monopoly firm is in profit

maximizing equilibrium ,its MC is always less than price it charges.

MR = MC Determines the Profit-Maximizing Output**Elasticity and revenues Monopolist always produce where

demand is elastic , MR is positiveA profit maximizing monopoly will

never sell in the range where demand is inelastic

Monopoly profitsThree possibilitieseconomic profitsZero profitsLosses

Profit Maximization

0

$200

175

150

125

25

100

75

50Pri

ce,

Costs

, an

d R

even

ue

1 2 3 4 5 6 7 8 9 10

Quantity

By A Pure Monopolist

D

MR

ATC

MC

MR=MC

Pm=$122

A=$94

EconomicProfit

Zero-profit monopolist

Loss Minimization

0

Pri

ce,

Costs

, an

d R

even

ue

Quantity

By A Pure Monopolist

D

MR

ATC

MC

MR=MC

Loss

AVCPm

Qm

V

A

Economic Effects of MonopolyPrice, Output, and Efficiency

PurelyCompetitive

Market

PureMonopoly

D D

S=MC MC

P=MC=Minimum

ATC

MR

Pc

Qc

Pc

Pm

QcQm

Pure Competition is EfficientMonopoly Price is Greater Than MC

And Is Therefore Inefficient

a

b

c

Supply for monopolyWe are not equating p=MR= MC

like we did in PCFor a monopoly firm there is no

unique relationship between markept price and quantity supplied

Figure 13.5

Multi-plant monopolistHow to allocate production

between two or more plants?The given output will be allocated

where the MC of plants equatePlant A MC=20 producing 30unitsPlant B MC=17 producing 25

unitsCost reduce by 3 if you reallocate

Overall MC for multi plant is the sum of MC curves for its individual plants

Long RunDue to barriers to entry no firm

can enter the marketIf monopoly has losses in SR then

it can shut down in LR if they are unable to cover Variable costs

If profits are earned in SR , they can continue in the LR also due to barriers to entry