Unit 5.1 Pure Monopoly - Copy

PURE MONOPOLYLESSON NO: 10

11 Apr 2023

Pure MonopolyMonopoly – a market with a single firm.Produces and sells a commodity that has

no close substitutes,The firm = industry, no competition.Barriers to entry. The firm is a “Price Maker” – it is free to

fix its own price.AR curve or Demand curve is downward

sloping, the firm can sell more, but only at a lower price.

MR lies below AR. 2

Emergence of Monopolies1. Natural Monopoly: Large scale production (e.g.

electricity, railways) – high fixed costs, no room for second producer.

2. Geographical Monopoly: raw materials available in certain areas only (jute in Bengal, basmati rice in Himalayan foothills)

3. Patents and copyrights: Microsoft, or IBM, medicines, book publishing, scientific discoveries and inventions.

4. Government Monopoly: Government may give franchise to certain companies. Called ‘de jure’ monopoly.

5. Raw material control: such as diamonds by De beers in S. Africa. 3

Profit maximisation in MonopolyMonopolist faces a downward sloping

D-curve (AR)Let the cost curves be usual U-shaped

curves.Profit maximising conditions apply:

MC = MR,MC

If the monopolist decides how much to produce and sell, the D-curve shows the P at which it should be sold 4

Profit maximisation – Short RunC,R

0 Q

AR = D

MR

SACSMC

m

Q1

PR

CC1

Abnormal Profits

Profit maximising Q = Q1, where MC = MR, MC. Price = OP and TR = P X Q = Op x OQ1 = OPRQ1.TC = AC X Q = OC1 X OQ1 = OC1CQ1.Abnormal profits = C1PRC

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Long Run EquilibriumIn the long run, the monopolist experiences

Returns to Scale, and increases production.But he can still control his price.Hence he can still make abnormal profits.These profits attract new competitors,But the monopolist can create barriers to

entry, and prevent new competition.Pre empting licences,Buying copy rights and patents,Mergers with smaller firms.Economics of scale

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Long Run equilibrium - Monopoly and PC

CR

0 Q

ARm

MRm

LRAC

LRMC

m

Qm

C

RPm

C1

Monopoly: Abnormal Profits

C2ARpc = MRpc

LRAC = AR, Normal Profit in PC

Qpc7

Monopoly Firm Perfect competition Firm

1. Single firm, Price Maker 1. Large number of firms, Price taker

2. Downward sloping AR curve, MR < AR

2. Straight line AR parallel to X axis, AR = MR

3. Higher P, and lower Q 3. Lower P, higher Q

4. Short run Abnormal profits 4. Short run Abnormal profits possible

5. Long run: Abnormal profits 5. Long run: Normal profits

6. Long run: Firm produces at less than efficient level, LAC not minimum

6. Long run: Firm produces at minimum LAC, efficient firm

7. Long run: P > MC, so consumers are exploited

7. Long run: P = MC, no exploitation of consumers.

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Monopoly PowerLerner’s Index (Li) is a measure of the exercise

of monopoly power.Li = (P – MC)

P E.g. P = Rs.10, and MC = Rs.5, then Li = (10 –

5)/10 = 5/10 = 50%.If MC = Rs.5, and P = Rs.15, then Li = (15 –

5)/15 = 10/15 or 66%,So this firm has greater control over the market.In PC Comp. Li = 0 because P = MC, so P – MC

= 0.9

Price Discrimination

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Price DiscriminationPrice discrimination: practice of monopolists

of charging different prices to different consumers for the same or similar commodities, without significant differences in the costs.

Monopolist wants to take away or reduce consumer’s surplus.

This is possible when there are different buyers who cannot communicate with each other,

Or when it is not possible for buyers to trade with each other. 11

Price DiscriminationBased on:

a) Geographical distances: prices of text books in USA > prices in India or Europe,

b) Income differences: Medical services, higher for rich, and lower for poorer citizens.

c) Different age groups: less for senior citizens, children, more for others (e.g. railways)

d) Quality: e.g. hard bound books more expensive than paper back.

e) Time: Peak time airline tickets > off time tickets, or early bird tickets.

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First degree Price DiscriminationThe monopolist takes

away the entire consumer surplus.

Charges the highest possible price.

Highly luxurious goods e.g. Rolls Royce, or collector’s items such as rare paintings, etc.

“Take it or leave it” policy

P

0

Q

D

Q1

P1No consumer’s surplus.

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Second degree Price DiscriminationHere the firm charges different rates for

different users of the same commodity by dividing consumers into different categories:Timings (e.g. railway/airline tickets

cheaper for night travel, or during non-peak timings).

Age: lower charges for senior citizens or for children below 14 years.

Perceived quality: hard bound books costlier than paper back.

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Second degree Price DiscriminationTime: premier rates higher for new films,

or concerts, lower rates as time passes.Position: lower rates for front seats in a

theatre, or ‘economy class’ , ‘2nd class in trains’. As compared to first class or AC.

People in different categories cannot buy at lower rates and sell to others at higher rates.

Some but not all of consumer’s surplus is taken away by the monopolist.

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Second degree Price Discrimination Each unit (e.g. ticket) sold at a different price. TR of 3 units = 500 + 400 + 300 = 1200 If MC = MR gives P = 300. Uniform price Then TR = 300 X 3 = 900With price discrimination, the firm earns 300 Rs more, without any extra cost.

0

Q

D =MR

Q1

P1 = 500

Q2

P2 = 400

P3 = 300

Q3

MC

The blue triangles show that the monopolist cannot take away the entire consumer’s surplus 16

Third Degree Price DiscriminationWhen there are two or more different

markets.Separated from each other in terms of

space, time, or income levels. (e.g. in posh areas, and in low income areas, premier tickets)

The elasticity of demand is different in each market.

The high income market has less elastic demand,

The low income market has more elastic demand.

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Third Degree Price Discrimination

0

P

ARa

MARKET A MARKET B

0

P

ARb

MONOPOLIST FIRM

P

0 MR a+b

AC = MC

MRb

MRa

QB

PB

QA

PB

T

QA+QB

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Third degree Price DiscriminationThere are two unconnected markets A and BMarket A has inelastic D curve, Market B has elastic

D curve.The monopolist produces the commodity with

constant costs (MC = AC).At the firm level, profit maximising Q is determined

at T = QA+QB.He sells QB in Market B at price PB, and QA in

Market A at price PA.QA < QB, while PA > PB.Market with more elastic D, has lower P, market with

inelastic demand has higher P.Thus the monopolist can make more profits by selling

in two different markets at two different prices.19

Control of Monopoly Monopoly is discouraged by Governments,

as it leads to exploitation of consumers.Anti Monopoly Laws, Laws to encourage

Competition (MRTP Act, and Competition Act 2002 in India), Anti Restrictive Practices Acts, passed in many countries.

Or the Government can tax away the extra profits of monopolists – through both direct profit taxes, or through indirect taxes, and use the tax revenue for other welfare purposes.

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Questions1. Short Answer Questions:

1. What are the main features of Monopoly?2. What are the factors that lead to the emergence of Monopoly?3. What is meant by “barriers to entry”? What type of barriers can be put up by a monopoly firm?4. What is “Monopoly Power” and how is it measured?5. What are the methods used by Governments to regulate monopoly? 21

2. Essay Questions:1. Depict the long run equilibrium of a Monopoly Firm. How does it differ from a firm in P.C?2. What is Price Discrimination? Explain the different types of price discrimination that can be carried out by a monopolist.3. Why is monopoly considered to be less efficient than perfect competition? Give reasons for your answer.

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