Monopoly

Topic 6

MONOPOLY- Contents

1. Monopoly Characteristics2. Monopoly profit maximization3. Assessment of Monopoly4. Regulation of Monopoly5. Price Discrimination

Characteristics of a pure monopoly

Single seller High barriers to entry Unique Product

Barriers to Entry

High barriers to entry explain the existence of monopolies

Block all potential competitors

Barriers to Entry

Economies of scale In some industries, efficient, low-cost

production can only be achieved if producers are large – Natural monopoly

Legal Barriers Regulations, Patents and Licences

Control of the supply of raw materials

Monopoly Demand curve

Monopolist’s demand curve is the industry demand curve and therefore is down-sloping

Monopolist is a ‘price maker’ since it can influence total supply

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Q O

D

Demand Curve of a Monopoly Firm

Copyright 2001 Pearson Education Australia

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 QQ

Do

llars

Do

llars

200

150

200

50

750

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MRMR

Elastic

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DD

TRTR

Inelastic

Unit ElasticityUnit Elasticity

Demand, Marginal Revenue, Total Revenue

Demand and MR Demand curve: P= a - bQ

MR= a – 2bQ

D & MR start from the same point

Everywhere else MR bisects the distance between D curve & vertical axis

Profit maximisation under Monopoly

Rules for Profit maximization same as under Perfect Competition

MR = MC (where MC cuts MR from below)

Short Run: P ≥ AVC Long Run : P ≥ ATC

Profit maximising under monopoly$

Q O

MC

Qm

MR

AR

Copyright 2001 Pearson Education Australia

$

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ATC

MC

AR

AC

Qm

MR

AR

a

b

Profit maximising under monopoly

Copyright 2001 Pearson Education Australia

$

Q O

ATC

MC

AR

AC

Qm

MR

AR

Profit maximising under monopoly

Copyright 2001 Pearson Education Australia

Profit maximisation under Monopoly

Profit Maximisation Loss Minimisation

Points to remember

No supplier will produce an output corresponding to the inelastic section of the demand curve.

Why?

Points to remember A monopolist will not charge the highest

price possible (A monopolist seeks to maximise profit, not necessarily price)

A monopolist will not maximize profit per units but total profits

Monopolies are not always making profitLosses are possible Pure monopoly does not guarantee economic

profits In the short-run, monopolist may experience

losses because of weak demand or high costs

Assessment of MonopolyComparison with PC (with no monopolist economies of scale)

No economies of scale: means that the cost curve ( MC & AC) are the same under both PC and Monopoly

Monopoly: higher price, lower output

smaller consumer surplus

no allocative efficiency no productive efficiency deadweight loss to

society (area ABE)

Assessment of MonopolyComparison with PC (with monopolist economies of scale)

Economies of scale:

means that the costs will be lower under Monopoly

Monopoly: lower price, higher output

larger consumer surplus

more efficient as overall costs will be lower than under PC

Assessment of other factors

Income distribution: Monopoly profits tend to concentrate in higher income

groups.

X-inefficiency the difference between theoretically defined efficient

behavior of firms and how they actually behave Monopoly tends to perform less well compared to PC since

they face less pressure to improve efficiency & cut costs

Technological progress: Monopoly have financial resources hence more R& D than

competitive firms

Regulating Monopolies

Historically, monopolies have been operated or heavily regulated by the government

Competition policy & Legal action: Actions against firms overcharging price

Incentives to new entrants Price ceilings

at the point where MC cuts the D curve (allocative efficiency achieved)

More about price ceilings - When MC is increasing-

• Price ceiling is set at PC

• Increase in consumer surplus: PmAEPc

• Allocative efficiency is achieved (Price = MC)

•Deadweight lost ABE is eliminated

• Monopolist still earn a profit: PcETPt

More about price ceilings - When MC is decreasing-

Two part pricing regulation:

Price ceiling is set at PC Monopoly firm will

incur a loss PaPcEB

Allow monopolist to charge a fixed fee so that the loss will be recovered

Price DiscriminationPrerequisites There is Monopoly

control Clearly identifiable

market segments between which resale

cannot take place

Different price elasticities of demand in the different segments

This is 3rd degree price discrimination

Degrees of price discrimination

1st Degree Each unit sold at the highest price a buyer is willing

to pay (leaving zero consumer surplus)

2nd Degree Different prices charged for blocks of output, rather

than each unit as in 1st degree discrimination

3rd Degree Different prices to different groups of consumers.

Within a group the price remains constant irrespective of the number of units consumed