2. Monopoly
The market structure of monopoly is at the opposite end of
perfect competition – exists when an industry is in the hands of a
single producer.
A firm is viewed as a monopoly if
•it is the sole seller of its product and the only potential supplier
•it produces a product which does not have close substitutes
3. A monopoly arises due to barriers to entry
These have three major sources:
•ownership of a key resource
•a government gives just one firm the right to produce a product
•may arise from patent and copyright laws
•cost of production make a single producer more efficient than a
large number of producers
one firm can supply market cheaper than two or more firms
4. While a competitive firm is a price taker, a monopoly is a price
maker.
As it is the only producer and supplier of the product, its demand
curve is the market demand curve for the product.
As this curve is downward sloping each extra sale pushes down
the price at which all units are sold.
As a result the marginal revenue arising from an increase in
sales will be less than the price at which the unit is sold.
7. Comparing a Monopoly with Perfect Competition
Equilibrium in a competitive industry occurs at the intersection of the
supply curve (MC) and demand curve. Output is QC and price PC.
Monopolist sets MC = MR output falls to QM, given output level QM price is
PM. Monopolist reduces output and increases price.
Monopolist does not operate where price is equal to MC and so the level
of output is not allocatively efficient and leads to a welfare loss.
If the cost structures of the
monopoly and the
competitive industry are
the same, then the
marginal cost curve, MC is
the competitive industry’s
supply curve.
8. Welfare loss of Monopoly
In perfect competition equilibrium occurs at PC and QC and consumer
surplus is given by areas 1, 4 and 3.
When a monopolist runs the industry price increases to PM and consumer
surplus is now only area 3. Area 1 is lost due to reduction in output. Area
4 is lost due to increase in price and transferred to the monopolist.
9. In perfect competition producer surplus is given by areas 2 and 5.
When a monopolist runs the industry price rises and producer
surplus area 2 is lost, but the monopolist has gained area 4. Area 4
is greater than area 2 as output QM and price PM maximizes profit.
Society, however, loses areas 1 and 2 as a result of the monopoly
and this is the deadweight loss arising from allocative inefficiency.
Public policy makers have attempted to deal with the problem of
monopoly through a number of channels.
i.Making industries more competitive
ii.Regulating monopolies
iii.Turning them into public enterprises
However others have suggested doing nothing as ‘Political Failure’ is
usually greater than ‘Market Failure’.
10. Discriminating Monopoly
If a monopolist supplies two separate groups of customers
•with differing elasticities of demand
It can be shown that a monopolist can increase profits by charging different
prices to different individuals.
•business travellers may be less sensitive to price levels than tourists
Monopolist may increase profits by charging higher prices to businessmen
than tourists
Discrimination is more likely to be possible for goods that cannot be resold
•dental treatment
•train and airline travel
•private medical treatment
11. Perfect price discrimination occurs where a monopolist charges
each individual exactly what they are willing to pay. Therefore the
discriminating monopolist collects the surplus on each transaction.
Because consumer surplus is zero for the perfectly discriminating
monopolist, the total surplus is equal to profit. This case has been
described as first degree price discrimination.
12. THIRD DEGREE PRICE DISCRIMINATION
This takes place where different prices are charged to different groups of
consumers for the same product.
For this to take place the firm must be able to separate consumers into two
sub-markets and the demand curve for consumers in these two sub-groups
must be different.
13. For simplicity assume the MC curve is constant (equal to 5).
The profit maximising firm will equate marginal revenue with marginal cost.
Output will equal 10 and price charged will equal 10.
Profit = TR – TC
Profit = P.Q – AC.Q
= (10 x 10) – (5 x 10)
= 50
As marginal revenue differs across submarkets the monopolist could re-
allocate its output and increase its profit by charging a lower price to
consumers with a higher elasticity of demand – lower willingness to pay.
Profit = (TRA
– TCA
) + (TRB
– TCB
)
Profit = [(14 x 4) – (5 x 4) + (9 x 6) – (5 x 6)]
= 56 – 20 + 54 – 30
= 60
By exploiting the different elasticities of demand in the two markets profits
have increased from 50 to 60.
14. Summary
A monopoly compared with perfect competition implies
•higher price
•lower output
Monopolist can increase profits by price discriminating
Monopoly results in welfare lose
The firm by exploiting economies of scale may imply the
consumer doesn’t always lose from monopoly
Policy makers can respond to inefficiencies of monopoly
behaviours through competitive legislation, regulation of prices,
or by turning the monopoly into a government-run enterprise
If the market failure is viewed to be small, policy makers may
decide to do nothing at all
Notas do Editor
See section 4-2 and Figure 4-4 in the main text.
See Section 8-6 in the main text, and Figure 8-12.
