Monopoly

Monopoly
Price determination
under imperfect
competition

Patterns of imperfect
competition
The major kinds of imperfect competition are:
 Monopoly,
 Oligopoly, and
 Monopolistic competition

We shall see that for a given technology, prices are
higher and outputs are lower under imperfect
competition than under perfect competition.

Imperfect competitions also have virtues along with vices.
Large firms exploit economies of large-scale production
and are responsible for much of the innovation that
propels long-term economic growth.

competition
Definition of Imperfect Competition:
If a firm can appreciably affect the market price of
its output, the firm is classified as an “imperfect
competitor.”
 Imperfect competition prevails in an industry
whenever individual sellers have some measures of
control over the price of their output.
 It does not imply that a firm has absolute control
over the price of its product.
 For example Coca-Cola and Pepsi where if the
average price in the market is Rs.75, they can sell
Rs.70 or 80 and still remain a viable firm.

competition
Definition of Imperfect Competition:
 The firm could hardly set the price at Rs.400 or Rs.5
a bottle because at those prices it would go out of
business.
 This tells that an imperfect competitor has some
but not complete discretion over its prices.
 Moreover, the amount of discretion over prices will
differ from industry to industry.

competition
Firm demand under Firm demand under
P perfect competition P imperfect competition
Price (Rupees per unit)

Price (Rupees per unit)
d
d’

d d
B

d
d’
q q
0 0
Firm quantity Firm quantity

competition
Explanation of the graphs:
 The figure (a) shows that a perfectly competitive firm
can sell all it wants along its horizontal dd without
depressing the market price.
 But the imperfect competitor will find that its demand
curve slopes downwards as higher price drives sales
down. And unless it is sheltered monopolist, a cut in its
rivals’ prices will appreciably shift its own demand curve
leftwards to d’d’.
We can also see the difference between perfect and
imperfect competition in terms of price elasticity.
For a perfect competitor; demand is perfectly elastic; for an
imperfect competitor; demand has a finite elasticity.

competition
Varieties of imperfect competition:
Economists classify imperfectly competitive markets
into three different structures.
 Monopoly

 Oligopoly

 Monopolistic competition.

competition
Sources of market imperfections:
Most cases of imperfect competition can be traced
to two principal causes.
 First, industries tend to have fewer sellers when
there are significant economies of large-scale
production and decreasing costs.
 Under these conditions, large firms can simply
produce more cheaply and then undersell small
firms, which cannot survive.

competition
Sources of market imperfections:
 Second, markets tend toward imperfect competition
when there are “barriers to entry” that make it difficult
for new competitors to enter an industry.
 In some cases, the barriers may arise from government
laws or regulations which limit the number of
competitors.
 In other cases, there may be economic factors that
make it expensive for a new competitor to break into a
market.

competition
Sources of market imperfections
Costs and Market Imperfection:
 The technology and cost structure of an industry help
determine how many firms that industry can support and
how big they will be.
 If there are economies of scale, a firm can decrease its
average costs by expanding its output, at least up to a
point(where they produce most of the industry’s total
output).
 That means bigger firms will have a cost advantage over
smaller firms.

competition
To understand how costs may determine market structure, let’s
look at a case which is favorable for perfect competition.
P D Perfect Competition
AC
AC, MC, P

MC
Total industry demand DD is so vast
relative to the efficient scale of a
single seller that the market allows
viable coexistence of numerous
perfect competitors.

D
0 Q
1 2 3 4 5 10000 12000

competition
Oligopoly

P D
AC
AC, MC, P

MC
Costs turn up at a higher level of
output relative to total industry
demand DD.
D

0 Q
100 200 300 400

competition
Natural Monopoly

P D
AC, MC, P

AC
When costs fall rapidly and
MC indefinitely, as in the case of natural
monopoly, one firm can expand to
monopolize the industry.
D
0 Q
100 200 300 400

competition
Barriers to entry:
Barriers to entry are factors that make it hard for new firms to
enter an industry.
 When barriers are high, an industry may have few firms and
limited pressure to compete.
 Economies of scale act as one of the common type of
barriers to entry, there are others as well, such as:
 Legal Restrictions
 High Cost of Entry
 Advertising and Product Differentiation

Marginal Revenue and
Monopoly
The concept of marginal revenue
Suppose that a firm finds itself in possession of a complete
monopoly in its industry.
 The firm might be fortunate owner of a patent for a
new anticancer drug,
 Or it might own the operating code to a valuable
computer program.
 If the monopolist wishes to maximize its profits, what
price should it charge and what output level should it
produce?

Monopoly
The concept of marginal revenue
To answer these questions, we need the marginal
revenue (MR) concept.

Marginal Revenue is the change in revenue that is
generated by an additional unit of sales.

MR can be either positive or negative

Monopoly
A Monopoly’s revenue
 Total Revenue
P x Q = TR
 Average Revenue
TR/Q = AR = P
 Marginal Revenue
DTR/DQ = MR

Quantity Price Total revenue Marginal revenue
q P=AR=TR/q TR=P*q MR
0 220 0
+200
1 200 200
+160
2 180 360
+120
3 160 480
+80
4 140 560
+40
5 120 600
0
6 100 600
-40
7 80 560 -80
8 60 480 -120
9 40 360
-160
10 20 200
-200
11 0 0

Price determination under monopoly
220

180

140

100

60

20 d=AR
-20 0 1 2 3 4 5 6 7 8 9 10 11 12
-60

-100
MR
-140

700

600

500

400

300

200

100

0 TR
0 2 4 6 8 10 12

Monopoly
When the marginal revenue is negative it does not mean
that the firm is paying people to take its goods.
 Negative MR means that in order to sell additional
units, the firm must decrease its price on earlier units so
much that its total revenues decline.
 For example, when the firm sells 6 units, it gets
TR(6 units) = 6*$100= $600
 when it sells the additional (7th)unit, it can increase sales
only by lowering price. Because it is an imperfect
competitor.
TR(6 units) = (6*$80)+(1*80)= $560

Monopoly
The necessary price reduction on the first 6 units is so large
that, even after adding in the sale of the 7th unit, total
revenue fell.
 Even though MR is negative, AR, or price, is still positive
 MR turns negative when AR is halfway down towards
zero.
 With demand sloping downward,

P > MR

Monopoly
Elasticity and Marginal Revenue
 Marginal revenue is positive when demand is elastic, zero
when demand is unit-elastic, and negative when demand is
inelastic.
 Demand is elastic when a price decrease leads to a revenue
increase.
 In such a situation, a price decrease raises output
demanded so much that revenue rise, so marginal revenue is
positive
If demand is Relation of Q and P Effect of Q on TR Value of MR
Elastic (ED > 1) %change Q > %change p Higher Q raises TR MR > 0

Unit-elastic (ED = 1) %change Q = %change p Higher Q leaves TR MR = 0
unchanged
inelastic (ED < 1) %change Q < %change p Higher Q lowers TR MR < 0

Monopoly
Profit maximization of monopoly
If a monopolist wishes to maximize total profit, what should it
do??

We know that: TP = TR – TC = (P * q ) - TC

 To maximize its profits, the firm must find the equilibrium price
and quantity that give the largest profit, or the largest
difference between TR and TC.

 A monopoly maximizes profit by producing the quantity at
which marginal revenue equals marginal cost.

 It then uses the demand curve to find the price that will
induce consumers to buy that quantity.

Quant Price Total Total Total Marginal Margin
ity P revenue cost profit revenue al cost
q TR TC TP MR MC

0 220 0 185 -185
+200 30
1 200 200 215 15
+160 25
2 180 360 240 120
+120 20
3 160 480 260 220
+80 30
4 140 560 290 270
+40 40
5 120 600 330 270 0 50
6 100 600 380 220
-40 70
7 80 560 450 110 -80 90
8 60 480 540 -60 -120 110
9 40 360 650 -290
-160 130
10 20 200 780 -580
-200 150
11 0 0 930 -930

Monopoly
Profit maximization of monopoly
 The maximum profit price (P*) and quantity (q*) of
a monopolist come where the firm’s marginal
revenue equals its marginal cost.

MR = MC, at the maximum profit P* and q*

 Thistells us that when MR exceeds MC, additional
profits can be made by increasing output;
 when MC exceeds MR, additional profits can be
made by decreasing q.

Monopoly Equilibrium in Graphs
200

160 MC

120 G

AC
80
F

40 E

0 MR d
0 1 2 3 4 5 6 7 8 9 10 11 12

700 At maximum profit
point, slopes of TC
TC
and TR are parallel
600

500
At maximum profit
400 $270 point, slopes is zero
and horizontal
300

200
$270
100
TR
0
0 1 2 3 4 5 6 7 8 9 10 11 12
-100

-200 TP

Monopoly
Comparing Monopoly and Competition
 For a competitive firm, price equals marginal cost.
P = MR = MC

 For a monopoly firm, price exceeds marginal cost.
P > MR = MC

Monopoly

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Monopoly