Monopoly

Absolute monopoly occurs when a single seller provides a product with

no close substitute.
Sources:
1.
2.
3.
4.
5.

Legal Monopoly: based on patents, copyright, license

Nationalized industry: post, railway, telecom
Local monopoly: one gas station, cafeteria
Natural monopoly: based on economies of scale.
High cost of entry:

LRAC
6. Advertising and product differentiation: Barbie dolls
7. Import restrictions: Indian car industry (till 90s)
8. Industry standard: Microsoft as PC standard
Monopoly Profits:

P
MC
D
C

AC

A
D=AR

B
MR
A Profit maximising (MC = MR)
B Maximum Revenue (MR = 0)
C Lowest cost of prduction (optimum output MC = AC)
D Social optimum (MC = P)
E Normal Profit (AC = AR)
XY = Abnormal profit (above AC curve at Production point P)
Note:
- Monopoly is able to earn super-normal profits even in the
long-term b/c of barriers to entry.
- Will not produce at most efficient output MC=AC
- Instead will produce less and charge more. (MC = MR)

Against Public Interests:

A. High prices
- Less consumer surplus Net welfare loss
B. Less output
- Less employment
- Inefficient resource allocation
- Barriers to entry

C.
D.
E.

F.
G.

natural monopolies have barriers to entry in the

form of large economies of scale and high fixed
costs.
- artificial monopolies have them as price
discrimination, limit pricing, suppression of
competition.
Suppression of competition
Limited consumer choice
- Poor quality goods
x ineffiency
- Poor service
- No need for efficiency
Slow technological progress
- Less innovation, research & development.
Restricts price mechanism

Potentially in Public Interest:

A. Lower production costs
- Economies of Scale (falling LRAC curve)
- Less advertising
- Better working conditions
B. No wasteful duplication
C. Short Term:
- limit pricing can keep prices down
D. Stable output/prices
E. Some gain from price discrimination, cross-subsidies
F. Public sector monopolies can consider public interest
G. Monopolist cannot set both price and output(limited by
demand curve but still a price maker)
H. Reward for inventions/research + Patents
I. Schumpeter: creative destruction monopolies provide
incentive for discovery of better products.
J. Large funds for research and development
- i.e.: Bell Labs transistors, microwave, fibre
optics, UNIX, semiconductors (did 10% of US basic
industrial research in 70s)
K. Pure monopoly is theoretical
- More realistic: monopolistic competition / oligopoly

Oligopoly
A few big companies produce similar goods (some product
differentiation):
- i.e.: USA car industry (top 5 producers sell 80% of
cars), beer market, detergents.
Characteristics:
- high barriers to entry
- i.e.: technological barrier to entry
- interdependent behavior:
- firms consider the reactions of other firms when
making their own decisions on output and price.
- non-price competition
- compete by branding and advertising products and
product differentiation.
- stable/rigid prices
Kinked demand curve:
Price

D1

P1
MR1
MC2
MC1
D2
Output

Q1
MR2
Note: a range of cost curves between MC1 and MC2 exist a profit maximising
oligopolist will produce at P1 and Q1 even large shifts in costs will cause
prices to remain fixed.

Perfect Competition
Market where the degree of competition between firms is
absolute/perfect.
Characteristics:
- firms are price takers
- theoretical model
- but useful to compare w/ the theoretical
perfect/pure monopoly to draw conclusions on the
effects of markets being more/less competitive.
Assumptions:
1. Many sellers
2. Many buyers
3. Homogeneous (identical) products
4. No barriers to entry into the industry
5. Perfect knowledge
Therefore the demand curve is perfectly elastic.
D

S
D = AR = MR

Market
Note:

Firm

TR = P x Q
AR = TR/Q = PxQ/Q = P

Short-run equilibrium:
Price

MC
ATC

p
D,AR,MR
p2

Output

Firm will produce where MR = MC where profit is maximized.

Below p2, normal profit, above: supernormal profit. eventually the industry
supply will shift w/ new companies and demand for the firm will lower to p2 (longrun equilibrium).

Firms Shut-down Point:

Price

MC
ATC
AVC
D,AR,MR

p
Firms shut-down point
0
q

Output

At prices lower than 0p the firm will not cover their variable costs. firm makes
a smaller loss by closing down and paying only fixed costs. MR=MC=AVC is shut-down
point.

Monopolistic Competition
Market w/ a large number of firms producing a relatively small
percentage of total output + highly competitive / firms have a
monopoly over their own brand but there are many close substitutes.
- i.e.: restaurants, performance artists
Characteristics:
- Low barrier to entry/exit to industry
- High profits eroded by new entrants
- Seller have little control over price.
- Results in product differentiation
- Homegenous product (therefore close substitute)
Short run equilibrium:
MC
ATC

Output
MR
Shaded area: supernormal profit.
Long run equilibrium: eventually DEMAND shifts down so that MC=MR,
p=ATC, and TR=TC normal profit only.

Competition vs. Monopoly

A. When there are no economies of scale:
p1

S = MC
p0

D=AR

Output
q1

MR q0

Monopolist taking over a multi-plant (plant = factory, office, farm) industry will
produce at (p1,q1) instead of (p0,q0) less allocatively efficient position (p
does not = MC).

B. When there are economies of scale: (LRAC sloping down w/ output)

p0

MC1 = S (perfect comp.)

MC2
p1

D=AR

Output
q0

q1

MR

With economies of scale, a monopolist faces a different MC curve (MC2). Production

shifts from (p0,q0) to (p1,q1) which is still not allocatively efficient but
results in a lower price and greater output.

natural monopolies
Note: to force the monopolist to produce allocatively efficiently:
- Gov. subsidy
- Nationalize industry (order prices to equal MC)
- Regulate private monopoly prices.

Price Discrimination
Charging a higher price to some customer than to others for an
identical good or service.

Reasons:
-

trying to increase profit by absorbing consumer

surplus
Necessary Conditions:
1. Supplier must be a monopoly power (i.e.: price maker)
2. Must be groups of buyers w/ different elasticities of demand
3. The groups can be identified and separated