MONOPOLY

A monopoly (from the Greek word “mono” meaning single and “polo” meaning to sell) is that form of
market in which a single seller sells a product (good or service) which has no substitute.

Monopoly exists when there is no close substitute to the product and also when there is a single
producer and seller of the product

. E.g. Indian Railway is a monopoly, since there is no other agency in the country that provides
railway service.
Pure monopoly is that market situation in which there is absolutely no substitute of the product, and
the entire market is under control of a single firm.

 Single seller
.The entire market is under control of a single firm.
 Single product
.A monopoly exists when a single seller sells a product which has no substitute or, at least, no
close substitute in the market.
 No difference between firm and industry
.There is a single firm in the industry
 Independent decision making
.Firm is regarded as a price maker
 Restricted entry
. Existence of barriers leads to the emergence and/or survival of a monopoly

TYPES OF MONOPOLY

 Legal Monopoly
. Created by the laws of a country in the greater public interest.
. To prevent disparity in distribution of wealth, or imbalanced growth of the economy
 Economic Monopoly
. Created due to superior efficiency of a particular player.
.Attainment of economies of scale leads to monopoly, often referred to as an “innocent” or a
structural barrier.
. Technical know-how restrained in the hold of single firm
 Natural Monopoly
 .Formed when the size of the market is so small that it can accommodate only one player.
 Regional Monopoly
.Geographical or territorial aspects also help in creation of monopolies.
Price and output Decisions in Long Run

 A monopolist is in full control of the market price

.It would not continue to incur loss in the long run.
.It would try to reduce cost of production.
.Otherwise it would close down in the long run.
• Monopolist would try to earn at least normal profit in the long run and may earn
supernormal profit due to entry restrictions in the market.
• If in the long run a monopoly firm earns supernormal profit
. This would attract competition and high price would make it possible for a new entrant
to survive.
 To retain its monopoly power, the firm may have to resort to a low price and earn only
normal profit even in the long run to create an economic barrier to new entrants.

Supply Curve of Monopoly Firm

 A monopolist is a price maker

 The firm itself sets the price of the product it sells, instead of taking the price as given.
 It equates MC with MR for profit maximization, but unlike perfect competition, it does not
equate its price to MR.
 Supply of the good by the monopolist at a given price would be determined by both the
market demand and the MC curve.
 As such, there is no defined supply curve for a monopolist.

Multi Plant Monopoly

 A monopolist may produce a homogeneous product in different plants.

. different cost functions but the same demand function for the entire market.
. hence the same AR and MR curves for the entire market.
 A multi plant monopolist has to take two decisions:
.how much to produce and what price to sell at, so as to maximize its profit
.how to allocate the profit maximizing output between the plants.
 Assuming that a monopoly firm produces in two plants, A and B.
 Profit maximising output will be at MR = M*C_{A} = M*C_{B}
 If M*C_{A} < M*C_{B} it would increase production in A, (lower MC) and reduce
production in B (higher MC), till the equality is satisfied.
 The firm produces till MC and M*C_{8} are individually equal to MR, which is same for
both plants.
Price Discrimination

.Discrimination among buyers on the basis of the price charged for the same good (or service).
.Object of s to maximise sales
Preconditions of Price Discrimination
 Market control
. Market imperfection and control are necessary
.Monopoly is the most suitable market condition, because it is a price maker.
 Division of market
. when the whole market can be divided into various segments, and transfer of goods
between the markets is not possible
 Different price elasticities of demand in different markets
. Separation of market is a necessary condition for price discrimination, but the sufficient
condition is that price elasticities of demand should be different in these market segments.

Bases of Price Discrimination

 Personal
.On basis of the paying capacity and/or the intensity of needs.
.Since this discrimination is being done on a personal basis, the good (or service) is non
transferable.
 Geographical
.People living in different areas are required to pay different prices for the same product.
.E.g. edible oils and many packaged food items are sold at different prices in different States
of India.
  Time
.The same person may be required to pay different prices for the same product.
.E.g. off season discounts.
 Purpose of use
.Customers are segregated on basis of their purpose of use.
.E.g. electricity rates are lower for domestic purpose and higher for industrial purpose.

Degrees of Price Discrimination

Pigou has identified three degrees of price discrimination.
 First Degree
.Charges a price exactly equal to the marginal utility of the consumer and leaves no consumer
surplus.
.Joan Robinson referred to it as perfect discrimination.
 Second Degree
.Divides consumers in groups on the basis of their paying capacities; a person with lower
paying capacity is charged a lower price and vice versa
. Takes away the major (but not entire) portion of consumer surplus.
 Third Degree
.Segregates consumers such that each group of consumers is a separate market, and charges
the price on basis of price elasticity of different groups.
.Takes away only a small portion of consumer surplus.

Price and Output Decisions of Discriminating Monopolist

  Assume that the firm can segregate the market on basis of price elasticity of demand: M_{1}
with high price elasticity and M_{2} with low price elasticity.
 The rule is:
. Lower price and more supply in the market with high price elasticity
. Higher price and less supply in the market with low price elasticity.
.The firm will charge lower price in the market M, and higher price in the market M_{2} and it
would supply more to the market M_{1} and less to the market M_{2}
. Firm would determine the profit maximizing output at MC = MR while MC is increasing.
.The upper portion of the AR curve refers to the less elastic demand and the lower portion to
highly elastic demand.
.The MR curve corresponds to the AR curve.

Economic Inefficiency of Monopoly

.A monopoly firm operates at less than optimum output and charges a higher price.
.Monopoly does not allow optimum use of all the factors of production, thereby allowing loss of
output and creating excess capacity in the economy
.Considered as a loss of social welfare, hence authorities make regulations to check and prevent
monopoly practices.
.Also termed as deadweight loss to the economy, since this increase in output is actually possible
under perfect competition.
.Compare two firms, one under perfect competition, and the other under monopoly to explain the
condition; assuming that both the
.Theirms earn normal profits. The firm under perfect competition faces a horizontal demand curve
(D_{c}) whereas the monopoly firm faces a downward sloping curve D_{y} Which is less elastic.
Summary
 A monopoly is that form of market in which a single seller sells a product (or service) which has
no substitute.
 Pure monopoly is where there is absolutely no substitute of the product, and the entire market
is under control of a single firm.
 A monopoly has a single seller, sells a single product (pure monopoly) and decides on its own
price and output, based on individual demand and cost conditions and is hence regarded as a
price maker.
 In monopoly the firm and the industry are one and the same.
 Barriers to entry are the major sources (or reasons) of monopoly power and may include
restriction by law, control over key raw materials, specialized know how restricted through patents
or licences, small market and economies of scale.
 A monopoly firm has a normal demand curve with a negative slope. The demand curve is
highly price inelastic because there is no close substitute.
 A monopolist firm may earn supernormal profit, or normal profit, or may even incur loss in the
short run, but would not incur loss in the long run.

 The monopolist being a price maker does not have any supply curve.
 A multi plant monopolist decides on how much to produce and what price to sell at so as to
maximize its profit on the basis of the principle of marginalism.
 When a seller discriminates among buyers on basis of the price charged for the same good (or
service), such a practice is called price discrimination.
 Price discrimination can be done on personal basis (demographical, paying capacity or need),
on the basis of geography, on the basis of time or purpose of use.
 The discriminating firm will charge a higher price and supply less to the market having higher
price elasticity and a lower price and supply more in the market having lower price elasticity.
 Monopoly runs at less than optimum level of output and generates excess capacity in the
economic system, which in turn results in deadweight loss that adds neither to consumer surplus,
nor to seller’s profit.