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35 views

Topic 5

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a17539
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Topic 5

Market Structure (Part 2)


Monopoly

1
Learning Objectives

5.1 Monopoly
a) Characteristics
b) Price and output decisions
c) Short run and long run profit maximization
d) Shut down, continue and exit decisions
e) Price Discrimination

2
5.1 Monopoly

a) Characteristics

1. One seller
2. Price maker
3. Product has no close substitutes / unique
4. High barriers to entry (blocked)

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Barriers to Entry
1. Legal Barriers

• The government undertakes rules and


regulations to restrict competition in certain
industries in the form of:
a. franchising
b. licensing
c. patents and copyrights

4
Barriers to Entry
2. Economies of Scale

• Economies of scale can be a barrier because the


existing large producers are able to produce
goods at a lower average cost compared to those
new firms just starting up in the industry.

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Barriers to Entry
3. Control of Important Inputs

• A monopoly can exist because the firm has


managed to control/owns an essential resources.

• Example:
 DeBeers Company, a company in South Africa
controls more than 80% of the world’s production
of raw diamonds.

6
Examples of Monopoly Firm in Malaysia
b) Price and Output Decisions
Price decision
• Price is set at the firm can charge for the profit maximizing
quantity.
• The price is determined from the demand curve of the
firm’s product.
• The demand curve for a monopolist is downward sloping
and inelastic.

Profit maximizing output decision


• Firms should produce output when:

MC = MR
• When MC = MR:
 firm maximize profit
 firm minimize cost 8
Revenues for a Monopoly Firm

Quantity Price Total Revenue Marginal Revenue Average Revenue


(Q) (P) (TR = P × Q) (MR = ∆TR / ∆Q) (AR = TR / Q)
0 6 0 - -
1 5 5 5 5
2 4 8 3 4
3 3 9 1 3
4 2 8 -1 2
5 1 5 -3 1

From the table above, we can see that:

D = P = AR

P > MR
c) Short Run and Long Run Profit Maximization

(i) Short Run Profit Maximization

• All firm’s objective is to maximize profits.

• There are 3 types of possibilities a monopoly firm can


faced in short run:

1. Economic profit (P > ATC)


2. Economic loss (P < ATC)
3. Zero economic profit (P = ATC)

12
Losses for the Monopolist

• Being a sole supplier does not guarantee that consumers


will demand your product.

• A monopolist will incur a loss if there is insufficient


demand to cover average total costs at any price and
output combination along the demand curve.
A Monopolist’s Zero Economic Profit
(ii) Long Run Profit Maximization

• In long run, monopoly firm will only earn economic profit.

• This is due to the effect of high barriers to entry (blocked).


Other firms cannot enter, so economic profit can persist in
the long run.

17
d) Continue, Shut Down and Exit Decisions
• A firm generating economic losses in short run faced a tough
choice.

• There are 2 possibilities for a firm:


1. whether to continue to produced
OR
2. whether to shut down its operation

• To make this decision, the firm needs to consider the


Average Variable Cost (AVC).

• If:
1. P > min AVC : Continue the operation
2. P = min AVC : Continue the operation
3. P < min AVC : Shut down the operation 18
e) Price Discrimination

Definition:

Sometimes sellers will charge different customers


with different prices for the same good or service
when the cost of providing that good or service
does not differ among customers.

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Conditions for Price Discrimination

In order to price discriminate, a monopoly must be able to


have:

1. Monopoly power

• Price discrimination is possible only with monopoly or


where members of a small group of firms follow
identical pricing policies.

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2. Market segregation

• Price discrimination can only occur if the demand


curve for markets, groups or individuals are
different.
• If the demand curves are not different, a profit
maximizing monopolist would charge the same price
in both markets.
• In short, price discrimination requires the ability to
separate customers according to their willingness to
pay.

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3. No resale

• For price discrimination to work, the purchaser buying


the product at a discount must have difficulty or too
costly in reselling the product to customers being
charged more.
• Otherwise, consumers would buy extra product at
the discounted price and sell it at a profit to others,
reducing the number of customers paying the higher
price.

22
Reference

Tucker, I.B.(2017).
Economics for today’s world.
(9th ed.). Mason (OH):
Thomson South Western.

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