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Lecture 18

Lecture 18

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Published by: praneix on Aug 11, 2009
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LESSON 18
 
ANALYSIS OF MONOPOLY MARKET SITUATION
 
Learning outcomes
After studying this unit, you should be able to:
Identify the market where small sellers and buyers dominate.
Analyze the price output decisions undertaken by single or fewsellers and buyers.
Discover the situation of market disequilibrium in some cases.
INTRODUCTION
 In this unit we shall continue our study of imperfect competition but we shall now movefrom the case of large group to the case of small group of sellers. We shall attempt an in-depth analysis of such market structures where a small number of sellers operate. Suchmarkets may assume a variety of form like monopoly, duopoly, monopsony, duopsonyand Oligopoly, bilateral monopoly etc. An extreme case is just one firm. More commonlyencountered situations have a number of firms, each large enough to have some controlover the market, selling either differentiated or similar products. This part of imperfectcompetition is very complex and, therefore, offers a variety of situations and solutions.There are, however, a few clear-cut equilibrium solutions. A study of these situationswould also help in appreciating the reality around us, particularly the present status of monopoly regulation in the country. Pricing strategy is at the heart of many businessdecisions. The discussion proposed in this unit should prepare us to take up thisinteresting issue in the next unit.
MONOPOLY
If perfect competition is at one extreme and of the market structureuniverse, the other end is characterized by monopoly It exists when just one firm is onthe sole producer of a product which has no close substitutes. Just as perfect competitionis rare, monopoly is also rare in less regulated market economics. The public sector inIndia has significant monopoly elements. 4nalytically public sector monopolies have adifferent place in managerial economies and we shall not deal with them here.Although monopoly’s an extreme. form of market concentration, its study helps tis inanalyzing less extreme cases. Many of the economic relationships found under monopolycan be used to estimate optimal behaviour in the less precise but more prevalent/partlycompetitive and partly monopolistic market structures that dominate the real world:Under monopoly, the firm is the industry, naturally, a monopolist faces a downwardsloping demand curve. The fact that just one firm constitutes the industry imposes acrucial constraint on a monopolist. He can set either the price or the quantity but not both.
 
Given a demand curve, if the monopolist decides to change the price, he has to accept thevolume that it will accompany. Similarly, with the volume determination, the price getsautomatically established through the demand curve. What will he do? He will operate atthat level where his profits are maximum that is where marginal revenue equals marginalcost. You will notice from Figure 1 that the graphicalPRICING UNDER MONOPOLYfor maximum profits we must haved
Π
1
d2
Π
1
 --------- = 0 and ---------- < 0dQ
1
dQ
21
 NOW, remember that firm I makes variations in its quantities assuming that the quantityof firm II remains at a given level. This means that in computing d
Π
1
/ dQ
1
we must treat Q2 as const, It. When we do that, it can be readily seen thatd
Π
1
--------- = 0 gives us 95 – Q
1
– 0.5 Q
2
= 0dQ
1
OR Q
1
= 95 – 0.5 Q
2
Coumot formulation calls this the 'reaction function'. Reaction functions express theoptional output of firm I as a function of firm II's output and vice versa.Given the value of d
Π
1
 -------dQ
1
we also note that d
2
 
Π
1
 
 
------- = --1dQ
21
 which is negative as required for the mximisation condition. Similar algebraicmanipulations for firm II should give us its reaction functions as .Q
2
= 50 - 0.25Q
l
 The typical reaction functions are depicted in Figure 3.The solution of a duopoly equilibrium crucially depends on the nature of the reactionfunction of each duopolist. The equilibrium is reached when the values of 01 and 02 aresuch that each firm maximizes its profit, given the output of the other and neither desireto alter the respective output.This is a very critical condition. From the reaction functions that we have, it can be seenthat if one firm increases its output, it will cause a reduction in the optimum output. thatthe other firm can have. However, for a common, solution, both the firms must achieve,maximum profits and at the same time have no incentive for changing respective outputlevels.. Such a solution is obtained at the intersection point 6fthe two linear reactionfunctions-(Please see Figure 3). .Let us therefore solve the two reaction function. equations in order to get the equilibrium,solution.Given Q
2
= 50 - 0.25 Q
1
; and Q
1
= 95 - 0.5Q
2
 Then, Q
2
= 50 – 0.25 ( 95 – 0.5 Q
2
)OR Q
2
= 50 – 23.75 +.0.125 Q
2
 Therefore, 0.875 Q
2
= 26.25Or, Q
2
=30 and Q
1
= 80You can easily verify that P = 45 and firm- I earns a profit of 3200 while that of the firmII is only 900.
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