Imperfect Market- Monopoly

Dr. Sanja Samirana Pattnayak

Overview

• Unlike competitive markets, some other market

structures allow firms to charge a price above
its marginal cost (market power)

• Monopolists determine prices differently than

competitive firms (P=MC), and they choose
their products’ quality, advertise, and engage in
research and development to maximize their
profits

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Overview

• To prevent the welfare loss that accompanies

monopoly pricing, governments sometimes
regulate the price a monopolist can charge

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Monopoly

 Monopoly
1. One seller - many buyers
2. One product (no good substitutes)
3. Barriers to entry
4. Price Maker – but a single uniform price
(multiple price monopolist or price
discrimination will be addressed later)

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What is Monopoly?

 To some extent the boundaries of an industry are

arbitrary. what is more important for a firm is the
amount of monopoly power it has, and that
depends on substitutes produced by the rival
industries.

 The post office earlier had a monopoly over the

delivery of letters, but it faces competition in
communications from telephone, faxes and e-mail.

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Average & Marginal Revenue

 The monopolist’s average revenue, price

received per unit sold, is the market demand
curve.

 Monopolist also needs to find marginal

revenue, change in revenue resulting from a
unit change in output.

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Average & Marginal Revenue

 Finding Marginal Revenue

As the sole producer, the monopolist works with the
market demand to determine output and price.
An example can be used to show the relationship
between average and marginal revenue

Assume a monopolist with demand:

P=6-Q

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Total, Marginal, and Average Revenue

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 Average and Marginal Revenue
$ per 7
unit of
output
6 For a linear demand curve, the
marginal revenue has the same P
5 intercept and is twice as steep.

4 Average Revenue (Demand)

2
Marginal
1 Revenue

0 1 2 3 4 5 6 7 Output
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 Marginal Revenue and Own Price Elasticity of
Demand
$ per 7
unit of
output
6

5 elastic

4 Unitary elastic

2 inelastic
Marginal
1 Revenue Demand

0 1 2 3 4 5 6 7 Output
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A simple Example

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A simple Example

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Why MR is less than P ?

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Why MR is less than P ?

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Why MR is less than P ?

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Why MR is less than P ?

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Monopolist Does not have a supply curve

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Monopolist Does not have a supply curve

 The unique association between price and supply does

not exist as we see in perfect competition.

 Monopolist determines both quantity and price.

 Depending on the shape of the demand curve, the

monopolist might supply the same quantity at two different
prices or different quantities at same price.

 Thus a monopolist does not have a supply curve.

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Monopolist Does not have a supply curve

 Figure (slide 20) explains that for demand curve D1, the
profit maximizing quantity is 5 million units per year and
price $15 per unit. If the monopolist’s demand curve shifts
to D2 the profit maximizing quantity continues to be 5
million but price per unit becomes $20.

 It is thus possible, depending on the market demand, for a

monopolist to sell a given profit maximizing quantity (5
million units) at different prices ($15 and $20).

 Therefore, no unique supply curve exists for a monopolist.

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Monopolist’s Output Decision

 Profits maximized at the output level where MR = MC

 (Q)  R(Q)  C (Q)

 / Q  R / Q  C / Q  0  MC  MR
or MC  MR

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 Monopolist’s Output Decision
$ per
unit of A profit
output MC maximizing
monopolist will
P1
never price on the
inelastic portion
P*
AC of the demand
curve. Why?
P2
Lost
profit

D = AR

Lost
MR profit

Q1 Q* Q2 Quantity
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Monopoly: An Example

Cost  C (Q )  50  Q 2
C
MC   2Q
Q
Demand : P (Q )  40  Q
R(Q )  P (Q )Q  40Q  Q 2
R
MR   40  2Q
Q
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Monopoly: An Example

MC  MR P (Q )  40  Q
2Q  40  2Q P (Q )  40  10
4Q  40 P (Q )  30
Q  10

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 Example of Profit Maximization
$/Q

40 MC Profit = (P - AC) x Q
= ($30 - $15)(10) =
$150
P=30

AC
Profit
20
AR
AC=15

10
MR

0 5 10 15 20 Quantity
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Measuring Market Power

 An economic agent has Market Power if

s/he can affect, through his/her own actions,
the price that prevails in the market.

 Often this is thought of as the degree to

which a firm can raise price above marginal
cost.
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Welfare Analysis of Monopoly

 Monopoly outcomes results in higher prices

and lower quantities.
 However, does the monopoly outcome make
consumers and producers in the aggregate
better or worse off?
 We can compare producer and consumer
surplus when in a competitive market and in a
monopolistic market.

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Deadweight Loss from Monopoly Power

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Deadweight Loss from Monopoly Power

 To maximize profit, the monopolist produces at the

point where MR=MC, so price and quantity are pm
and Qm.

 In a competitive firm, P=MC and competitive price

is pc and quantity is Qc (point of intersection of
the AR curve and MC curve.

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Deadweight Loss from Monopoly Power

 Now compare surplus when we move from competitive

price (pc) and quantity(Qc) to monopoly price (pm)
and quantity (Qm).

 Due to higher price, consumers who buy the good lose

surplus of an amount given by rectangle A.

 Those consumers who do not buy the good at price pm

but who would buy at price pc also lose surplus,
namely by an amount given by triangle B.

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Deadweight Loss from Monopoly Power

 Total loss of consumer surplus is given by A+B

 The producer however, gains rectangle A by selling at a

higher price but loses triangle C, the additional profit it
would have earned by selling QcQm at price Pc.

 Total gain in producer surplus is A-C.

 Subtract the loss of consumer surplus from the gain in

producer surplus, we see a net loss of surplus given by B+C.
this is a deadweight loss from monopoly power.

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Deadweight Loss from Monopoly Power

 The deadweight loss is the social cost of this

inefficiency.

 Because of its social cost, antitrust laws prevent

firms from accumulating excessive amount of
monopoly power.

 Price regulation is another means that govt. can

use to limit monopoly power.

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 Deadweight Loss from Monopoly Power
$/Q

Lost Consumer Surplus Because of the

higher price,
consumers lose A+B
MC and producer gains
Deadweight
Loss A-C. So from the
Pm managerial
perspective this
A gives us
B benchmarks for
PC performance.
C
AR=D

MR

Qm QC Quantity
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Is monopoly necessarily bad
Negatives are
 Inefficiency
 Possibility of exploitation
 Possibility of rent seeking (lobbying Govt.)

There are positives

 Incentive for innovation

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