NEU Business School

E-BBA Program

Topic 8

Firm’s decision making in

monopoly

Lecturer: Dr.Tran Thi Hong Viet

 Market structures

Nature Market Barriers Non- price

Market Example No of Competition
of product power of entry
structures firms
Perfect Many
Homoge- No No
Compe Agr. small neous
-tition products firms “price taker”
Monop Hairdresser Many Adver
Differen Low
-olistic Phở, Beers, relatively Low -tising
-tiation
Competi. small firms
Oligo OPEC, Some Identical, Adver
High High
-poly Cars, Mobi relatively Differen -tising
network big firms -tiation
EVN, Only Very Very
Mono Unique
VNR One big High high
-poly
firm “Price maker”
 Monopoly-
Characteristics
 Monopoly exists when there is only one supplier
of a product for which there are no close
substitutes
 Characteristics:
 Only one firm provides good/service
 Unique product, (No “close” substitute.)
 High barriers to enter and exit.
 High market power, “price maker”
 Imperfect information
 Sources of Monopoly
(Barriers to enter)
 Economies of scale (Natural monopoly)
 Control of resources
 Government restrictions (patents, licences,
copyright)
 Policy of Government
 Collusion strategies- “predatory pricing or
“limit-pricing” or “price blocking”
Demand & Marginal Revenue
curve of Monopoly

P
- D firm= D market
- D of firm slopes downwards, left
P to the right
- More market power, more inelastic
MR demand curve.
- Marginal revenue curve slopes down
D and is below the demand curve
MR Q ( MR<P)
Q1 because to sell one more unit,
the price must be lowered on all
D: P=a-bQ units sold
MR: P= a-2bQ
Total Revenue for the Firm

 TR curve is: TR
TRmax
 bell shaped
 rises, reaches a maximum,
then falls
Q
because MR= slope of TR:
P
MR>0 TR
MR=0 TR max
MR<0 TR E=1
P1 D
Q
Q1 MR
 Elasticity and Revenue-
Monopoly

 When MR is positive:
TR
TR is rising and demand is elastic TRmax
 When MR is negative:
TR is falling and demand is inelastic
 When MR=0:
Q
TR is a maximum and demand
P
is unit elastic
(Midpoint of the demand curve)
E=1
P1 D
Q
Q1 MR
 Profit Maximization-
Total approach
$ Slope of TR= MR TC
  =TR-TC
 Where
maximum TR
gap Slope of TC= MC
between
TR and TC Q
 Amount of $
profit is
shown by MC
this gap
 So, at
MC=MR D
MR
Q* Q
 Profit Maximization-
Marginal approach
P
Q* : MR=MC
MC P*: depends on Q* vµ D
max
max= Q* (P* - ATC*)
P* ATC
ATC* Rule of Thumb:

P* 
MC MC
MR D 1 E1
d
Q
Q* Market power is measured by
Monopoly does not guarantee Lenner indicator:
profit but there can be above
-normal profit even in the
long run
L P  MC = -1/ E (0 L 1)
P d
 Monopoly Profit
maximization- Example
Quantity Price Average Profit +
of (Average Total Marginal Total Total Marginal or
Output Revenue) Revenue Revenue Cost Cost Cost Loss –

0 $172 $ 0 $100 – $100

1 162 162 $162 $190.00 190 90 – 28
2 152 304 142 135.00 270 80 + 34
3 142 426 122 113.33 340 70 + 86
4 132 528 102 100.00 400 60 + 128
5 122 610 82 94.00 470 70 + 140
6 112 672 62 91.67 550 80 + 122
7 102 714 42 91.43 640 90 + 74
8 92 736 22 93.73 750 110 – 14
9 82 738 2 97.78 880 130 – 142
10 72 720 – 18 103.00 1030 150 – 310
Profit Maximisation
Under Monopoly
200
P MC
Profit
175 Per Unit

150

125
$122
ATC
Profit
100
$94
75
D
Competitive
50 Price
25 MR = MC MR
0 1 2 3 4 5 6 7 8 9 10
Q
 Check your
understanding ???
P
100 MC

80
ATC
Q* = ?
60 P*=?
MC* =?
ATC min MR* =?
40 ATC* =?
max =?

20 MR D

Q
0 2 4 6 8 10
Net Social Benefit’s Loss
(DWL)
P
I
P* A MC
DWL Competition: B (Q1, P1)
H We have: CS= IBP1
P1 B PS= P1BC
NSB= IBC
MC* E D
C Monopoly: E (Q*, P*)
MR We have: CS=IAP*
Q PS=P*AEC
Q* Q1 NSB= IAEC

SO: Monopoly creates DWL

Market power creates DWL
(P>MC, Q*<Q1)
 Evaluating Monopoly

 No Productive inefficiency
 Minimum ATC is not necessarily chosen
 May not use “best” techniques
 No Allocative inefficiency
 P>MC
 Dynamic efficiency?
 Monopolist has the profits to innovate but no
competitive pressure
 Income distribution
 Inequality may result
 Monopoly and Perfect
Competition: A comparison

 Perfect Competition  Monopoly

P P
Market MC MC
price, P1 D=MR
P*
D
MR
Q Q
Q* Q*
- Price taker -Price maker
- Horizontal, perfectly elastic D - Slope down D
- MR=P - MR<P
- No barriers - Barriers
- P= LAC. - P LAC
- No long run economic profit - Possible.
- Allocative efficiency - No allocative efficiency
- Productive efficiency - No productive efficiency
- Dynamic efficiency - Dynamic efficiency: depend on
 Some more …about
Monopoly
 Not highest price
 monopolists seek to maximise profit, not necessarily price
 Total profits not unit profits
 monopolists seek to maximise total profit, not necessarily
per-unit profit
 Losses are possible
 Pure monopoly does not guarantee economic profits
 In the short-run, monopolist may experience losses
because of weak demand or high costs
 No supply curve in monopoly. Why?
 At any given demand and cost conditions, there is only
one profit-maximising price–output combination
 Price discrimination
Price Discrimination
 Concept: The practice of selling a good at different prices to
different consumers (or different quantity) to take consumer surplus
 Conditions:
 Market power
 Different consumer groups
 Resale is not possible
 Examples:
 Airline/train ticket
 Student discounts on movies and concerts
 Discount price for whole selling
 Main types:
 Perfect price discrimination (level 1)
 Price discrimination level 2 (different quantities)
 Price discrimination level 3 (different customers)
 PERFECT PRICE
DISCRIMINATION
P
I
Not discrimination:
MC P*, Q*; PS= P*AEC

Discrimination:
A Set all of the price
P* level on the demand
curve;
Expand output to Q1
B
PS = IBC
So, by perfect price
E D Discrimination, firm
C increases profit
MR by taking more CS
and DWL
Q
Q* Q1