Monopoly

Dr Vighneswara Swamy
Professor
Vighneswara Swamy
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 Market Monopoly
Price and output determination both in the short run and long run, Three degrees of price discrimination, the concept of deadweight loss

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Profit Maximization for a Monopoly
A monopoly maximizes profit
by choosing the quantity at
which marginal revenue
equals marginal cost (point A).

It then uses the demand

curve to find the price that
will induce consumers to buy
that quantity (point B).

For a competitive firm:

P = MR = MC.
For a monopoly firm:
P > MR = MC.

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Monopoly: Minimizing Losses
▪Monopoly Loss = (ATC – Price) × Quantity
▪It is possible that a monopolist can actually
lose money if ATC exceeds the price that
people are willing to pay for any quantity of
output.

▪Losses can be caused by a change in

consumer tastes or by changes in the cost of
inputs.

▪If the monopolist cannot make a profit, then it

will shutdown the firm so it can put the
resources to better uses.

▪Monopolist will still produce the quantity where

marginal revenue equals marginal cost
because that quantity corresponds to the
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market price that will minimize its losses.
Monopoly Profit

▪ Profit equals total revenue minus total costs.

▪ Profit = TR - TC
▪ Profit = (TR/Q - TC/Q) Q
▪ Profit = (P - ATC) Q
▪ The monopolist will receive economic profits as long as price
is greater than average total cost.
▪ A monopoly has a downward sloping MR curve.
▪ It will still produce where MR = MC, but at this level price will
be higher. This allows the monopoly to make excess profits.
▪ Productive Efficiency: MC = Minimum ATC
▪ Allocative Efficiency: MC = Market Price
▪ Monopoly Profit = (Price - ATC) × Quantity 6
 Short-run Price and Output Determination under Monopoly
● Demand curve for the firm
is the market demand
curve
● Firm produces a quantity
(Q*) where marginal
revenue (MR) is equal to
marginal cost (MR):
MR=MC
● Exception: Q* = 0 if
average variable cost
(AVC) is above the
demand curve at all levels
of output
● The aim of the
monopolist in the short-
run is the same as that of
perfect competitor, that
is, to maximize the profits
or minimize the losses.
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Long-run Price and Output Determination under Monopoly

● In the long-run all inputs

and costs of production
are variable and the
monopolist can
construct the optimal
scale of plant to produce
the best level of output.
● As in the case of perfect
competition, the best
level of output of the
monopolist is given at
the point which Marginal
Revenue (MR) is equal to
Long-run Marginal Cost
(LMC)
● MR=LMC 8
 Social Cost of Monopoly

● A Deadweight Loss, also

known as excess burden
or Allocative
Inefficiency, is a loss of
economic efficiency that
can occur when the free
market equilibrium for a
good or a service is not
achieved.
● Consumer surplus = GHT
● Monopolist’s profit =
HE’NT
● Deadweight Loss: HE’E
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Inefficiency of Monopoly
Price
Deadweight
MC
Loss Deadweight loss is
the reduction in net
Monopoly economic benefit
price Allocative Efficiency
due to inefficient
P = MC
allocation of
resources.

Marginal
revenue Demand Deadweight loss is
caused by a
monopoly
0 Monopoly Efficient Quantity
quantity quantity
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Deadweight Loss
Costs and
● Total Welfare is maximized only Revenue

when MC = MB for society

● Since MB = Price => only when Price = MC Monopoly
B

price
● Allocate efficiency is when P = MC
Average total cost
● Any other production point produces A
deadweight loss
○ Monopolies are not allocatively Marginal Demand
efficient (P > MC) cost

○ Competitive firms are (P = MC) Marginal revenue

0 Q QMAX Q Quantity

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Deadweight Loss

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The Perceived Demand Curve for a Perfect
Competitor and a Monopolist
1. A perfectly competitive firm perceives
the demand curve that it faces to be flat
(no price change).

2. A monopolist perceives the demand

curve that it faces to be the same as the
market demand curve, which for most
goods is downward-sloping. Thus, if the
monopolist chooses a high level of
output (Qh), it can charge only a
relatively low price (Pl).

Conversely, if the monopolist chooses a

low level of output (Ql), it can then
charge a higher price (Ph). The
challenge for the monopolist is to
choose the combination of price and
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quantity that maximizes profits.
Degree of Price Discrimination
Arthur C. Pigou made a distinction between different levels of price discrimination in his book “The
Economics of Welfare”, 1920. Price discrimination refers to the charging of different prices by the
monopolist for the same product. Price discrimination is the practice of charging a different price for the
same good or service. Three degrees of discriminating monopoly are:

Third degree
First degree Second degree
Third-degree price
First-degree price Second-degree price
discrimination means
discrimination, discrimination means
charging a different
alternatively known as charging a different
price to different
perfect price price for different
consumer groups.
discrimination, occurs quantities, such as
Third-degree
when a firm charges a quantity discounts for
discrimination is the
different price for bulk purchases.
commonest type..
every unit consumed.
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First Degree Price Discrimination

First-degree price discrimination, alternatively

known as perfect price discrimination, occurs
when a firm charges a different price for every
unit consumed.

As seen in the figure, the producer surplus

equals total surplus (A+B). There is no
deadweight loss, even though there is no
consumer surplus (A, which was extracted by
the monopoly), and at the end both quantity
and price are equal to those that would result
from perfect competition.

First-degree price discrimination is, however,

quite unrealistic, and too theoretical.
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Second Degree Price Discrimination

Second-degree price discrimination, or nonlinear pricing,

involves setting prices subject to the amount bought, in
an attempt to capture part of the consumer surplus.

A bulk sale strategy, such as quantity discounts, will be

applied and consumers will choose the block that better
suits them.

In the adjacent figure: a monopoly will be able to

implement this type of price discrimination to a certain
consumer by offering discounts for buying a higher
quantity. Note that d corresponds to the consumer’s
demand curve, not the market’s. By offering a lower
price, p2, for quantity q2, the monopoly is able to extract
part of the consumer surplus.
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Third Degree Price Discrimination
Third-degree price discrimination, also referred to as market segmentation of price discrimination, consists
of varying prices depending on what segment of the market the consumer belongs to. Each consumer will
be charged with a different price, but it will remain constant whatever the amount bought. This degree of
discrimination is the most commonly used by firms and it includes examples such as students or age
discounts.
As shown in the figure, the firm will disaggregate the global demand, and it will charge each market segment
the price that will maximize its profit. Higher prices will be charged to those segments where the elasticity of
demand is low.

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Price Discrimination:

These graphs show multiple market price discrimination. Instead of supplying one price and taking the
profit (labelled “(old profit)”), the total market is broken down into two sub-markets, and these are priced
separately to maximize profit.

The graph shows how a seller wants to generate the most revenue possible for a good or service. The
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elasticity of a market influences the profit.
Necessary Conditions for Successful Discrimination
1. The firm must be able to identify different market segments,
such as domestic users and industrial users

2. Different segments must have different price elasticities (PEDs).

3. Markets must be kept separate, either by time, physical distance

and nature of use. Time based pricing – also called dynamic
pricing – is increasingly common in goods and services sold
online. In this case, prices can vary by the second, based on real-
time demand related to consumers’ online activity.

4. There must be no seepage between the two markets, which

means that a consumer cannot purchase at the low price in the
elastic sub-market, and then re-sell to other consumers in the
inelastic sub-market, at a higher price.

5. The firm must have some degree of monopoly power. 19

Monopolist: As a Benevolent Social Planner

The Efficient Level of Output.

A benevolent social planner who
wanted to maximize total surplus
in the market would choose the
level of output where the demand
curve and marginal cost curve
intersect.
Below this level, the value of the
good to the marginal buyer (as
reflected in the demand curve)
exceeds the marginal cost of
making the good.
Above this level, the value to the
marginal buyer is less than
marginal cost.
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Regulating a Monopoly
Marginal-cost Pricing for a
Natural Monopoly.

A natural monopoly has

declining
average total cost, because
marginal cost is less than
average total cost.

Therefore, if regulators require a

natural monopoly to charge a
price equal to marginal cost,
price will be below average
total cost, and the monopoly
will lose money. 21
Comparing Perfect Competition and Monopoly
Characteristic or
Perfect Competition
Event
Market Large number of sellers and buyers
producing a homogeneous good or
service, easy entry.
Demand and marginal The firm’s demand and marginal
revenue curves revenue curve is a horizontal line at
the market price.
Price Determined by demand and supply;
each firm is a Price Taker. Price
equals marginal cost
Profit maximization Firms produce where marginal cost
equals marginal revenue
Profit Entry forces economic profit to zero
in the long run
Efficiency The equilibrium solution is efficient
because price equals marginal cost.
Monopoly
Large number of buyers, one
seller. Entry is blocked
The firm faces the market demand curve;
marginal revenue is below market demand.
The monopoly firm determines price; it is a
Price Setter. Price is greater than marginal
cost.
Firms produce where marginal cost equals
marginal revenue and charge the
corresponding price on the demand curve.
Because entry is blocked, a monopoly firm can
sustain an economic profit in the long run
The equilibrium solution is inefficient because
price is greater than marginal cos 22
 Key Takeaways
▪ A monopoly firm produces an output that is less
than the efficient level.
▪ The higher price charged by the monopoly firm
compared to the perfectly competitive firm reduces
consumer surplus, part of which is transferred to
the monopolist.
▪ The monopoly firm’s market power reduces
consumers’ choices and may result in higher
prices, but there may be advantages to monopoly
as well, such as economies of scale and
technological innovations encouraged by the
patent system.
▪ Forces that limit the power of monopoly firms are
the constant effort by other firms to capture some
of the monopoly firm’s profits and technological
change that erodes monopoly power. 23
 Key Words
● Monopoly: a situation in which one firm produces all of the
output in a market

● Barriers to Entry: the legal, technological, or market forces that

may discourage or prevent potential competitors from entering a
market.

● Marginal Profit: Profit of one more unit of output, computed as

marginal revenue minus marginal cost

● Natural Monopoly: A firm that confronts economies of scale over

the entire range of output demanded in an industry.

● Monopoly Power: A firm that sets or picks price depending on its

output decision is called a price setter. A price setter possesses
monopoly power. 24
Thank you.

Vighneswara Swamy 25
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