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CHAPTER –ONE
1. MONOPOLY MARKET STRUCTURE

Chapter Objective
1.1 Definition and Reason for existence of monopoly
1.2 Demand & Review of monopoly firm
1.3 Equilibrium of monopoly
1.4 The Multiplan firm
1.5 Price discrimination

Introduction

We have seen about perfect competition which is the may-small-sellers extreme

of the market structure. Now, we will consider the opposite extreme: a
monopoly. This section is designed in a way that it first defines what a
monopoly is, including its basic characteristics, followed by the discussion of
factors which lead to monopoly power.

1.1 Definition and Features of Monopoly

Colleague, can you define a monopoly? Can you list the major features of a
monopoly market? Ok. By definition, a monopoly is the one seller of a product
for which there is no close substitute. It is an industry in which there is only
one firm. Monopoly in its strict sense means the concentration of economic
powers in a single hand.

The basic features of monopoly are:

1) One seller: There is a single seller in an industry, and as a result, the

monopolists is a price-marker. In fact, firm and industry are the same in
pure monopoly.
2) Price market: There are no close substitutes for the good or service the
monopolist produces.
3) Barriers to entry: The assumption of free entry into industry must not
apply, i.e., entry is blocked.
1.2. Reason of monopoly power (Causes for barriers to entry)
For a monopoly to be stable there must be some barriers to entry. Monopolies
exist because barriers to entry exist in the market, and the stronger the

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barriers to entry, the more complete the monopoly will be. Barriers take
various forms, legal and illegal, and some of these major

1. patents, copyright and trademark

A patent is a legal protection which prevents original inventions from being

copied, and once a patent is granted it is protected by law for a period of time.
Copyright protects written work like plays, books, music, and films which are
all protected from copying by copyright laws. Trademarks can be names of
logos, and sometimes shapes. The Coca-Cola bottle, for example, is actually a
trade mark and it is illegal to copy it without permission.

Protection of patents, copyrights, and trademarks come from a country’s legal

system and from international agreements. Some countries have no such laws
and copying is, therefore, not illegal. In countries where we have these laws,
owners of the indicated intellectual property rights will have some monopoly
power on their products or services.

2. Government License

Some businesses are illegal unless a government license has been granted.
Television. Telephone, and electricity are some of the examples of businesses
that in most countries require government permission. These services, in
country for example, are monopolized by the government and no one is entity
to provide them unless licensed

3. Natural monopolies

This situation is likely to occur either when the market is small or when fixed
costs are necessarily very large. For example, if market for a given product is
very restricted in a small town with small population size, having two suppliers
of a given product may not be profitable. A good example where high fixed costs
exist is for railways or water works. Hence, it would seem to be absurd to have
two railways alongside each other or to have two sets of water pipe running
into your home.

A natural monopoly is a monopoly that exists because of economies of scale,

that is, the market demand is too small to support many firms, each producing
at minimum ATC.

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4. Mergers and Takeovers

Merging of two or more companies is an expression which implies that each

firm enters the venture on friendly terms and that the companies become one.
A takeover, on the other band, implies that one company purchases another.
These help monopolies to acquire power through growth in the market. Merger
can be horizontal merger (two or more firms in the same industry at the same
stage of production merge), vertical merger (two or more firms in the same
industry at different stages of production merge), and conglomerate merger
(two or more firms in different industries merge).

5. Internal Growth

Companies can also grow without merging, and they do this by raising money
to finance the growth. Sources of money are from retained profits, bank loans,
and issues of new shares. This will help companies to be financially strong
which in turn helps them to monopolize the market.

6. Aggressive Tactics

Aggressive tactics are just tricks, where a seller sells its products below the
prevailing market price usually less than its cost of production. What do you
think is the purpose of doing this?

A business that sells its product for less than costs of production is said to be
engaging in predatory pricing. The aim of predatory pricing is usually to force
another firm out of business before raising profits.

7. Control over key Factors of production

Consider the possibility of one firm owning the entire supply of a raw material
input that is essential to the production of a particular commodity. The
exclusive ownership of such a strategic resource serves as a barrier to entry
until an alternative source of the raw material input is found or an alternative
technology not requiring the raw material in question is developed.

1.3. Demand under Monopoly

The demand curve for a monopoly is different from that of perfectly competitive
firm. In perfectly competitive industry, we have to distinguish between the
industry demand and demand for the output of an individual firm, which are
quite different. B/c of the single seller in monopoly market, there is not
distinction b/n the market demand curve and demand curve of the firm

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1.4. Equilibrium under monopoly

The equilibrium under monopoly market or monopolist maximizes it’s profit in
the short run followed by the long run situation.

A. Short run equilibrium under monopoly

In order to simplify the analysis of monopoly equilibrium lets us assume that

the shape of cost I revenue curves in monopoly. However, the revenue price is
not constant. The shape of revenue R and TC is

Revenue and cost curve of a monopolist

 Based on the about figure, determine the range in which profit is negative
and positive
- When the output is at a and at b profit is zero
- When the output is below a & above profit is negative
- When the output is within the ranges between a to b the profit is
positive

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 A monopolist, with an objective of profit maximizing, is expected to look for

the maximum gap between revenue R and cost (TC) curves, and this
possible at Qm in below figure
P

 At point Q the two curves are equal and 1t brings us to the condition of
profit maximization.
 At point
 Mc= MR- means the slop of cost curve is the same as the slope of
revenue curve.
 The slope of Mc is greater than the slope of MR. This means mc curve
cuts MR curve from below
 At point E
- MR= MC and MC cuts MR from below
- Point “E” equilibrium point for monopolist
 To determine monopoly price, Trace up through equilibrium point to AR line
to point G. Therefore the monopolist price is Pm
 In monopolist market
Revenue R= P x Q= area of rectangle OQM GPM
Cost C = Ac x Q = area of rectangle OQM HA
TL = R- C the area of rectangle AHGPM
 Therefore In monopolist can’t decide on both price charge and level of sales
it will achieve the market
- Monopolist constrained by demand curve & he or she can decide the
price or quantity not both
- In monopolistic the decision on price or output is interdependent by
interaction of MC and MR which will be sold at corresponding price.

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Example- if the demand curve of a profit maximizing monopolist is given Q=

40- Q.2p and cost function as C = 30+30Q. find equilibrium output level,
monopolist price and profit solving the demand equation for price we have P =
200 – 5Q

3rd substitute in demand equation

1st Find MR and Mc P=200-5Q

R = PQ = (200 – 5Q) Q 200-5 (17)

= 200Q – 5Q2 200-35
MR = d(TR) = 200 -10Q P= 115
d(Q)
MC = d(Tc) = 30
d(Q)

2nd Equate MR with MC, we have

= 200-10Q= 30
200-30 = 10Q Q= 17
10 10
Profit II = R – C
 = PQ – (30+30Q)
 = 115 x 17 – (30+ (30x17)
 = 1955 – 540 = 1415
Example 2 – if the demand curve of profit maximizing monopolist is given as
P= 1200 -2Q and cost function as C = Q3 – 61.25Q 2 + 1528.5Q+2000, find
equilibrium output level, monopolist price and profit

 To determine whether the monopolist gets profit or not depends up on the

condition of the demand and short run average cost curves
- If Ac curves lies below the demand curve, as it is indicated, we have a loss
indicated by the rectangle PmHGA and if AC is below the demand curve at
equilibrium, we have positive profit of the shaded area.

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-it is also possible that the monopolist neither makes abnormal profit or incurs
loss, but this only when the short run AC curve of monopolist tangent to AR or
demand curve and the same time MC curve cuts the me curve from below.

B. Long Run equilibrium of the monopoly

- Since entry is blocked, the monopolist can maintain he/her short run
abnormal profit in long run. In long run the monopolist has the time to
expand his/her plant or to use the existing plant to any level which will
maximize profit.
- In long run, with entry is blocked: it’s unnecessary for the monopolist to
reach an Optimal (minimum point of LRAC),If in long run the monopoly
makes loss the business not stay and the minimum price acceptable by
monopolist can use in three different scale
I. At Sub Optimal scale-, this is a falling part of LRAC. The monopolist is not
induced to expand the existing plant is underutilized and hence there is
excess capacity.

II. At Optimal Scale: - This is at minimum point of LRAC curve. Here, the
market size is just large enough to permit to monopolist to build the optimal
plant and use at full capacity

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III. Surpass the Optimal Scale- It is beyond the minimum point of LRAC

- The Size of the market is so large that the monopolist in order to maximize
his output
- The plant must build than optimal and over utilize it.

1.4. Multi plant Monopolist

The multi plant monopolist is a monopolist having more than one plant. And
it’s focused for maximizing profit and decisions to be made by monopolist will
be discussed equilibrium determination by the multi plant monopolist

It considers a monopolist with two plants each with different cost structure at
two different locations.

That means we have two different marginal cost where the total marginal cost
is equal to the horizontal summations of individual marginal cost. The
monopolist now is expected to make two decisions.

 How much output to produce together and at what price to sell it so as

to maximize profit
 How to allocate the production of the optimal (Profit maximizing) output
between the two plants.
 The monopolist maximizes output by utilizing each plants up to the level of
which the marginal cost are equal to each other and to Tv common marginal
revenue

MC1 = MC2 = MR

 The monopolist maximizing output by utilizing each plant mc are equal to

common MR

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 Means:- If MC1 is less than MC2, the monopolist would increase his profit by
increase the production in plant 1 and decrease it in plant2, until the
condition of MC1= MC2= MR is satisfied

Example – Assume that the demand equation of the multi plant monopolist is
given as Q=200-2P (P = 100- 0.5Q) and cost of the two plants are given as C 1
=10Q1 and C2 = 0.25Q22. Find equilibrium level of price and maximum level of
profit

First, calculate marginal Revenue (MR) & marginal cost (mC1 MC2)

R = PQ

= (100-0.5Q)Q

= 100Q-0.5Q2

MR = d(c)
d(Q)
=d (100Q -0.5Q2)

= 100-Q

MC1 = d(C1) = d(10Q1) = 10

d(Q) d(Q)

MC2 = d(C2) = d(0.25Q22) = 0.5Q2

d(Q) d(Q)

2nd. Equate MC1 = mc2 and MC1 = MR since Q1+Q2 = Q

MC1 = MC2 MC1 = MR Q = Q1+Q2
10 = 0.5Q2 10 = 100-Q Q1= Q-Q2
0.5 0.5 Q = 100-10 Q1 = 90-20
Q2 = 20 Q = 90 Q1 = 70

3rd – to calculate equilibrium price substitute “Q” in demand equation

P= 100-0.5 Q
= 100-0.5 (90)
= 100 -45
= 55

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4th – The monopolists profit can be calculated as:-

II = R-C1-C2
= PQ – C1-C2
= (PQ) – (10Q1) – (0.25Q22)
= (55 x90) – (10x 70) – ((0.25 (20) 2)
= (4950) – (700) – (100)
= 4150
 To check MC1 = MC2 = MR
10 = 0.5 (Q2) = 100 –Q
10= 0.5 (20)= (100-90)
10 = 10 = 10
1.5. Price Description
It’s defined as Charging different Prices to different Customers for different
unit of the same Product on the basis’s of non- Cost- Related Characteristics of
to consumers

The Degrease of Price discrimination

 A Seller with the degree of monopoly power and any time that faces dawn
weld sloping demand cone has a power of price
 The reason for the Monopolist to apply price discrimination is to obtain
an increase in his total revenue and profit
 The Increase in total Revenue is archived by taking away part of the
consumer’s Surplus. Depending on the amount of consumer’
I. First degree Price discrimination
- This involves changing different price for every sola.
- The aim of first-degree Price discrimination for to time is to appreciate
the entire consumer Surprise.
- In this degree the producer Charges the highest price that the
consumer is willing to pay for each unit sold.

It’s the limited case in which the monopolist negotiates individually with
each buyers. Also called Perfect price discrimination or “take-it- or
Leave it” Price discrimination.

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P Consumer Surplus Firm’s revenu

r

Firm’s revenue

Q Q
No discrimination 1st degree price description

- The consumer will have - If we have 1 st degree pric

a surplus, There is no price discrimination, the entire
discrimination surplus of consumers will
taken a way by monopolist.
II. Second Degree price discrimination
 This involves changing different price for different blocks of
Consumption. The aim of monopolist. Say a Public utility, it’s to
charge a relatively high price for the 1 st block of consumption, a
lower price for the Next block and so on..

P1 ---- A

P2 -------------C

P3 --------------------- E

D1
Q1 Q2 Q3
Second-degree price discrimination

 The Producer Charges price Op for units up to quantity Q1

 F1 Unit Between Q1 and Q2, The producer Changes Price Op2, The
monopolist earns area of Total, revenue Op1AQl+Q1BCQ2+Q2DEQ3

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 With Out the 2nd degree price discrimination The revenue earned
given by the area OP3EQ3 at price of Op3, which is, Less than
revenue under discrimination

III. Third Degree Price Discrimination

 In this case, the monopolist able to separate two or more markets

with different demand & Change different price in separate market.
 Consider the profit maximizing output & price of discriminating
monopolist who operate in two completely independent markets.
 Below Which shows AR & MR of two (A&B) market and Combined
me Curve to ,both market at “C”, at given price, elastic in, of
demand is greater in market B then “A”
 For profit maximization, MRA & MRB Must equal. If there were not
so, then profits could be increased by selling extra unit of output in
the market with the higher MR.

R R

Market A Market B Overall Situation

As usual, The profit Maximizing Levels of Output OQ1 is found where MR

total is equal to MC, The Out précis divided between two market with
OQA being sold in market A at price OPA and OQB Being Sold in market
B at price OPB. Notice that OQA+OQB=OQ1

Price Discrimination and price elasticity of Demand

The price discriminating monopolist has to decide on the total output
that he/she must produced, haw much to sell in each market to a high –
price Market

Mc=MR1=MR2 &P1<P2 but E1>E2

The equilibrium Condition is to equate the two MR

(MR1=MR2=MC which is the same as P1 (1-1/E )=P2 (1-1/E2)

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Example- Assume the following price discriminating Monopolists aim at

maximizing profit. The total demand for the producer of monopolist is
Q=50-5P (P=100-2Q)
 The demand in market one is Q1=32-0.4P1=80-2.5Q1)
 The demand in market two is Q2=18-0.1P2=180-10Q2)
 Cost function is C=50+10Q (Where Q=Q1_Q2)
 Find equilibrium (Q1&Q2) equilibrium Prices (P1 & p2),Profit (II)
and elasticity’s (E,IE2)

Solution

1st Compute R & MR for two market & MC

R1=P1Q1 R2=P2Q2

= (80-2.5Q1)Q = (180-10Q2)Q

= 80Q,-2.5Q2) =(180Q-10Q22)

MR1= D(R1) d(80Q1-2.5Q2) MR2=d(R2)

D (Q) d(Q) d(Q)

MR1 = 80-5Q1 MR2= d(180Q-10Q22)

d(02)

Mc=d(C) MR2 = 180-20Q2

d(Q)

MC=d(50+4Qc) = MC= 40

d(Q )

2nd Equate Condition of MC=MR1=MR2 since Q=Q1+Q2

Mc=MR1 MC=MR2

40=80-5Q1 40=180-2002 Q=Q1+Q2

5Q1=80-40 Q0Q2=180-40 Q=8+7

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5Q1 = 40 Q0Q2= 140 Q=15

5 5 26 20

Q1=8 Q2= 7

3rd Calculate equilibrium price = (Substitute Q1+Q2) in to P 1 &

P2
function

P1=80-2.5Q1 P2= 10Q2

P1 = 80 – 2.5 (8) =P1=60 =180-10(7)=P2=110

4th Equilibrm profit (II=R1+R2-C

II = P1Q1 + P2xQ2 – (50+40Q)

II = 60x8 + 110x7 - 50+40X15)

= (430+770)-650

= 1250-650 600
 Elasticity= (E1&E2)

E1= /dQ1. P1/ E2= /dQ2. P2/

dp1 Q1 dp2 Q2

E1=/d(32-0.4P1) 60/ E2 = /d/18-0.1P2). 110/

d(P1) 8 d(P2) 7

E1 = /C-0.4).60 E2=/-0.1) 110/

3 7

E1 = 3 E2 =1.57

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Mc =MR1=MR2

40=80-5Q1=180-20Q2

40=80-5(8) =180 – 20(7)

40 = 40 = 40

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