MONOPOLY

There are four types of market structures perfectly competitive, monopoly,

monopolistically competitive and oligopoly market structure. Our concern in this chapter
is to deal with one of the above mentioned types, i.e., Monopoly.
These are some of the characteristics or features of this market structure called ‘monopoly’.
1.1 Characteristics:
1. Single Seller: It is a market structure in which the entire supply is controlled by one firm,
which implies that the firm and industry are same.
2. No clear substitutes: there are no close substitutes for the goods produced.
3. The monopolist is the price maker: It does not take a price which is determined by the
interaction of market demand and market supply. In order to expand its sale, it decreases the
price of the commodity.
4. Entry Barrier/Obstacle: Entry is blocked in such market structure. The barriers may be
legal, financial, and natural.
5. No Collusion and Competition: Because there is only one firm there is no competition
exists and no collusion among firms also.
Causes for the existence of the monopoly:
1. Exclusive knowledge of technology.
2. Exclusive ownership/access to strategic raw materials needed for production.
3. Government Policies: Patent Rights.
4. Size of market: The size of the market may not allow more than a single seller.
5. Natural Monopolies: Electricity, Water etc.,
1.2 Demand and Revenue for a Monopoly.
The whole market supply is controlled by a single firm. In order to sell more output the firm
reduces price and to increase price the firm reduces its output. Consequently, output and
price decisions are interdependent. So that increasing of one will result in a reduction of the
other and vice versa. As a result, the demand curve of the monopoly is downward sloping.
Note: The monopoly firm faces the industry demand function which is negatively slopped.
Suppose the demand function of the monopoly is given by Q = a – bP.

Solve for p

TR = PQ

1
At any level of output average revenue and price are the same.

= =

Comparison of price and marginal revenue will result in having identical vertical intercepts,
but marginal revenue is twice as steeper as the inverse demand.
From TR = PQ, find MR

From MR =

MR =

P= since is negative. P > MR

P is always greater than MR. It is so because the firm has to reduce price for all the units of
output to sell additional units of output.
The relationship between Elasticity and Marginal Revenue.

Proof:

Price elasticity of demand is defined as

Solving for

Substitute (2) in (1)

2
Costs: It is similar to competitive firms. ATC, AVC, and MC curves are U shaped and AFC
is rectangular hyperbola. The marginal cost curve is not the supply of the monopolist as in
the case of pure competition.
1.3 Short Run Equilibrium of the monopolist.
The monopolist maximizes his short run profit if the following two conditions are fulfilled.
1. The marginal cost is equal to the marginal revenue.
2. The slope of marginal cost is greater than the slope of the marginal revenue at the
point of the intersection.
Proof:
The monopolist aims at the maximization of his profit: Π = R – C
(a) The first – order condition for maximum profit Π

→ or

That is MR = MC
The second – order condition for maximum profit

→ or

[Slope of MR] < [Slope of MC]

A Numerical Example
Given the demand curve of the monopolist:
X = 50 – 0.5P → 50 – Q = 0.5P
Which may be solved for P: P = 100 – 2X
Given the cost function of the monopolist: C = 50 + 40 X
The goal of the monopolist is to maximize profit: Π=R–C
(i) We first find the MR

TR = QP = Q(100-2Q) → Q = 100Q – 2Q2 → MR = = 100 – 4x

(ii) Next find the MC

T C = 50 + 40Q → MC =

(iii) Equate MR = MC
100 – 4Q = 40 → 100 – 40 = 4Q → 60 = 4Q → Q = 60/4 = 15

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(iv) The monopolist’s price is found by substituting Q = 15 into the demand-price equation
P =100 – 2Q = 70
(v) The profit is Π = TR – TC
= PQ –TC = 70(15) – [50 + 40 (15)] = 1050 – 650 = 400
This profit is the maximum possible profit, since the second-order condition is satisfied:

(a) When →

(b) from =-4 we have → Clearly -4 < 0.

So we can say output level 15 maximizes profit; and hence it is optimal. Therefore, we can
see that the classical condition for equilibrium of equating the marginal revenue and marginal
cost remained intact, except that price is different from marginal revenue (unlike the case of
perfect competition).
Graphically
The decision for the maximization of the monopolists profit is the equality of his MC and
MR, provided that the marginal cost cuts the marginal revenue curve from below.
P D
SMC SATC

C
P
ATC
B

ε Profit = PCBATC
MC=MR |
D

0 Q MR X

Monopolist supply curve in the short - run

There is no unique supply curve for the monopolist derived from his MC. Given his MC the
same quantity may be offered at different prices depending on the price elasticity of demand.
Graphically this is shown by the following diagram.
P

Qe is sold at P1 for some consumers and

at P2 for others.
SMC

P2
P1
D1
D2

MR2 MR1
4
Similarly, given the Mc of the monopolist, various quantities may be supplied at any one
price, depending on the market demand and the corresponding marginal revenue curve. Such
a situation is depicted in the following figure.

P
SMC

Both Q1 and Q2 are sold at the same price P.

D1
D2
0 Q1 Q2
Q
MR2 MR1

Since the monopolist can sell the same quantity of output at different prices and can sell
different quantities at the same price, depending on elasticity of demand, there is no distinct
relationship between price and quantity supplied by a monopolist. To conclude we must say
that “the supply curve is not clearly defined.

1.4 Long run Equilibrium of Monopolist

In the long run the monopolist has the time to expand his plant or to use his existing plant at
any level which will maximize his profit. But given entry impossibility into a monopolist
market the firm may not necessarily build the optimal plant size. (That is to build up his
plant until he reaches the minimum point of the LAC).
Given entry barrier, the monopolist will most probably continue to earn super normal profits
even in the long run. However, the size of his plant and the degree of utilization of any given
plant size depend entirely on the market demand.
The monopolist may reach the optimal scale (minimum point of LAC) or remain at
suboptimal scale (falling parts of his LAC) or operate beyond the optimal scale (expand
beyond the minimum LAC) depending on the market condition.
(i) For instance if market is limited/small the firm will maintain a sub-optimal plant
and may under utilize the plant.

5
 P
C

SMC LMC
P SAC

E LAC

At long-run equilibrium
D SMC = LMC = MR

0 Q MR
Q
Fig.1. Monopolist with suboptimal plant and excess capacity.
The firm is employing plant size smaller than the optimum and it is under utilizing the plant
(excess capacity).
(ii) If the market is so large relative to the expansion path, the firm may build a
production plant larger than the optimal and may over-utilize the plant.
When the market is larger, the optimum occurs to the right of the minimum point of Long run
average cost as at point e.
P
C
LMC

A
LAC
P

D
SAC SMC
E

MR
0
Qε Q
Fig.2 Monopolist operating in a large market: his plant is large than the optimal (e) and it is
being over-utilized (at ε|).
(iii) If the market size is just large enough to permit the monopolist to build the optimal
plant, the firm will be operating at minimum point of LAC.

6
 P
C

LMC
SMC Fig: Monopolist operating at
LAC his optimal plant size (Full
P SAC capacity utilization)

0 Qε Q
MR
If the monopolist is at his optimal plant size SMC = LMC = SAC =MR at minimum of LAC.
Note: The firm still earns supernormal profit because price is greater than the marginal
revenue (profits in the shaded area).
1.5 Price Discrimination
Price discrimination exists when the same product is sold at different prices to different
buyers or to different groups of individuals or else to different localities. The cost of
production is either the same or different but not as much as the difference in the changed
prices. Ex: different binding of the same book, different locations of seats in a theater etc.,)
Some of the necessary conditions for the firm to practice price discrimination are as follows:
1. The monopolist must distinguish between more price elastic consumer and less price
elastic consumer. (The market must be divided into sub markets with different price
elasticities.)
2. There must be effective separation of the sub markets, (no reselling can take place
from a low price market to a high price market). Eg., Services like transport, a show,
services of doctor, electricity supply etc.,
By practicing price discrimination the monopolist can increase revenue and hence profit by
selling the optimal output (where MR = MC) at different prices in different markets.
Degrees of Price Discrimination
Monopolists normally practice three kinds price discrimination.
a. First Degree price discrimination,
b. Second Degree Price Discrimination and finally
c. Third Degree Price Discrimination.

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Third Degree Price Discrimination
In this type of price discrimination output is sold for two or more different categories of
individuals at different prices but every individual in the same group takes the same price
is called third degree price discrimination.
Suppose the monopolist takes a market with two sub markets based on different elasticities of
demand.
Market 1 with more elastic demand will be treated with demand curve D1.
Market 2 with less elastic demand will be treated with demand curve D2.
The price discriminating firm has to decide a) The total output that it must produce and b)
How much to sell in each market and at what price, so as to maximize it’s profits?
Total quantity to be produced is defined by intersection point of the MC and the aggregate
MR curves.
P
C

P2 MC
P

P1

If the firm charges uniform price in two markets the total revenue is OPAqe. But the firm
increases its revenue or profits by charging different prices according to MR1=MR2=MC.
MR1=MR2=MC condition is fulfilled at points at which the horizontal dotted line through e
(MR=MC) intersects MR1 & MR2.
CASE 1: The firm charges uniform (identical price) P where MC =MR.
TR = OPAQ
CASE 2: The firm charges different prices depending on the elasticity of demand.
TR1 = OP1FQ1
TR2 = OP2EQ2

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TR = OP1FQ1 + OP2EQ2 since OP1FQ1 = CBQQ2
TR = OP2EQ2 + CBQQ2
By practicing price discrimination the firm gains PP 2ED and losses ABCD. But the gain
(P1P2ED) is greater than the loss. Revenue from price discrimination is greater than
revenue from a uniform price. Since the cost is the same, profit is also higher under price
discrimination.
Revenue earned from price discrimination is greater than the revenue from a single (uniform)
price sale. Since the cost is the same, profit is also higher under price discrimination.
The increase in total revenue is achieved by taking away a part of the consumer ‘s surplus.
To understand this let’s concentrate on an given demand curve, which is depicted below.

P If the total output Q is sold at a

uniform price P, total revenue will be
R = OPAQ. If the firm sells the first
D OQ1 units at P1 and Q1Q units at P,
the total revenue will be greater by
B P1BC. At uniform price P, PDBA
P1 was consumer surplus. Because of
price discrimination the additional
revenue is obtained by extracting the
Second Degree Price Discrimination: part of the consumer surplus
(PP1BC).
If the firm negotiates at more than two prices more of the consumers’ surplus can be
extracted and revenue can be further increased. This way of increasing revenue is called
second degree price discrimination.

P1

P2
P3

Q1 Q2 Q3

If the total output Qis sold at a uniform price P, total revenue is OPDQ. But if the firm sells
the first OQ1 units of output at P1, Q2, Q3, outputs at P2 and P3 the firms total revenue will
be OP1AQ1+EQ1Q2B+fQ2Q3C+GQ3QD.
By practicing price discrimination the firm’s revenue has increased by PP1Ah+ehiB+efcg,
which was a part of consumers’ surplus.

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First Degree Price Discrimination:
In the extreme case, the firm might negotiate price with every consumer to change his/her
the maximum price. He/she is willing to pay (reservation price). It extracts the entire
consumer’s surplus and it is called first degree price discrimination.
In this case the MR is the same as the price. The contribution of every unit of output sold at
its reservation price is MR.

Price discrimination and the price elasticity of demand.

Note that the firm that practice price discrimination charge higher price when elasticity is
lower and lower prices where elasticity of demand is higher.

Initially we have established that

In the case of price discrimination we have

at equilibrium MR1 = MR2 = MC

If e1 = e2 the ratio of prices is equal to unity.

This implies that when elasticities are same, price discrimination is not possible. The
monopolist will charge uniform price for his product.
But if elasticities are different.

→If e1 > e2, then this means P1 < P2

The market with higher elasticity will have the lower price.

Exercise:

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1. Consider a monopolist that takes a market which can be divided into two submarkets with
demand functions.
Q1 = 100 –P1 Q = Q1+Q2
Q2 = 100-2P2 = 200 – 3P
If MC is constant at $10 calculate the prices that must be charged in the two markets and
quantities if the firm practices price discrimination.
Solution:
First change the direct demand factions in to inverse demand functions.
Q1 = 100 – P1 Q2 = 100 – 2P2
P1 = 100 – Q1 P2 = 50 – ½ Q2
R1 = P1Q1 R2 = P2.Q2
Q1[100-Q1] Q2[50-1/2 Q2]
100Q1-Q12 50Q2-1/2 Q22
MR1 = 100-2Q1 MR2 = 50 – Q2
Set MR in each market with MC
MR1 = MR2 =MC
100 – 2Q1 = 10 50 – Q2 = 10
100 – 10 = 2Q1 50 – 10 = Q2
Q1 = 90/2 =45 40 = Q2
Q1 = 100 – P1 = 45 Q2 = 100 – 2P2 = 40
P1 = 100 – 45 =55 = 100 - 40 = 2P2
P2 = 60/2 = 30
The Elasticities in each market are

e1>e2, thus P1 < P2

Given total demand function Q = 50 – 0.5P. Assume further that the market is sub-divided into two.
Q1 = 32 – 0.4P1
Q2 = 18 – 0.1P2 Where Q1+Q2 = Q
*Given the total cost function C = 50 + 40 Q [C = 50 + 40 (Q1+Q2)]
(a) Find Price levels of the two markets.
(b) Find Q1 and Q2
(c) Compare the profits obtained by the firm when it practice price
discrimination and without discrimination.

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 (d) Proof that at higher elasticity the firm charges lower price.

2. Given TC=5Q+20, TC = 5

Q
q1=55- p1 – The DD function in market 1
q2=70- 2p2 – The DD function in market 2
1. Determine q1, q2, p1, and p2 that maximizes profit
2. Find the elasticity of DD in the two markets?
3. Calculate the total profit the monopolist will obtains from its sell in the two markets
4. Present the outputs and prices in the two markets in the back to back diagram

 Solution

1. For market 1
1st Find the inverse DD function
q1=55-p1
q1-5
p1=55-q1
nd
2 Find TR1=p1q1
(55-q1) q1
55q1-q12
3 Find MR1= TR1
rd

q1
=55-2q1
4th Equate MR1=MC
=55-2q1=5
-2q1=5-55
-2q1= -50
q1=25
5th Substitute q1=25 in the inverse DD fun.
p1=55-q1
p1=55-25
p1=30
 For market 2
 Inverse DD function
q2=70-2q2
q2-70= -2q2
p2=35-0.5q2
 TR2=p2q2
=(35-0.5q2) q2
=35q2-0.5q22
 MR2= TR2
q2
35-q2
 MR2=MC
35-q2=5
-q2=5-35
-q2= -30
q2=30

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 Substitute q2=30 in the inverse DD fun.
P2=35-0.5q2
P2=35-0.5 (30)
P2=35-15
P2=20
2. Price elasticity of DD in market 1
q1=55-p1 q2=70-2p2
1= q1 x p1 2=q2 x p2
p1 q1 p2 q2
-1 x 30 -2 x 20
25 30
-1.2=1.2 -1.33=1.33
The above result tells us that DD is more elastic in market 2. Therefore, the monopolist charge lower
price than market 1.

3. Profit of the monopolist

= (TR1 + TR2) – TC or
= (p1q1 + p2q2) – (5Q + 20), where Q is q1+q2
= 30 (25) + 20 (30) – (5 (25 + 30) + 20)
= 750 +600 – (5 (55) +20)
=1350 – (275 +20)
=1370 – 295
= 1055
 The market with less elastic of DD curve (DD1) has higher price. This implies that the
monopolist will charge high price in the market in which quantity purchased is less responsive
to price changes.

4.5 Multi plant Monopolist

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A monopolist can produce identical product in different plants. For simplicity we assume the
firm has only two plants, Plant A and Plant B, each with different cost structures. In this case
the monopolist has to make two decisions.
b. Price and output levels.
c. How much to produce in the first plant and how much in the second plant.
The monopolist should know the market demand curve the corresponding MR curve and cost
structure of those plants.
MC = MC1 + MC2

Optimum point is obtained by the equality point of MC1, MC2 and MR.
In other words, the monopolist maximizes his profit by utilizing each plant up to the level at
which the marginal costs are equal to each other and to the common marginal revenue. This
is because if the MC on one plant, say plant A, is lower than the marginal cost of plant B, the
monopolist would increase his profits by increasing the production in A and decreasing it in
B, until the condition MC1 = MC2 = MR is fulfilled.
Graphically the equilibrium of the multi-plant monopolist may be defined as follows. The
total profit-maximizing output and its price is defined by the intersection of MC and MR
curves Point E in the diagram. From the point of intersection we draw a line, parallel to the
X-axis , until it intersects the individual MC1 and MC2 curves of the two plants. At these
points the equilibrium condition (MC = MR = MC1 = MC2) is satisfied. If from these points
(E1 and E2) we draw perpendiculars to the X-axis of plant A and plant B, We find the level
of output that will be produced in each plant. Clearly Q1+Q2 must be equal to the profit
maximizing output Q. the total profit is the sum of profits from products of the two plants.
The profit from plant A is the shaded area pbcd and the profit from plant B is the shaded
hpfi.

Numerical Example:

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 Given the monopolist’s cost and demand curve.
Q = 200 -2P or P = 100 – 0.5Q
C1 = 10Q1 C2 = 0.25Q22.
Find Q, Q1, and Q2, P Where Q = Q1 + Q2.
P = 100 – 0.5Q
TR = P , Q = 100.Q – 0.5Q2
MR = 100 – Q Q = Q1 +Q2 → = 100 – Q1 – Q2
TC1 = 10X1 → MC1= 10
TC2 = 0.25 Q22 → MC2 = 0.5Q2
MC1 = MR → 10 = 100 – Q1 – Q2
MC2 = MR → 0.5Q2 = 100 – Q1 – Q2
Q1 + Q2 = 90 → 1.5Q2 + Q1 = 100 → -Q1 – Q2 = 90 → 1.5Q2 + Q1 = 100 → 0.5Q2 = 10 → Q2 = 20
Q1 + Q2 = 90 → Q1 = 90 – 20 = 70
P = 100 – 0.5 (90) = 100 – 45 =55

Monopolist profit → = 4950 – 10(70) – 0.25 (400)= 4150

OR. MULTI P-LANT MONOPOLIST

 So far we have assumed that a monopolist own and produce an output by means of only one
plant. This is not all the case. It is possible for the monopolist to install more than one plant and
hence cost conditions may differ from one plant to another. The cost curves associated to each
plant are different. The problem faced by monopolist is the allocation of production between
plant 1 and 2. The monopolist maximizes profit by equating MR equal to MC. However, there
is one MR and three MC curves when we assume the monopolist have two plants. That is,
MC1 for plant1, MC2 for plant 2, and MC common marginal cost (multi-plant MC). The
monopolist maximizes profit by producing output level where each plant’s MC is equal to MR.
 Consider the following table to examine how a monopolist with two plants having different
cost of production first determines total output and then decides how much to be produced sing
each plan.

Q P MR MC1 MC2 MC
1 3
1 5.00 - 1.92 2.04 1.92
2 4.50 4.00 2.00 2 2.14 5 2.00
4 8
3 4.10 3.30 2.08 2.24 2.04
4 3.80 2.90 2.16 6 2.34 10 2.08
7
5 3.55 2.55 2.24 2.44 2.14
6 3.35 2.35 2.32 9 2.54 2.16
7 3.20 1.30 2.40 2.64 2.24
8 3.08 2.24 2.48 2.74 2.24
9 2.98 1.18 2.56 2.84 2.32
10 2.89 2.08 2.64 2.94 2.34
 The total output level that maximizes the profit of the monopolist is 8, MR=MC. The
monopolist will produce 5 units using plant 1 while 3 units using plant 2. This, is because
profit is maximized when MR=MC1=MC2=MC.
 Mathematical example: Given, Q=200 - 2P, TC1=10q1 and TC2=0.25q22, find q1, q2, Q and
profit of the firm.
 Solution:

15
 1st find the inverse fun
Q=200 – 2P 7th Apply simultaneous equ. for
Q – 200= -2P MR=MC1 and MR=MC2
P= 100 – 0.5Q, where Q is q1 +q2 100-q1-q2=10
2nd TR=PQ -(100-q1-q2=0.5q2)
= (100 – 0.5Q) Q 10- 0.5q2=0
= 100Q – 0.5Q2 10=0.5q2
3 MR= TR1
rd
q2= 10/0.5=20
q1
=100 –Q 8th MR=MC1=100-q1-q2-10
4th MC1= TC1 = 100- q1-20-10
q1 q1=100-30
= 10 q1= 70
MC2=TC2 9th The profit of the monopolist
q2 Π=TR-TC
=0.5q2 =(TR)-(TC1+TC2)
5th Equate MR=MC1 =(100Q-0.5Q2)-(10q1+0.25q22)
100 – Q=10 =(100(90)-0.5(90)2)-(10(70)+0.25(20)2)
100 – q1 – q2 –10=0 =(9000-4050)-(700+100)
6th Equate MR=MC2 = 4950 - 800
100 – Q=0.5q2 = 4150
100-q1-q2=0.5q2

SOCIAL COSTS OF MONOPOLY

Price is higher and output is lower in the monopoly market model than the competitive
market model. Because of these monopoly is said to be socially inefficient in allocating
factors of production.
In Competitive Market P = MC
Monopoly Market P > MC
To calculate the degree of inefficiency due to monopoly we can use the concepts of
producer’s surplus and consumer’s surplus.

Under Competition the net welfare gained by the consumers and producers is as follows:
Net Welfare = aePc + Pcef
Consumer’s Producer’s

16
 Surplus Surplus
Under Monopoly the net welfare gained by the consumers in (aPmb) which is less than net
welfare gained under competitive (aePc). Pmbc Pc is taken by producers. But the area bed is
totally lost. (Which is not consumer surplus & Producers surplus)? Area bed is dead
weight loss due to monopoly allocation as opposed to competitive market.
OR. SOCIAL COST OF MONOPOLY
 Is the existence of a monopolist evil? The answer to this question is no and yes. No if the
monopolist charges different prices based on the marginal WTP, bulk discount, and elasticity
of DD. That is, as we have seen in the three types of price discrimination that a monopolist
charge higher and lower price for those who have high and low willingness to pay for its
product-discrimination across person, on the basis of bulk discount-discrimination across
product consumed, and elasticity of DD-across group of people in first, second, and third
degree price discrimination, respectively are Pareto efficient.
 We have seen in chapter 5 that a remarkable outcome of perfect competitive market is resource
allocation efficiency, which results to social welfare and increase in employment. This is
because at competitive equilibrium, the marginal utility of the consumed good (MU=DD)
equals price (P), which in turn equals the MC of producing the good. Hence, if MU=P (social
welfare) and P=MC (allocation efficiency), then MU=MC.
 An alternative way to understand the efficiency of competitive market is through the concept
of Consumers surplus. Consumers’ surplus is willing to pay (proportional DD curve) for and
the amount actually paid (prorata DD curve). In other words, it is the area to the left of the
perceived DD curve above the equilibrium price or since equilibrium represents the money not
spent by consumers who would have been willing to pay a price higher than equilibrium. In
short, it is the savings of the consumer for buying Qe at Pe.
 Clearly, an economy is performing well when it generates much to the consumer surplus and
an efficient situation is one in which the maximum amount of consumers’ surplus is squeezed
out of the system.

P P

CS E CS E
Pe Pe

MU=DD=ƒ(Qd) MU=DD= ƒ(Qd)

Qe Qe
Linear DD curve Non-linear DD curve
 The MC of goods represents supply. Equating the MC curve that passes through point E in the
above graphs shows producers’ surplus. Producers’ surplus is the area above the MC curve but
below the equilibrium Price (Pe). In other words, it indicates the difference between the
additional cost (MC) firms are willing to incur and what they actually incurred (Pe=MC). In
short, it is the money that suppliers would not have received if demand had been less than Qe.

17
 P
MC=SS
CS

Pe
PS
DD

Qe
 Given Pd=25-Q2 and Ps=2Q+1 as demand and supply function, respectively calculate the
consumers’ and producers’ surplus.
 1st find the equilibrium Q and P
Pd=Ps -2±10
25-Q2=2Q+1 2
2
25-1=2Q+Q -2+10 and –2-10
24=2Q+Q2 2 2
Q2+2Q-24=0 Q=4 and Q= -6
2nd Use the quadratic formula to get Q 3rd find equilibrium P
2
-b±√b -4ac Pd=25-Q2 or Ps=2Q+1
2a Pd=25-(4) 2 or Ps=2(4)+1
2
-2±√2 - (4(1)(-2) Pd= 25-16 or Ps=8+1
2(1) Pd=Ps=9
-2±√4+96
2
-2±√100
2
4th Show the equilibrium Q and P graphically

25 SS

CS
9
PS
DD
1 4

5th CS= -PeQe =9(4)-

= =36-(2Q2/2+Q)
=36-(2(42/2)+4)
=(25Q-Q3/3)/ -36
=36-(32/2)+4)
=25(4)-43/3-36 =36-20=16
=100-64/3-36
=100-21.3-36
=42.7
6th PS=PeQe-

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 Exercise
 Given the inverse DD and SS function as Pd=90-Q and Ps=(2Q+2) 2 find the CS for
Qd=30and Pe=40 and PS for Qs=5 and 42, respectively.
 Answer =CS is 1050 and PS is –76.7.
 These being the CS and PS in perfectly competitive market, the social cost of monopoly
arises due to the fact that a monopolist operates inefficiently as compared to perfect
competition in the sense that Pm>Pc and Qm<Qc. This is because a monopolist
determines its Q and P by equating MR=MC unlike sellers in perfect competition
market that equate P=MC. As a result some part of CS and PS obtained in perfectly
competitive market are lost. To understand the social cost (DWL) of monopoly,
consider the graph below.

P MC

Pm A

Pc B Ec

Em

DDm
MRm

Qm Qc Q
 The above graph shows the change in the CS and PS for a movement from competitive
(monopoly) to monopoly (competitive) output. The CS goes down (up) by area
PcEcAPm. That is, it goes down (up) by rectangle PcBAPm since consumers are not
(now) getting all the units they were buying before at a higher (cheaper) price; and it
goes down by a triangle ABEc since they loose (get) some surplus from the lower
(extra) units that are being sold.
 The PS on the other hand, goes up (down) by area PcBAPm due to the higher (lower
price) on the units he was already selling. It goes down (up) by EmBEc due to looses
(profits) on the lower (extra) units it is now selling. The area PcBAPm is just a transfer
from the consumers (monopolist) to the monopolist (consumers) and hence one side of
the market is made better off while the other worse off, but the total surplus does not
change as a result of the transfer. However, the area ABEc and EmBEc represent the
DWL due to monopoly behaviour (a true increase in surplus-measure the value that the
consumers and the producers place on the extra output that has been produced).
 The DWL provides a measure of how much worse off people are paying the monopolist
than paying the completive price. The DWL due to monopoly like that of the DWL due
to tax increase measures the value of the lost output by valuing each unit of lost output
at a price that people are willing to pay for a unit. In other word, as we move from
competitive to monopoly output, the sum of the distance between the demand curve and
the MC curve generates (gives) the value of the lost output (Qc-Qm) due to monopoly
behaviour. The total area between the two curves is the DWL when moving from
competitive to monopoly output.
 Numerical Example:
 Assume there is a tendency of moving from competitive to monopoly output. If the
demand and total functions are Q=100-2P and TC=14Q+2Q2, respectively
A. Determine Pc, Qc, Pm, and Qm.
B. Show the equilibrium Q and P you obtained in A above graphically.

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 C. Calculate the CS and PS under competitive and monopoly market structure.
D. Calculate part of CS transferred to the monopolist due to inefficiency of
monopoly.
E. Calculate the social cost (net loos or DWL) of monopoly.
 Solution:

Equilibrium Q and P in perfectly competitive market

A. P=MC → 50-0.5Q=14+4Q → 50-14=4Q+0.5Q → 36=4.5Q →
Qc=8
Pc=50-0.5Q or 14+4Q → =50-0.5(8) or 14+4(8) → =50-4 or 14+32 → =46=46
Equilibrium Q and P in monopoly market
TR=PQ → =(50-0.5Q) Q → =50Q-0.5Q2
MR=∂TR=50-Q
∂Q
MC=∂TC=14+4Q
∂Q
MR=MC → 50-Q=14+4Q → 50-14=4Q+Q → 36=5Q → Qm=7.2
Pm=50-0.5Q → =50-0.5(7.2) → =50-3.6 =46.4
MC=SS
B.
Pm
Pc
DDm
MRm

Qm Qc
Consumers’ and producers’ surplus in perfect competition
C. CS=1/2 (50-46) x 8
=1/2(4) x 8→ =16
PS=1/2(46-14) x 8
=1/2(32) x 8 → =16 x 8=128
CS and PS under monopoly
CS =1/2(50-46.4) x 7.2
=1/2(3.6) x 7.2 → =1.8 x 7.2=12.96
PS = ½ ((42.8-14) x (7.2)) + ((46.4-42.8) x 7.2)
=1/2((28.8) x (7.2)) +(3.6 x 7.2)
=14.4(7.2) + 25.92→ =103.68+25.92=129.6
The CS transferred to the monopolist and DWL due to monopoly output
D. Consumers’ loss due to monopoly =CS under perfect –CS in monopoly
16-12.96 → 3.04
E. The amount of surplus transferred from consumers to the monopolist is
(Pm-Pc) x Qm
(46.4-46) x 7.2
0.4 x 7.2 → 2.88
DWL= CS not transferred + PS lost
=1/2(((Pm-Pc) x (Qc-Qm)) + ½ ((Pc-MC at Qm) x (Qc-Qm)
=1/2(46.4-46) x (8-7.2) + ½ ((46-42.8) x (8-7.2)
=1/2 ((0.4) x (0.8)) + ½ ((3.2) x (0.8))
=0.2(0.8) + 1.6(0.8) → =0.16+1.28=1.44

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