Monopoly

The Monopoly Model
• • • • Sellers are price makers Sellers do not behave strategically Entry into the industry is completely blocked Buyers are price takers

Market Structure
• • • • • Many buyers ONE seller No close substitutes for the firm‟s product Well informed buyers Blocked entry to the market

How does Monopoly Arise? • Control over critical inputs • Economies of scale and scope • Intellectual Property Rights • Regulation .

conditions imply that MR = MC and MR cuts MC in its rising part (as slope of MR < slope of MC) • How do we get this MR curve of the monopolist? • What‟s the AR curve of the monopolist? .The Profit-maximising Monopolist • Monopolist faces the industry demand curve • Profit max.

Marginal Revenue Output per Price per Total Rev Marginal month unit (Rs. MR becomes negative .) (Rs) Rev (Rs) 0 40 0 1 35 35 35 2 30 60 25 3 25 75 15 4 20 80 5 5 15 75 -5 6 10 60 -15 • Marginal revenue falls as output sold increases • Marginal revenue is less than price (AR) • After TR is max.

where p = f(q) is demand curve AR = pq/q = p = f(q) = demand curve MR = p (1 – 1/|e|) .Demand & MR Curves 50 40 30 20 Rs 10 0 -10 -20 Output per month 0 2 4 6 D 8 MR TR = pq = f(q) * q.

Monopoly Equilibrium Rs MC P AC Monopoly Profit D Q MR Qty .

the monopolist can earn profit. i. losses) as long as p exceeds AVC at the optimum level of output. make losses or just break even • It will continue to operate (i. R.e.When will the monopolist shut down? • In the short run. p* < SAVC P.e. C MC SAC SAVC P* AR Q* Q MR . min.

Demand curve • But the monopolist stops producing if he incurs losses in the long run . the monopolist chooses output as in short run.Short Run & Long Run ? • In the long run the firm is on its long run cost curves • No entry of new firms takes place. i.e. so economic profit can exist in the long run • Hence in long run also. at MR = LMC and sets the price from the cor.

What’s the supply curve of a monopolist? • A monopolist does not have a supply curve • He chooses output and then price corresponding to that output from the demand curve • So. supply curve does not exist for a monopolist .

LI >0 Higher LI. P = MC. hence lower market power .Measurement of Monopoly Power • Price Elasticity of demand: the degree of market power is inversely related to e. greater the firm‟s market power • Lerner Index: LI = (P – MC) / P where P is the price the monopolist sets o o o o Under perfect competition. Fewer the substitutes. higher is market power LI is inversely related to price elasticity of demand • Cross price elasticity: A high positive cross pelasticity implies existence of close substitutes. less is e. hence LI = 0 Under monopoly P > MC (as P> MR = MC).

Monopoly v Competition: Social cost of monopoly • Consider a perfectly competitive industry under constant returns to scale (implying horizontal long run supply curve of the industry) • Suppose this industry is now converted into monopoly with same demand and cost curves • The monopoly will charge a higher price and produce less output • There will be a redistribution of income from consumers to the monopolist and • A welfare loss due to less efficient resource use called „deadweight loss‟ .

Monopoly v Competition Rs Deadweight loss of monopoly PM Monopoly profit PC LAC = LMC D = AR Q M QC Qty MR .

we had MRTP Act • Competition Act 2002 and CCI .Public Policy Toward Monopoly • Patent Policy o Allow temporary monopoly power to encourage innovation • Anti-Monopoly (Antitrust) Policy o Conduct Remedies – regulate firm behaviour o Structural Remedies – introduce/maintain competition (where possible) • Regulation of existing monopolies • In India.

a single firm can produce the total industry output at less cost than any greater number of firms • LAC curve might be falling over entire range of market demand or the MES is achieved at a very high level of output .Natural Monopoly • Economies of scale are extensive in relation to the size of the market • Hence.

choice will occur at MR = MC1 = MC2 . there are two plants described by two different cost structures TC1 and TC2 • Hence the total cost will be TC = TC1 and TC2 • From this we get MC = MC1 + MC2 • The monopolist then equates MC with MR to decide the total output to be produced • Then he would equate the MR with individual MC‟s to decide how much to produce in the two respective plants • Hence. profit max.Multiplant Monopolist • The monopolist operates more than one plant • Sup.

Multiplant Monopolist Plant 1 MC1 Plant 2 MC2 Multiplant Monopolist MC P* DD MR Q1* Q1 Q2* Q2 Total Q Q .

stereotypes.Price Discrimination • Price discrimination occurs when a firm charges different prices to different customers for reasons other than differences in costs • Price-discriminating monopoly does not discriminate based on prejudice. it divides its customers into different categories based on their willingness to pay for good . or ill-will toward any person or group o Rather.

g. prevent low-price customers from reselling to high-price customers) . by age.Conditions for Price Discrimination • To successfully price discriminate.) o Firm must be able to prevent arbitrage (i.e. region etc. sex. three conditions must be satisfied o The firm must have some degree of market power facing a downward sloping demand curve o Firm must be able to separate consumers into two or more groups (e.

2 yr etc.] o 3rd degree is different prices to different consumers (B changed)[ journal subscription rates different for individuals and libraries] . Same price for all units. B. Can one profit from this? o 1st degree is different prices for different consumers and different units (both A and B are changed)[doctor charging different fees to different patients and for different consultations] o 2nd degree is different prices for different units (A changed). • Changing one or both of these is called Price Discrimination. Same price to all customers.Price Discrimination • Basic model: a monopolist charges: A. [ journal subscription rates different for 1 yr.

he has MR1 and MR2 • He obtains MR = MR1 + MR2 • Monopolist produces in a single plant • For profit max. he equates MR = MC • How much he sells in market 1 and market 2 is determined by equating MR1 = MR2 = MC 22 .3rd-degree price discrimination • There are two markets where resale is not possible between them • Hence two demand curves D1 and D2 • Hence.

Price Discrimination Market 1 Market 2 Monopolist MC P1 P2 D MR1 D1 Q1 Q2 MR2 D2 Q MR • Monopolist will set higher price in the market where price elasticity of demand is low • In this case it is Market 1 .

2nd Degree Price Discrimination • All consumers face same price “menu” • Actual price paid depends on consumer‟s preferences or type • Usually used when consumers cannot be distinguished ex ante • Consumers self-select themselves for different schemes • Ex: Quantity discount • Journal subscriptions for 1 year. • Pricing of cinema hall tickets by time of day or day of the week . 2 years etc.

• What is the maximum a monopolist with zero marginal cost could make charging the same price per umbrella? • What is the max it could make charging a price for 1 and a special for two together? o Hint: what would happen if they charge 100 for one and 150 for two? 25 . • They each want to maximize the difference between their value and the price they pay. • Varun values 1 umbrella at 110 rupees and also values 2 umbrellas at 150 (together).2nd degree Price Discrimination • Aryan values 1 umbrella at 100 rupees and has no need for another umbrella.

• It‟s also called perfect price discrimination • Difficult to implement in reality 26 . • 1st degree is efficient. • To do this properly. a monopolist must have strong information on: o Consumers‟ preferences o Who is who • 1st degree captures the whole consumer surplus.1st-Degree Price Discrimination • Different prices for both consumers and units.

• Book publisher having different prices for different country editions of a book • How about paperbacks • Publisher charging libraries a higher rate to libraries than to individuals. • Frequent Flyer Programs • First Class Train tickets • Entry Fee Packages at Amusement Parks 27 .Examples of Price Discrimination.

Monopoly Pricing • Dumping (international price discrimination) • Two-part Tariff (another practice to extract consumer surplus) • Tying and Bundling • Discrimination over time (durable good monopoly/ peak-load and off-load pricing) .

Predatory and Sporadic Dumping .Dumping • Charging of lower price abroad than at home for the same commodity due to higher price elasticity of demand in the foreign country • It‟s like third degree price discrimination to increase profits • Persistent.

• Charge a price per unit that equals marginal cost plus a fixed fee equal to the consumer surplus each consumer receives at this per unit price. 30 . F (for the right to purchase a product)plus a per unit fee.Two-Part Tariffs • Definition: A two-part tariff a lump sum fee. r (as the price for each unit of product they purchase) • Example: The sports center charges a fee to join and then a per usage fee. or Fee at Nicco Park. telephone charges etc.

(2) set F=surplus=72.P Example: Surplus Extraction w/ Two-Part Tariff Optimal two-part tariff: 14 (1) maximize surplus by r =2. 55 Why? 72 2 10 12 14 Q 31 .

g. Buffet at restaurants. • Pure and Mixed bundling 32 .Tying and Bundling • A consumer can buy one good only by purchasing another good as well • Polaroid film with polaroid camera • Bundling is a special case of Tying where two or more commodities are sold in the situation where customers have different tastes but the monopolist cannot price discriminate E.

the monopolist increase profits by extracting more consumer surplus 33 .Bundling • Pure bundling occurs when a firm sells two or more products only in a bundle and not individually • Mixed bundling means commodities are available both in bundles and individually • By bundling products.

34 . This will make a total profit of $200 x 2 = $ 400. $220 + 200 = $420. it should price both the products at $ 80 for Word and $ 100 for Excel so that each consumer can buy both the products. $120 for Excel. o B values $80 for a Word. $100 for Excel. • It can make a profit of $80 x 2 + $100 x 2 = $ 360 • They could package both together (and stop selling it individually) at the price of $ 200. • Microsoft has zero marginal cost. • If Microsoft charges separately for each program. i.Bundling • Two types of people: o A values $120 for Word. • But he still could not extract the entire consumer surplus.e.

manager of the movie theater made the following suggestions: “Since Chalchitra is a local monopoly. . Despite having market power. we should just increase ticket prices until we make enough profit. it is currently suffering losses. In a conversation with the owner of the Chalchitra Cinema. Thus Chalchitra Cinema possesses a degree of market power. The nearest rival movie theater the Chhayachitra.” • Is it a correct strategy? Comment.Caselet 1 Chalchitra Cinema is the only movie theater in Sunderbans. is 35 miles away.

Graphically illustrate the impact of an increase in demand on price and quantity under monopoly. • .Caselet 2 • Interior Style is a monopolist in its state in interior designing. With more consciousness among the higher middle class people these days. the company faces an increase in demand recently.

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