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Market Structure: Monopoly

and Monopolistic
PROF. VANITA SINGH
MDI GURGAON
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Monopolist

 A monopolist is a firm that is the only producer of a good that has no close substitutes.
An industry controlled by a monopolist is known as a monopoly. e.g. De Beers

 The ability of a monopolist to raise its price above the competitive level by reducing
output is known as market power.
What a Monopolist Does?
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 Under perfect competition, the price and

quantity are determined by supply and
demand. Here, the equilibrium is at C, where
the price is PC and the quantity is QC. A
monopolist reduces the quantity supplied to
QM, and moves up the demand curve from C
to M, raising the price to PM.
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Why Monopolies Arise?

A monopoly is a firm that is the sole seller of a product without close substitutes.
The fundamental cause of monopoly is the presence of barriers to entry.
 Barriers to entry have four sources:
 Monopoly Resources: Ownership of a key resource.
 Government-Created Monopolies: The government gives a single firm the exclusive
right to produce some good. Example: Patent, Copyright
 Natural Monopolies: Costs of production make a single producer more efficient than a
large number of producers.
 Mergers/ Acquisition/Takeover : Industry becomes concentrated. A firm is able to gain
control of other firms in the market and thus grow in size.
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Economies of Scale – Cause of Monopoly
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How Monopolies Make Production And
Pricing Decisions

 The key difference between a competitive

firm and a monopoly is the monopoly's
ability to control price.
 A monopoly faces a downward sloping
demand curve
 A monopoly can increase price and not
lose all its sales.
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Monopoly versus Competition

Monopoly
Is the sole producer
Faces a downward-sloping demand curve
Is a price maker
Reduces price to increase sales
Competitive Firm
Is one of many producers
Faces a horizontal demand curve
Is a price taker
Sells as much or as little at same price
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Monopoly’s Marginal Revenue

 A Monopoly’s Marginal Revenue

 A monopolist’s marginal revenue is always less
than the price of its good.
 The demand curve is downward sloping.
 When a monopoly drops the price to sell one
more unit, the revenue received from previously
sold units also decreases.
 When a monopoly increases the amount it sells,
it has two effects on total revenue (P  Q).
 The output effect—more output is sold, so Q is
higher.
 The price effect—price falls, so P is lower.
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Profit Maximization

 A monopoly maximizes profit by producing the

quantity at which marginal revenue equals
marginal cost.
 It then uses the demand curve to find the price
that will induce consumers to buy that quantity.
 Comparing Monopoly and Competition
 For a competitive firm, price equals marginal cost.
P = MR = MC
 For a monopoly firm, price exceeds marginal
cost.
P > MR = MC
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Monopolist’s 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
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The Inefficiency of Monopoly

Because a monopoly sets its price above marginal

cost, it places a wedge between the consumer’s
willingness to pay and the producer’s cost.
Thiswedge causes the quantity sold to fall short of
the social optimum
The monopolist produces less than the socially
efficient quantity of output.
The deadweight loss caused by a monopoly is
similar to the deadweight loss caused by a tax.
The difference between the two cases is that the
government gets the revenue from a tax, whereas a
private firm gets the monopoly profit.
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Price Discrimination

Pricediscrimination is selling the same good at different prices to different customers, even
though the costs for producing for the two customers are the same.
 Arbitrage will limit a monopolist's ability to price discriminate.
 Arbitrageis the process of buying a good in one market at a low price and then selling it in another
market at a higher price.
 In order to price discriminate, the firm must have some market power.
 Perfect Price Discrimination occurs when the monopolist knows exactly the willingness to pay
of each customer and can charge each customer a different price.
 Two important effects of price discrimination:
 It can increase the monopolist’s profits.
 It can reduce deadweight loss.
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Welfare with and without Price Discrimination

Monopolist with Perfect Price

Monopolist with Single Price Discrimination
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Public Policy Toward Monopolies

 Government responds to the problem of monopoly in one of four ways.

 Increasing competition: Prevent mergers, make laws for making monopolized industries
more competitive.
 Price Regulation: Regulating the behavior of monopolies.
 Turning some private monopolies into public enterprises.
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Thank You!!
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Monopolistic Competition

Monopolistic competition is a market structure in which

 there are many competing producers in an industry,
 each producer sells a differentiated product, and
 there is free entry into and exit from the industry in the long run.
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Monopolistic

 Monopolistic firm looks like any monopolist: it faces a downward-sloping demand curve, which
implies a downward-sloping marginal revenue curve.

 We assume that every firm has an upward-sloping marginal cost curve but that it also faces some fixed
costs, so that its average total cost curve is U-shaped.

The firm in panel (a) can be profitable for some output
levels: the levels at which its ATC, lies below its demand
curve, DP. The profit-maximizing output level is QP, the
output at which marginal revenue, MRP, is equal to
marginal cost. The firm charges price PP and earns a
profit, represented by the area of the shaded rectangle.
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The firm above can never be profitable because the
ATC lies above its demand curve, DU. The best that it
can do if it produces at all is to produce output QU and
charge PU. This generates a loss, indicated by the area
of the shaded rectangle. Any other output level results
in a greater loss.
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Monopolistic Competition in the Long Run

If the typical firm earns positive profits, new firms will enter
the industry in the long run, shifting each existing firm’s
demand curve to the left. If the typical firm incurs losses,
some existing firms will exit the industry in the long run,
shifting the demand curve of each remaining firm to the
right.
In the long run, equilibrium of a monopolistically
competitive industry, the zero-profit-equilibrium, firms just
break even. The typical firm’s demand curve is just tangent
to its average total cost curve at its profit-maximizing
output.
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Entry and Exit into the Industry Shift the Demand Curve of Each Firm
Entry will occur in the long run when existing firms are profitable. In panel (a), entry causes
each firm’s demand curve and marginal revenue curve to shift to the left. The firm receives
a lower price for every unit it sells, and its profit falls. Entry will cease when remaining firms
make zero profit.

Exit will occur in the long run when existing firms are unprofitable. In panel (b), exit out of
the industry shifts each remaining firm’s demand curve and marginal revenue curve to the
right. The firm receives a higher price for every unit it sells, and profit rises. Exit will cease
when the remaining firms make zero profit.
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Zero-Profit
Equilibrium
A monopolistically
competitive firm is like a
monopolist without
monopoly profits.

If existing firms are profitable, entry will occur and shift each firm’s
demand curve leftward. If existing firms are unprofitable, each firm’s
demand curve shifts rightward as some firms exit the industry. In long-
run zero profit equilibrium, the demand curve of each firm is tangent to
its average total cost curve at its profit-maximizing output level: at the
profit-maximizing output level, QMC, price, PMC, equals average total cost,
ATC .
 Monopolistic Competition versus
Perfect Competition
Panel (a) shows the situation of the typical firm in long-
run equilibrium in a perfectly competitive industry. The
firm operates at the minimum-cost output QC , sells at the
competitive market price PC , and makes zero profit. It is
indifferent to selling another unit of output because PC is
equal to its marginal cost, MCC .
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Panel (b) shows the situation of the typical firm in long-run
equilibrium in a monopolistically competitive industry. At QMC it
makes zero profit because its price, PMC, just equals average total
cost. At QMC the firm would like to sell another unit at price PMC,
since PMC exceeds marginal cost, MCMC. But it is unwilling to lower
price to make more sales. It therefore operates to the left of the
minimum-cost output and has excess capacity.
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Firms in a monopolistically competitive industry have excess capacity:

they produce less than the output at which average total cost is minimized.

The higher price consumers pay because of excess capacity is offset to

some extent by the value they receive from greater diversity.

Hence, it is not clear that this is actually a source of inefficiency.

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Thank You!!