Microeconomics IMonopoly Market

ByKwame Agyire-Tettey (PhD)

Learning outcomes• Identify the characteristics and sources of monopoly power.• The monopolist faces a downward sloping demand and marginal revenue curves.•A monopolist sets marginal cost equal to marginal revenue, but marginal cost is less than price.•Changes in cost alters the equilibrium situation.•Analysis a monopolist that operates more than one plant.• Profit can be increased for a monopolist if it is possible to charge different prices to different customers or in separate markets.• Pure profits exist in the long run under monopoly, so long as there are entry barriers.

Definition of Monopoly• This is a market structure in which a firm has absolute power to produce and sell a commodity of which there are no close substitutes and there are barriers to entry. What will be the cross-price elasticity?• For a firm to be a monopolist it should possess monopoly power.•Monopoly power is the firm’s ability to control the market. That is the degree to which the firm can increase price above the marginal cost.• Though the firm may have monopoly power, it is restricted by the extent to which it can increase price above the marginal cost by two factors:

• Indirect competition• Potential competition

Source of monopoly

• The existence and survival of monopolies is due to factors which prevent the entry of other firms into the market.

•Barriers to entry are the major causes or sources of monopoly power.

• The sources of barriers to entry can be grouped into two broad groups:• Legal barriers •Technical barriers

Legal barriers• Monopolies are created out of legal reasons:

• Laws or acts that are passed to protect public interest:• When government enacts laws establishing monopolist firms

because it believes the commodity in question is important to society as a whole and leaving it to the dictate of market forces won’t be in the interest of society (leads to Franchise Monopolist).

• Patent rights• This is where exclusive rights to a firm to solely produce a specified

commodity using a specified technology. Patents are awarded to firms for being innovative and inventing the commodity or technology used in the production process. This will define the specific property rights and it lasts for some years.• The rationale of the patent system is to make innovations profitable

in order to encourage technical advancement. – Patent monopolies

Technical Barriers• Control over key inputs• ownership or control over key factors• ownership or control over outlets

• Efficiency • economies of scale• lower costs for an established firm• legal restrictions• mergers and takeovers• aggressive tactics• intimidation• product differentiation and brand loyalty

• Monopolies resulting from efficiency is known as natural monopolies.

Demand and revenue functions• Since there is a single firm in the market/industry, it implies that the demand facing the firm is the same as the market/industry demand.

• The demand curve is download sloping and this implies that for the firm to sell an additional unit of the good it should reduce the price it charges.

• It also implies the monopolist can control price and consumers will determine the output they purchase.

• And when the monopolist decides on output to supply consumers will decide on the price to pay.

Price, revenue

Q O

D=AR MR

Relationship between demand, MR and AR under monopoly

Relationship between demand, MR and AR• Relationship between Average revenue (AR) and demand function.

• Marginal revenue (MR) function and that of the Demand function.

• Slope of the demand function and that of the marginal revenue.

• Relationship between price and marginal revenue.

• The marginal revenue of the firm is positively related to price elasticity of demand.

• At the mid-point of the demand curve price elasticity is equal to 1

Price, revenue

Q O

D=AR MR

Relationship between price elasticity of demand and MR

0 < e < 1

e=1

e > 1

50 100

50 100

pric

e pe

r un

it

0

0

MR

TR

A profit maximizing monopolist will never produce and along the inelastic portion of the demand curve.

Elasticity greater

than one >1Unity elasticity

=1

AR

Revenue curves and demand elasticity

Quantity

Quantity

Elasticity between zero and one

0 < <1

MC

ATC

AVC

D = ARMR

QuantityProfit-maximizing quantity

pric

e pe

r un

it

p0

q00

The Equilibrium of a Monopoly

c0

Supply curve of the monopolist• Supply curve or function shows a unique relationship between price

and the output that a firm is will and able to supply onto the market.• The monopolist, unlike the prefect competitive firm is not a price

taker implying the absence of a unique correspondence between price and marginal revenue when market demand shifts.• Note also that the monopoly firm is a price maker, not a price taker.• Asking such a firm about the quantity it would produce at any price

is meaningless, as both price and quantity to supply are determined simultaneously.• Indeed, the monopolist’s decision about how much to supply is

impossible to separate from the demand curve it faces. The shape of the demand curve determines the shape of the marginal revenue curve, which in turn determines the monopolist’s profit maximizing quantity.• In a gist the monopolist has no supply curve

Long-run equilibrium• The monopolist in the long run can expand its plant size or

make use of the existing plant at any level which maximises its profit.

• Note that there barriers to entry so there is no threat of competition. Thus the firm does not necessary have to adjust its plant size to produce at the optimal level (producing at the minimum point of the LAC).

• Sub-optimal level• Optimal level • Surpass optimal level

Types of Monopolist firms•Multi-plant monopolist• This is a monopolist which produces a homogenous product

using different plants. This type of monopolist will behaviour differently from a single plant-operating monopolist. In this case the firm faces two separate cost structures.

• Price discriminating monopolist• This is a monopolist who sell the same products to different

consumers at different prices.

Multi-plant monopolist• Assumptions:• To simplify our analysis we are assuming that the firm operates only two plants –

A and B.• Each of these plants have different cost structure.• The monopolist know its demand curve and by extension knows the market

demand as well.• Since it knows the market demand it also knows the marginal revenue function.• We also assume that the firms knows the cost structure of each plant.

• Given these assumptions for the monopolist to maximise profit it has to make two decisions• The total output to produce using both plants in order to maximise profit.• How to distribute the total output among the two plants. That is, what

quantity should each plant produce.

• Note MC = MCA + MCB

Equilibrium of the multi-plant monopolist

Price Discrimination• This is a market condition which allows a monopolist to sell

the same (or slightly differentiated) product to different consumers at different prices.

• The difference in price is not as a result of differences in cost of production. Actually, the cost of producing for the two consumers/markets is the same.

• The monopolist will discriminate on the basis of:• income; purchasing power; geographical location; age; sex; quantity

of the commodity purchased; etc

Conditions necessary for price discrimination• The market for the commodity should be divided into sub-markets.

This implies that the two groups must have different demand curve/functions, that is, price elasticity of demand must be different for the two markets or individuals.

• Markets for the two groups of consumers must be separated, so that there is no seepage of information from one market to another. That is consumers in low priced market should not be able to resell in the high priced market, that is, no room for arbitrage.

• The firm/seller must possess monopoly power over the supply of the product, without which it won’t be able to discriminate

Why discriminate• Increase its total revenue and given cost increase

profit. The firm make higher profit when it discriminate compare to selling a single market.

• The firm discriminate in order to realise normal profit which makes the firm’s existence feasible.

• It will also discriminate in order to make the product more affordable to consumers who can’t purchase the product at the market price.

Equilibrium of the price discriminating monopolist