Monopoly

• A monopoly exists when there is only one firm in the industry.

• Whether a firm is a monopoly or not is depended on:

• Definition of industry.• Closeness of substitutes.• Market power.

Assumptions

• There is a single seller.• There is no close substitutes.• There are barriers to entry.• Monopolist is the price maker.• Monopolist can make abnormal profit in the

long run.

Barriers to entry

• Anything that prevents other firms from entering the industry is called barriers to entry.

Barriers to entry

• ECONOMIES OF SCALE;• As the size firm increases, firms gain

average cost advantages.• Eg; specialization, division of labor, bulk

buying etc.• Lack of economies of scale will stop the

new entrants from entering the industry.

Barriers to entry

• NATURAL MONOPOLY:• A situation where long run average cost would

be lower if an industry were under monoploy than if it were shared between two or more competitors.

• It is likely if the market is small.• Eg: Two bus companies might find it

unprofitable to serve the same route, each running with half-full buses, whereas one company could make a good profit.

Natural Monopoly

• D1 is the monopoly demand curve.

• Monopolist is able to make profit between q1 to q2 (AR > LRAC)

• When one more firm enters, demand curve shifts to D2.

• Since LRAC is higher at every level of output, production becomes impossible.

LRAC

Barriers to entry

• BRAND LOYALTY:• When there is huge brand loyalty, consumers

think of the product as the brand.• If it is very strong, new firms may be put off

from entering the industry.

Barriers to entry

• LEGAL BARRIERS:Patents.Licenses.Copyrights.Public franchise.Tariffs, quotas, and other trade restrictions.

Barriers to entry

• ANTI-COMPETITIVE / AGGRESSIVE BEHAVIOUR:

Cutting prices (price war).Aggressive advertisement.Takeover threats.Dissuade new firms from entering the

market.

Barriers to entry

• Control of essential resources, wholesale and retail outlets:

Demand Curve in Monopoly

• Since the monopolist is the industry, the demand curve is downward sloping.[Normal demand curve]

Profits in monopoly

• Monopolist can make abnormal profits in both the short run and long run.

[As long as the barriers to entry is strong]

Loss in monopoly

• If monopolist is producing something for which there is little demand, there is chance of loss even in monopoly.

• Even after long term plans, if they fail to earn at least a normal profit, the will close down.

Revenue maximization in Monopoly

Instead of Profit maximization (MC=MR), a monopolist may choose revenue maximization (MR=0).

Revenue: Output (quantity) x cost of each output

Profit: Total revenue- total costs

Profit maximization: Profit maximization occurs when MC = MR (Marginal cost = marginal revenue)

Revenue maximization: Revenue maximization occurs when MR=0 (Marginal revenue = 0)

Efficiency in Monopoly

• Profit maximization:MC=MR.(Q1)

• Productive efficiency: MC=AC.(Q2)

• Allocative efficiency: MC=AR(Q3)

Advantages of Monopoly

Advantages of Monopoly

Economies of scale Investment in R & D

Economies of scale

• In perfect competition, equilibrium is where DD=SS.[Price=P comp, Output= Q1]

• In monopoly, equilibrium is where MC=MR[Price=P mon, Output= Q2]

Investment in R & D

• Firms in perfect competition is small in size and they may not be able to spend money on research and development.

• But since a monopolist is making abnormal profits, may be able to so the same.

Comparison of price and output in monopoly and perfect competition

• If there is no significant economies of scale, monopolist will restrict the output and charge higher prices.

• PM is the monopoly price and QM is the monopoly output.

• PC is the price in competition and QC is the quantity produced.

Conclusion

A monopoly is:

Productively and

allocatively inefficient.

Charge higher prices and

produce lower output.

Exercise anti-competitive behaviour.