MONOPOLY.

REPRESENTED BY:-Prof. S.D.BHARDWAJAND PROF. BHAWANA BHARDWAJ

MONOPOLY The word monopoly has been derived from

greek words, Mono+Pollein which means single control.

Monopoly is a market situation in which there is a single producer of a commodity which has no close substitutes.

According to Leftwitch, “ Pure monopoly is a market situation in which there is a single seller of a particular product for which there are no good substitutes.”

In the words of Stonier and Hague, “ A monopolist is the sole producer of his product and the distinction between the firm and the industry, both producing, the same product so important in perfect competition goes.”

According to E.H.Chamberlin, “ In monopoly, there is only one seller of the product and he has full control over its supply.”

FEATURES OF MONOPOLYThere is only one seller of the product,

who has full control over the supply of the commodity.

No close substitutes of the commodity are available in the market i.e. cross elasticity

of demand for the product is zero. There is no difference between firm and

industry.

Revenue curves of the monopolist are downwards sloping from Left to Right i.e. the monopolist has to reduce the price to increase the sale of his product.

Epx<1 AR,MR

AR(D)

o MR x Output

Complete restrictions is imposed on the entry of the firm in the industry.No selling costs are incurred by the monopolist.Price discrimination is possible in monopoly. Excess capacity exists in monopoly i.e. scarce resources are not optimally used.

Basic foundation of monopoly power.

Legal Prohibition:- firms are prohibited to enter in industry by laws like railways,atomic energy and defence services. It will continue till the law is not changed.

Natural monopoly:- when a firm has full control over the supply of raw materials of a commodity is called natural monopoly.

Combination:- when firms join hand together i.e. they form a cartel it is called combination monopoly. It may be voluntary or compulsory of forced.

Good will and Good reputation of a firm:- If a firm enjoys a high reputation and good

will the other firms cannot enter in the industry. All types of monopoly are short lived except social monopoly i.e, legal monopoly.

A monopolist can earn maximum profits only at that level of output at which the gap between TR and TC is maximum. Therefore, he tries to find out this level of output by fixing different prices. In this way he can attain the equilibrium situation where slope of TC= slope of TR

which can be explained with help of the following diagram:-

AIMS OF MONOPOLIST AND WAYS TO ACHIEVE THEM.Though the monopolist has full control over

the supply but has no control on the demand would that he could control demand he would have been the God of the earth,but it is not impossible, therefore,he also follows the same conditions of equilibrium:-

TOTAL REVENUE AND TOTAL COST APPROACH:- A monopolist can earn maximum profits only at that level of output at which the gap between TR and TC is maximum.Therefore he tries to find out this level of output by fixing

different prices.In this way he can attain the equilibriumSituation where Slope of TC= Slope of TR which can be

explained with the help of following diagram:-

MARIGINAL APPROACHAs the slope of TR which is∑MR=Slope of TC which is∑MC,

therefore the monopolist will also be in equilibrium with the help of mariginal approach and will earn maximum

profits. When he satisfies the following two conditions,i.e.MC=MR and MC cuts MR from below.

i) Market period price determination under monopoly:-Market period is a period in which monopolist has no time

to produce the commodity, therefore supply is limitedUpto the existing stock of the commodity with the

monopolist. Hence he would like to charge such a price for his product at which is TR is maximum when MR is

zero.

Market period price determination under monopoly.

Market period is a period in which the monopolist has no time to produce the commodity, therefore supply is limited upto the existing stock of the with the monopolist. Hence, he would like to charge such a price for his product at which has TR becomes maximum. As TR=∑MR therefore TR will be maximum where MR is zero.

Y

AR

0 M M1 MR X

Costs curves are not shown as there is no production possible in market period. Therefore the monopolist will sell his output upto that level at which TR is maximum. Suppose his stock is OM. If he wants to sell all his stock is OM, he has to charge P1M1 price. But here his TR will not be maximum and will charge P1M1 price. In this way M1 M stock of his commodity will remain unsold. He can also fix reserve price for durable commodity by keeping in view the cost of its storage,rate of interest,liquidity prefernce,law of returns and future expected price etc.

PRICE AND OUTPUT DETERMINATION IN SHORT RUN UNDER MONOPOLY

Short run is a period in which the monopolist cannot change the fixed factors like plant and machinery etc, therefore he can make change in supply only by changing the variable factors alone. Therefore he remains unable to adjust supply according to the market demand for his product. As a result there are possiblities that the monopolist may earn abnormal or supernormal profits or normal profits or he may sustain losses in the short run.

THERE ARE THREE POSSIBILITIES ARE EXPLAINED BELOW:

ABNORMAL OR SUPER NORMAL PROFITS:-IF THE MONOPOLIST IS IN EQUILIBRIUM(MC=MR AND MC CUTS MR FROM BELOW) AT THAT LEVEL OF OUTPUT AT WHICH THE PRICE(AR) DETERMINED BY HIM IS MORE THAN HIS AVERAGE COSTS, HE WILL EARN ABNORMAL OR SUPERNORMAL PROFITD,WHICH CAN BE EXPLAINED WITH THE HELP OF FOLLOWING DIAGRAM:- Y

Abnormal profits= TR -TC = AR X Q- AC XQ = PM X OM- TM X OM = OMPP1-OMTS =STPP1

C,R,P SMC SACAbnormal Profits

P1 P P P1

S t

Q 0 X

OUTPUT M

NORMAL PROFITS. Y SMC SAR=SAC=PM.

P= AVC

P SAC

R AVC

Q SAR

0 M x Output

LOSSES Y SMC SAC LOSSES. S T P is the shut down AVC point for the monopolist. C,R,P P1 P (Price OP1=AVC(PM)). SAC(TM)>SAR(PM) LOSSES= STC-STR = SACXQ- SARXQ Q = TM X OM- PMX OM = OMTS-OMPP1=P1PTS SMR SAR

0 M OUTPUT X

INCREASING RETURNS TO SCALE. Y

ABNORMAL PROFITS

C,R,PAB.PROFITS

P1 P

S T

Q LMC LAC

LMR LAR

0 M Output x

LAW TO CONSTANT RETURNS TO SCALE.

Y

Abnormal Profits P1 PC,R,P S Q LAC=LMC

0 M Output x

LAW OF DIMINISHING RETURNS TO SCALE. y LMC ABNORMAL PROFITS LAC P1 P

C,R,PAB.PROFITS

S T

0 M Output x

DETERMINATION OF MONOPOLY PRICE OF A COMMODITY WITH ZERO COST OF PRODUCTION.

It is an extreme situation in which a monopolist does not incure any cost of production to produce a commodity. Suppose a monopolist has the patent-right of producing a natural mineral water, whose cost of production is zero. He will fix its price at that level of output at which his MR is zero,where, his profits will be maximum.

y

ABNORMAL PROFITS

Revenue Price P1 P

AR(D) Q

0 MR Output x

Measurement of Monopoly Power

Monopoly Power refers to the degree of control which a producer or seller possesses over the price and output of a commodity. It means the power to influence the quantity of output and price on the part of the monopolist is known as monopoly power.

LERNER’S MEASURE.Prof. A.P. LERNER suggested the following

measure to determine the monopoly power.

Monopoly Power= (P-MC/P) Monopoly Power= AR-MC Price=AR AR The firm will be in equilibrium when its

MC=MR, Therefore, monopoly power= AR-MR AR

In perfect competition AR=MRMonopoly power of a firm=AR-MR = 0 =0 AR AR• We know that MR= ARX(e-1)------(2)• e {e=elasticity of

demand}• By putting the value of MR from eqn.(1) we

get• Monopoly power= AR- ARX(e-1)• e • AR

Monopoly Power= AR-(e AR-AR) 1 e AR =e AR-e AR+ AR = AR e e AR AR AR X 1 = 1 e AR e Monopoly Power= 1/e

BAIN’S MEASUREProf. J.S.BAIN has used the rate of super-

normal profits as a measure of monopoly power,i.e.,monopoly power is measured by the difference between AR(price)and Average Cost,greater will be the monopoly power. A firm under perfect competition earns only normal profits in equilibrium in the long run. Its super normal profit is zero, hence its monopoly power is also zero. But a monopolist always earns super-normal profits he earns,greater will be his monopoly power.

TRIFFIN’S MEASUREProf.N.Kaldor suggested to measure the

monopoly power with the help of the concept of elasticity of demand for the first time. Later on Prof. Robert Triffin developed a theory of cross elasticity of demand explains the dependence of demand for the product of a firm to the price of a commodity produced by the other firm.

Lesser the coefficient of cross elasticity of demand for the commodity produced by a

firm , greater will be the monopoly power of this firm and vice-versa. According to Triffin and

other economists cross elasticity of demand is infinity under perfect competition, hence monopoly power is zero whereas cross elasticity of demand is zero in pure monopoly, hence monopoly power is infinity. But these are two extreme limits between which cross-elasticity of demand lies. Lesser the coefficient of cross elasticity of demand, greater will be the degree of monopoly power of a firm and vice-versa.

Features of Monopoly PriceThe monopoly price is always greater than

marginal cost,because AR>MR,in the equilibrium MC=MR therefore price or

AR>MC. The monopoly price is never the highest

price because the monopolist charges that price at which his total super normal profits are maximum i.e.,where MC=MR

and MC cuts MR from below.

The monopolist fixes higher price if Epx of his product is less than one and vice-versa.

Excess capacity exists in monopoly because production is stopped by the monopolist where his MC=MR and MC cuts from below and there AC is still falling, therefore,he never produces at minimum average cost. So he never fixes the lowest price. He is always interested in maximising his profits and not minimising the cost.

According to M.M.Bobber, “ The monopolist does not produce a commodity but produces the profits.”

The elasticity of AR or demand curve will be greater than one at the point of equilibrium.

e= A = A = A A-M A-(something+ve) less than A

Ordinarily monopoly price is higher than competitive price but under certain circumstances, the monopolist can charge even lower price than competitive price. E.g. when he enjoys the economies and benefits of large scale of production. When there is a fear of potential competitors to enter into the industry. When he is keen to have respect in society. When he is able to borrow sufficient capital at a very low rate of interest.

MULTIPLANT MONOPOLY.The multiplant monopoly refers to that

situation in which a monopolist produces his output with two or more plants producing identical goods. The main aim of the monopolist is to earn maximum super-normal profits. In order to produce the profit maximisation output, the monopoly firm will operate each plant in such a way the marginal cost(MC)in each plant is equal to his MR.

ASSUMPTIONS:The monopolist produces with two plants

X and Y.Both the plants produce identical goods.Plant X is more efficiency than Plant Y.The cost structure is different in both the

plants.The monopolist has the complete

knowledge of the market demand curve and the corresponding marginal revenue curve.

The monopolist fixes the same price for the output of both the plants.

Since the two plants are not equally efficient, therefore, the monopolist would have two cost-functions representing the two plants.

Multiplant Monopoly. y MCx MCy P1 P MCx+ MCyC,R,PAb. Profits

s Q MR AR(D)

0 Output x

The total marginal cost curve (MCx+Mcy) is equal to MR at Q also its cuts MR from below. It means the monopolist is equilibrium at Q also its cuts MR from below. It means the monopolist is in equilibrium at Q producing total output OM at PM price.We draw a perpendicular QS from Q on y-axis which intersect MCx at Qx determining OMx output for x-plant and it intersect MCx at Qx determining OMx output for Y-plant. We know plant X is more efficient than plant Y. Therefore MCx<Mcy. Hence , the monopolist will transfer some unit of output to be produced from plant Y to plant X in such way that MCx=MCy

The profit of the monopolist is the difference between his TR(Total revenue) and his total cost of production for both the plants. Thus the equation of total pr

of it can be written as given below: r=R(Mx+My)-Cx(Mx)-Cy(My). where Mx and My are the Quantity of output

produced in plants X and Y respectively. R(Mx+My) is his total revenue function. Cx(M)x and Cy(M)y are his cost functions for two separate function. Cx(Mx) and Cy(My) are his cost functions for two separate functions for two separate plants.

For profit maximisation we set the partial derivatives of the monopolist profit function equal

to zero.∂r =R’(Mx+My)-Cx’(Mx)=0-------------(1)∂MxWhere Mx and My are the Quantity of output

produced in plants X and Y respectively. R(Mx+ My) is his total revenue function. Cx(Mx) and Cy(My) are his cost function for two separate function

∂r =R’(Mx+My)-Cx’(Mx)=0--------------(2)∂My

Since R’(Mx+My) represents the monopolist MR and Cx’(Mx) and Cy’(My) depict the the marginal cost of the two plants. From equation(2) and equation(3) we may conclude that marginal cost of two plants is equal to marginal revenue and MC cuts MR from below thus the monopolist will earn maximum profit when MR=MCx=Mcy=MCx+MCy.