Monopoly by Komilla Chadha

8/2/2019 Monopoly by Komilla Chadha

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Monopoly Explained by Komilla Chadha

Note: Please watch these videos to guide you with this post http://a2withkomilla.blogspot.co.uk/2011/01/monopoly.html .

What is a Monopoly?

It is a market structure where only one firm exists, there are no close substitutes in themarket and many buyers are present. In the UK it is defined as any firm with over 25%market share.

What are the characteristics/assumptions of this market structure?

i. Only one firm exists.ii. There are high barriers to entry (& exit).iii.The firm is a price maker.iv.The firm is rational i.e. it is a profit maximizer

Different Sources of Monopoly

i. Control over inputs e.g. De Beersii.Benefits from economies of scale e.g. Evianiii.Patents given e.g. GSKiv.Network economies, so when firms make complimentary products like tea and sugarv.Government licenses/franchises, so when the government gives a firm a marketvi.Natural monopoly, where it is uneconomical to have more than one firm

Diagram

- As you can see in the diagram the MR curve has twice the slope as the AR curve. This ishow you can mathematically prove it:

R = PQ (This is a pre-established identity)P = a - aQ (Price is an inverse function of quantity)
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R is thus = aQ - aQ

AR = R Q = a - aQ = P(we established P earlier - also this shows why AR = demand thanks to P)

MR = R = a - 2aQ The 2 shows it is double as steep

q

Short-term equilibrium

- The equilibrium of the firm is equal to the equal of the industry as they are the only firm inthe industry.

- Monopolies function at MR = MC

Mathematically derivation of short-run equilibrium

Max: = R - C

First order: = R - C = 0Q Q Q

R = C Thus MR = MCQ Q

- Second order derivatives are not important in showing that monopolies are profit

maximizers and what their equilibrium looks like for three reasons.

1. MR is downward sloping so even if MC is falling it can still be greater than MR.2. As MR and MC are steep they are unlikely to intersect twice.3. Even where the slope of MR is larger, abnormal profits can still be made so having

second order derivatives as a condition of profit maximization is not so significant.

However, just because they dont need second order conditions to achieve profitmaximization does not mean MC=MR is enough. There is another condition and that isthat the profit maximization output must be one which is placed on the upper half of thedemand curve.

The reasoning behind this is as follows. Firstly, the mid point of the demand curve has anelasticity of 1 so any point above it has a positive elasticity, this meaning profit here can bemaximized. The second reason is that MC is only zero where productivity costs are zeroso MC must be positive and intersect on the upper half of the demand curve.

Price Discrimination

Please follow these videos for price discrimination demonstrations http://

a2withkomilla.blogspot.co.uk/2010/10/price-discrimination.html .

The mathematical derivation...
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Max: = R-C thus MR = MC

Market segregation: R = R + R = R MC =MR

Max: = R + R - C

R is a function of Q, R is a function of Q and C = f(Q, Q)

= 0 = 0 Q Q

= R - C = 0 Q Q Q

So MR = ,MC AND MR = MC

MR = MR = MR = MC

Efficiency

- Monopolies are not statically efficient like perfectly competitive firms, they are allocativeefficient as they make profits neither are they productively efficient as they dont need tobe to benefit from economies of scale.

- They are nevertheless dynamically efficient as the profits they make give them the

opportunity to in invest in R&D, human capital and new technology.

Deadweight Loss

- Monopolies are not efficient and as a result there are areas which are not consumer orproducer surplus and this we call dead weight loss.

Supply Curve

- The MC here is not the supply curve because it no longer dictates the relationshipbetween quantity and price, as the AR now down this. Furthermore, for one set quantity

there can be several prices available.

Documents

Monopoly by Komilla Chadha