Monopoly
Learning Objectives:
• What is a Monopoly?
• What are the sources of Monopoly power?
• How does a Monopoly choose how much to produce and what price to charge?
• What effect does a Monopoly have on economic efficiency?
• How does a government react to a Monopoly?
Definition of Monopoly
• A market for a product or service with only one firm producing and selling that particular product or service
• Examples of Monopoly: • Public utilities (may be local monopolies) • BCCI• Indian Railways (till 2009)
• Example: Entering the Aspartame Market
Source of Monopoly Power: Barriers to Entry
• Key input for production under the control of one firm
• Network externalities in the supply of the product • As more people use the product, its usefulness rises
• Economies of scale giving rise to Natural Monopoly• One firm can supply the entire market at lower average total cost
than many firms together
• Government imposed entry barrier • Patent & Copyright • Public Franchise
Monopolist’s Demand Curve and Marginal Revenue Curve
Monopolist’s demand curve is downward sloping
When a (non price discriminating) Monopolist lowers the price of the product in order to sell more of it:
More of the product gets sold, giving extra revenue
Total revenue from all the previous units decreases due to lower price being charged for each unit
How does a Monopoly choose Price and Output?
• A Monopolist maximizes profit
• Profit maximization rule:• Marginal Revenue (MR) = Marginal Cost (MC)
Profit = Total Revenue – Total Cost
Maximizing profit with respect to output:
A Monopolist Maximizing ProfitProfit Maximizing Price and Output:
P* & Q*
Monopolist’s Profit: □P*Act
A Rule of Thumb for Monopoly Pricing
Or,
• Markup over marginal cost as a percentage of price for a Monopolist should be equal to the negative of the inverse of the elasticity of demand for the monopolist’s product
• If demand for the product is very elastic, the Monopolist will get a lower markup
Calculating a Monopolist’s Profit Maximizing Price and Output Price (P) Quantity
(Q)Total
Revenue (P*Q)
Marginal Revenue
Total Cost (C)
Marginal Cost
20 0 0 - 41 -
19 1 19 19 45 4
18 2 36 17 50 5
17 3 51 15 56 6
16 4 64 13 63 7
15 5 75 11 71 8
14 6 84 9 80 9
13 7 91 7 90 10
12 8 96 5 101 11
Social Costs of Monopoly Power• Fall in Consumer
Surplus
• Rise in Producer Surplus
• Creation of Deadweight Loss, and thus leading to a fall in Economic Efficiency
• Example: In Prisons, Sky-High Phone Rates and Money Transfer Fees
Measuring Monopoly Power
• Lerner’s Degree of Monopoly Power
• For a Perfectly Competitive firm,
Multi-plant Monopoly
• Profit maximization:
,
where are output from plants 1 and 2 respectively.
Government Policy towards Monopoly
• Antitrust Laws
• Merger Evaluations
• Price Regulations
• Example: Dollar Tree Crowned Victor In Battle For Family Dollar
• Example: The Death of Google Reader Paves The Way For Real RSS Businesses