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THEORY OF THE FIRM & MARKET STRUCTURE
CHAPTER 8
Chapter 8.2 ::: MONOPOLY
DEFINITION OF MONOPOLY
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Monopoly is a market structure in which only a single firm makes up the entire market @ producing & supplying all
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output in the market.
Monopolies exist because of barriers to entry into a market that prevent competition.
Monopolies also have power to determine the price.
CHARACTERISTIC OF MONOPOLY
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There are five characteristics:
 Single seller & many buyers
 Price maker
 Unique product
 Blocked entry/ barriers to entry / no freedom of entry
 Ability to do price discrimination
a) Single seller & many buyers
 Only one firm in the market
 The difference between firm and industry does not exists in monopoly since there is one seller
 The firm may be monopoly in government & also private sectors
 Eg: TELEKOM, KTM, TNB, PETROLEUM etc
b) Price maker
 The firm can control the price but cannot conquer both P and Q
 Firms have the power to control market price
 However, this power is not absolute because if it controls the price, the consumers will not control the quantity
demanded
 Eg: if the monopolist increase the price, the consumer will reduce the quantity demanded (used the law of Dd)
c)
Unique product
 There are no close substitute
 The consumers do not have other alternatives even the monopolist increase the price of the goods
 eg: original spare part of minicooper, water supply by Bekalan Jabatan Air
d) Blocked entry/ barriers to entry / no freedom of entry
 There are restriction/ barriers for new firms to enter the market. (govt. law & regulation)
 This will create a monopolist & make it stronger over period of time
e) Ability to do price discrimination
 May decrease/ increase the price since the monopolist is the only seller in the market
 So, the consumer do not have other alternatives
HOW MONOPOLY ARISES
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Few factors that create a monopolist firm:
 Resource ownership
 Government regulations & laws
 To achieve the benefits of economies of scale
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 Resource ownership
 Monopolist can be created through exclusive ownership of any resources
 If the firm have the ownership power of input (diamond), so the firm will also have the power to control or join
in that market
 Eg: the firm can’t produced the diamond if that firm do not have ownership of diamond (diamond mines).
There’s a lot of diamond mines in the world but the De Beers company of South Africa controls the world’s
diamond mines
 Government regulations & laws
 Government can create a monopolist firm through its regulations such as a license, a patent & a government
franchise
 A license is the legal right granted to a firm to produce/ to sell a good
 A patent those firm who create a new product will be protected by the govt. through a patent (all right
reserved)
 A govt. franchise  the legal right granted to a firm to produced/ to sell & it is under the government control
Eg: Public utilities : TNB, SIRIM, BERNAS
 To achieve the benefits of economies of scale
 A part of goods can be produced efficiently if the production were made through the good achievement & with a
lot of big machine
 Basically, those firm who make the Public good & need the higher Fixed Cost
 So, only 1 firm needed because if another firm join the biz over a market, that will lead to wastage.
 Eg: Indah Water, TNB
THE MONOPOLY DEMAND CURVE
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Since the monopoly is the only seller in the market, therefore the monopolists Dd curve is the market Dd.
Monopolists sells good at different price by different level of consumer (based on the Qty consume by the customer)
The monopolist is facing a negative sloping (downward) Dd curve.
Means that it must decrease the price to sell more outputs.
Relationship between Revenue & elasticity
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A linear Dd curves has 3 elasticity:
 At higher price between P1 to P2
 Demand is very elastic, Ed > 1
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 A slight decrease in price will increase a large amount of quantity Dd the TR increase (LM)
At lower price between 0 to P1
 Demand is inelastic, Ed < 1
 A larger decrease in price will increase small quantity demanded
 This will reduce TR (MN)
At price P1
 A decrease in price will increase Qty Dd at the same rate
 TR is maximum (M)
SHORT RUN EQUILIBRIUM
 Objectives  max ∏
 Even the monopolist is the single seller in the market & have power to control the price, monopolist also react as the
buyer which buy the factors of production in the market input
 In the market input, monopolist as the price taker
 Eg: use labor to pay wages, buy the machines, and also raw materials based on the price market.
 Thus, monopolist have the cost curve same with the perfect competition
 To remind:
 Monopolist will produce the output when the AR has the Ed > 1
 This is because the elastic Dd curve will make the TR positive & increase
 Monopolist will not operate when the curve is inelastic (TR )
 The monopolist firm attain the maximum profit when MR = MC
 In SR, there are 3 profits earn by monopolist;
a) Supernormal profit
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Situation where TR > TC
The firm’s equilibrium is at point E(Pe,Qe)
Earn supernormal profit because TR (area A+B) is greater than
total cost (area A)
Supernormal profit/ economic profit is at area B
TR = P x Q
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TC = AC x Q
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∏ = TR – TC
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b) Normal profit
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Earns where TR = TC (zero profit/ break even) / minimum
profit
The firm’s equilibrium is at point E(Pe,Qe)
Earn normal profit because TR (area A) is equal total cost
(area A)
Supernormal profit/ economic profit is at area B
TR = P x Q
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TC = AC x Q
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= TR – TC
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c)
Subnormal profit
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Earns where TR <TC
The firm’s equilibrium is at point E(Pe,Qe)
Earn loss because TR (area F) is less than total cost
(area F + G)
Subnormal profit/ loss is at area G
TR = P x Q
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TC = AC x Q
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∏ = TR – TC
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LONG RUN EQUILIBRIUM
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Monopolist can earn economic/ supernormal profit in LR.
Main factor due to the existence of barriers to enter the market/ blocked entry.
eg: if a firm earns economics profit in SR, new firms are attached to join the market however they are barred to
enter the market either by govt. rulings such as license/ natural restriction as exclusive ownership of resources
So, the firm can continue having economic profit in the LR
PRICE DETERMINATION & CONDITION TO PRACTICE DISCRIMINATION
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A situation where a monopolist firm changes different prices to different consumer for a same good, but the cost are
still the same
Types:
 1st degree
 2nd degree
 3rd degree
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a) 1st degree
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Known as perfect discrimination
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A firm charges different price for each unit & charges each buyer the maximum price that he willing to pay for
each unit
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ie: auction, sales cars etc
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Example: You can see this type of price discrimination in the sale of both new and used cars. People will pay
different prices for cars with identical features, and the salesperson must attempt to estimate the maximum
price at which the car can be sold. This type of price discrimination often includes a bargaining aspect, where
the consumer attempts to negotiate a lower price.
b) 2nd degree
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The goods are grouped into blocks and each block is charged at different price
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i.e telephone rate (charge higher price at the peak day, and lower price at night), electric rate, parking charging.
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Example: In companies where a client orders in bulk and is able to purchase a high number of the same items at
once, the client may get a discounted rate. This rate would not apply to a client who only orders a few items at a
time. In retail stores, second-degree price discrimination often exists. A reduced price may be offered if you buy
two t-shirts instead of just one. This form helps to get rid of merchandise and generate more revenue for a
company.
c)
3rd degree
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Divided into many sub-markets or sub-groups
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i.e Movie tickets – adults charged higher price than children, transportation(each class gives different price),
transportation, medical, legal and entertainment sectors
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For example, senior citizens are considered a group, and are often offered discounts at movie theaters, for
transportation, in restaurants, and even in retail stores where seniors may have a “senior day” each week that
allows them to take a discount on merchandise. “Students” are another segmented group that may be offered
lower prices. Both seniors and students have a higher elasticity of demand and can generally afford to pay less
than the average worker.
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Also depends on the price elasticity of demand
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Causes:
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Geographical interface The goods from outside country Even the goods are cheaper, they have to
charge the cost of transportation that will lead to the higher price
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Season  Raining  Dd for umbrella being inelastic  P increase but in normal day the elasticity being
elastic  P decrease (Different charges)  Festival season  school season  holiday season
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The use of the goods  pineapple  consumer – use the pineapple to eat (raw)  producers – for
production  Bundling (Charge diff. P where higher P for consumer, lower P for producers)
COMPARISON BETWEEN MONOPOLY & PERFECT COMPETITION
There are a few comparisons:
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i) Characteristic
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In perfect competition:
- Large number of sellers
- Price taker
- Identical product
- Freedom of entry and exit
- Perfect knowledge
- Perfect mobility of factors of production
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In monopoly:
- Single seller & many buyers
- Price maker
- Unique product
- Blocked entry/ barriers to entry / no freedom of entry
- Ability to do price discrimination
ii) Long run equilibrium
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In perfect competition:
- Earns a normal profit in the long because of free entry and exit into the industry
In monopoly:
- Earns a supernormal profit in the long since there are barriers to entry and exit for newcomers
iii) Price and quantity
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iv)
Price
- The priced charged in a monopoly market is always higher than perfect competition
Quantity
- The equilibrium quantity in a monopoly is lower than in perfect competition market
Efficiency
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Allocation of resources is efficient in perfect market because the output (Qpc ) is produced at minimum
average cost (point Epc ).
In other words, a perfect competition is more effective than monopoly if the perfectly competitive firm
produces at the lowest point of the minimum AC and the product is standardized.
In monopoly: resources are not allocated efficiently because the output produced (Qm ) at higher AC(point Z),
even though AC is decreasing but monopolist has resources to enjoy the economies of scales.
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