Download Economics L-6 Monopoly and Monopolistic competition

Monopoly
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Monopoly- assumptions
 One seller
 Many buyers
 Entry and exit into the market: very
difficult or prohibited
 Monopolist usually produce unique
product with no close substitute
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Sources of monopoly
 Principal cause of monopoly is barrier to entry.
 Barriers to entry may arise from various
sources.
 When a firm can produce a good at a price
lower than any other firm can then monopoly
arises. We call this Natural Monopoly.
 Monopoly may also arise when a firm has
exclusive ownership of a factor of production.
 Government may create monopoly through
legal system (copyright, patent).
3
Shape of the monopoly market
demand curve
 Downward sloping
 Slope of the curve depends on the
elasticity of demand for the monopoly
product
 However, monopoly demand curve is
never horizontal
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Pricing under Monopoly
 The basic question is- “can the
monopolist charge any price for his
product?”
 The answer is- “yes, it can.”
 But, the point of consideration is“how much can he sell his product at
that price?”
 It depends on the elasticity of
demand for his product.
5
Note on the relationship between
demand and marginal revenue
 Marginal revenue and
demand are very closely
linked. If we look at the
marginal revenue, we get an
idea about the demand.
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Demand vs. Marginal Revenue
Suppose we have a demand equation:
Q = C – a.P
Where, Q is quantity demanded, P is price, a and C are parameters.
Rearranging the equation we get:
P = (C/a) - (1/a).Q
Multiplying both sides by Q we get:
2
PQ = (C/a).Q - Q /a
2
TR = (C/a).Q - Q /a
So, the marginal revenue is:
MR = (C/a) - (2/a).Q
The slope of the MR curve is just double of the demand curve. This
means the MR curve is twice as steep as the demand curve. This
also means that the demand curve will always lie above the MR
curve.
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Demand and MR curves
D
MR
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Pricing under monopoly
Q
P
TR
MR
TC
AC
MC
0
180
0
1
170
170
170
155.7
155.70
55.7
14.3
2
160
320
150
205.6
102.80
49.9
114.4
3
150
450
130
253.9
84.63
48.3
196.1
4
140
560
110
304.8
76.20
50.9
255.2
5
130
650
90
362.5
72.50
57.7
287.5
6
120
720
70
431.2
71.87
68.7
288.8
7
110
770
50
515.1
73.59
83.9
254.9
8
100
800
30
618.4
77.30
103.3
181.6
9
90
810
10
745.3
82.81
126.9
64.7
10
80
800
-10
900
90.00
154.7
-100
11
70
770
-30
1086.7
98.79
186.7
-316.7
12
60
720
-50
1309.6
109.13
222.9
-589.6
100
Profit
-100
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The optimum price level for the
monopolist
Where?
MC
P*
D
Q*
MR
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Superiority of Perfect Competition
over Monopoly
In Perfect Competition




Consumers maximize surplus
No deadweight loss
More output
No technical inefficiency
No rent-seeking
Whereas, in Monopoly all the opposite
statements are true.
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Perfect Comp. vs. Monopoly
Consumer’s surplus
MC
Deadweight loss
P*
MR=AR
P
D
Qp
Q*
MR
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Task
 Suppose the total cost for a
monopolist is given by2
TC = 500 + 20.Q and
Demand equation is given byP = 400 – 20.Q
What are the profit maximizing price
and quantity?
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Solution hints
 Profit maximizing happens where
MC = MR
 To get MR we need to have TR
 To get TR multiply P by Q. [TR = P.Q]
 Arrange the table to get MC and MR
 Find out the desired values from the
table
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Solution
Q
TC
TR
MC
MR
Profit
1
520
380
2
580
720
60
340
140
3
680
1020
100
300
340
4
820
1280
140
260
460
5
1000
1500
180
220
500
6
1220
1680
220
180
460
7
1480
1820
260
140
340
8
1780
1920
300
100
140
9
2120
1980
340
60
-140
10
2500
2000
380
20
-500
11
2920
1980
420
-20
-940
-140
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Monopolistic Competition
Monopoly
Perfect
Competition
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Definition
 Monopolistic competition is a market
structure in which:
 Number of buyers and sellers is
large
 Entry and exit are easy
 Products are differentiated
 Non-price competition exists
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Product Differentiation
 Product differentiation implies that the
products are different enough that the
producing firms exercise a “mini-monopoly”
over their product.
 The firms compete more on product
differentiation than on price.
 Entering firms produce close substitutes,
not an identical or standardized product.
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Many Sellers
 When there are many sellers, they do
not take into account rivals’
reactions.
 The existence of many sellers makes
collusion difficult.
 Monopolistically competitive firms act
independently.
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Non-price competition
 A key instrument for survival
 Indicates competition that do not
involve price setting decisions
 Examples are: advertising, sells
promotion, free gifts
 Helps to avoid price war
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Profit Maximization in a
Monopolistic Market
MC
P
AC
D
MR
Q
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