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TOPIC 8: MONOPOLY, MONOPOLISTIC AND OLIGOPOLY
TOPIC 8: MONOPOLY, MONOPOLISTIC
AND OLIGOPOLY
Introduction
Apart from perfect market competition, we will look at three other types of
market structure, namely monopoly, monopolistic and oligopoly in this topic.
We will also compare between the characteristics of the market structure.
In this topic, the emphasis will be on monopoly, while the other two structures
will be discussed briefly.
Learning Objectives
At the end of this topic, you should be able to:
1. outline the charcateristics of monopoly, monopolistic and oligopoly;
2. draw the demand curve for the monopoly,
3. explain how monopoly achieves market equilibrium in the short run;
4. analyse the different profit situations encountered by the monopolist;
and;
5. discuss the characteristics of monopolistic and oligopoly.
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8.1 Monopoly
Monopoly is an industry that has only one firm that sells a good which has no
close substitutes. Monopoly firms also represent industries because there
are no other firms in the market. Therefore, the demand curve for the firm’s
production is the same as the markets demand curve that slopes to the
bottom from the left to the right.
8.1.2 Characteristics of a Monopolist
(a)
There is only one firm in the market (single seller/producer) and there
are many buyers.
(b)
The firm is in control of the whole market whether it is from the angle of
determining the price or the quantity of production. A monopolist has
the power to determine the level of price because there is no competition
from other firms. Therefore, if the monopolist intends to sell a bigger
quantity, it has to reduce the price. This means that the monopolist
can only control the price or the quantity of sales, and not both at once.
(c)
Goods have no substitutes. Consumers have no choice other than
what is produced by the monopolist.
All competitors are prevented from entering the market. It is difficult for
other firms to enter the market because there are barriers and
hindrances such as:
(d)
(i)
The need for large amounts of capital to produce products as a
(ii)
result of a need for technology and high costs.
The Ownership Act -The monopolist owns a patent that prohibits
firms from copying or producing the same good.
(iii)
The government gives exclusive privileges to a monopolist to
carry on the production activities.
(e)
No need for advertising.
A monopolist does not need to advertise to increase sales. This is
because it has control of the market and consumers have no choice
but to buy from that one producer.
Examples of as monopolies in Malaysia:
(i)
The National Electricity Board (Tenaga Nasional Berhad) which
supplies electricity in Peninsula Malaysia.
(ii)
Flight services to local destinations by Malaysia Airlines, MAS.
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TOPIC 8: MONOPOLY, MONOPOLISTIC AND OLIGOPOLY
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TOPIC 8: MONOPOLY, MONOPOLISTIC AND OLIGOPOLY
Other than the above examples, what other examples of monopolists in
Malaysia do you know of?
8.1.2 Demand Curve and Monopoly Revenue
As discussed, monopolists have the power to control the quantity of output
produced or prices. However, if a monopolist wants to sell at a higher quantity,
it needs to reduce the price level.
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Table 8.1: Total Revenue, Average Revenue and Marginal Revenue
Quantity
(Q)
1
2
3
4
5
6
7
8
9
10
Price Total Revenue
(P)
(RM)
(TR)
(RM)
10
9
8
7
6
5
4
3
2
1
10
18
24
28
30
30
28
24
18
10
Average
Marginal
Revenue
Revenue
(AR)
(MR)
(RM)
(RM)
10
9
8
7
6
5
4
3
2
1
10
8
6
4
2
0
– 2
– 4
– 6
–8
In Table 8.1 above, the quantity produced that is sold by the monopolist
gradually rises when the price gradually falls. The relationship between the
quantity produced and the price producers the demand curve.
Total Revenue (TR) = P . Q
Average Revenue (AR) =
Marginal Revenue (MR)
=
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TOPIC 8: MONOPOLY, MONOPOLISTIC AND OLIGOPOLY
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TOPIC 8: MONOPOLY, MONOPOLISTIC AND OLIGOPOLY
Information given in Table 8.1 is shown in Figure 8.1
Total Revenue
Production
Figure 8.1: Total revenue monopolist curve
Production
Figure 8.2: Average revenue and marginal revenue monopolist curve
The monopolist’s total revenue curve is U-shaped and upside-down. In Figure
8.1, when production is high, up to the 6th unit, total revenue will rise. But
after 6 units of production, any additional production will cause the total revenue
to fall.
In Table 8.1, the price level for various products is always the same as the
average revenue [Second line = Fourth line]. Thus the AR curve is also the
demand curve for a monopoly; it is always sloping to the bottom from the left
to the right (not a flat line as in firms in perfect competition. Therefore, the AR
curve is the same as the demand curve. Other than that marginal revenue is
always much lower then AR where the MR curve is below the AR curve or
the demand curve.
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From both the graphs above, it is found that when:
• TR rises, AR and MR will fall
• TR is maximum, MR is the same as zero
• TR falls, AR and MR are falling but MR is negative.
Compare the behaviour/change of TR, AR, and MR in the perfect
competition market with monopoly when production changes.
8.1.3 Equilibrium Price and Output in the Short Run
There are two approaches to ascertain the maximum profit for a monopoly
in the short run:
(a)
Maximising the Positive Difference Between Total Revenue and
Total Cost
Table 8.2 illustrates the total maximum profit in monopoly which is at Q
= 3 where the positive difference is between total revenue and total
cost is at its maximum (RM4.50). Information available in Table 8.2 is
shown in Figure 8.3.
Table 8.2: Total Revenue, Total Cost and Monopoly Profit
Quantity
(Q)
0
1
2
3
4
5
6
Price
(P)
(RM)
TR
TC
(RM)
(RM)
9
8
7
6
5
4
3
0
8
14
18
20
20
18
6
10
12
13.5
19
30
48
Total Profit/Loss
(TR - TC)
(RM)
-6
-2
2
4.5
1
-10
-30
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TOPIC 8: MONOPOLY, MONOPOLISTIC AND OLIGOPOLY
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TOPIC 8: MONOPOLY, MONOPOLISTIC AND OLIGOPOLY
Figure 8.3: Equilibrium using the total revenue and total cost method
(b)
Marginal Revenue Equal to Marginal Cost
Maximum profit can be achieved when a monopoly is at an equilibrium
where MR = MC.
Production
Figure 8.4: Equilibrium using the marginal revenue and marginal cost method
In Figure 8.4, the MR curve crosses with MC curve at point E. Production
equilibrium is at point Q, and the price is at level P . (To get the price level,
we need to connect to the demand curve because it will give the level of the
selling price in the market).
1
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You can refer to the textbook by Parkin, M (2000) Economics about the
certainty of output and price in the short run on pages 268-269
As in the perfect competition market, in the short run, there are three types
of profits that may be obtained by the monopoly that is economic profit, zero
economic profit and loss. Each type of profit will be discussed in Figure 8.5
(a)-(c) as follows:
(i)
Economic Profit
In Figure 8.5 (a), monopoly equilibrium is reached when MR = MC, that
is, at point E. Production quantity that is produced is Q unit and the
price is P . Observe, when the monopolist earns economic profits; the
1
AR curve will be above AC.
Total Revenue =
P SQ
Total Cost
P TQ
=
1
0
0
0
Total Revenue > Total Cost. Therefore, the monopolist will earn a
profit of about P STP (shaded area)
1
0
Production
Figure 8.5(a): Monopoly profit above normal
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TOPIC 8: MONOPOLY, MONOPOLISTIC AND OLIGOPOLY
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TOPIC 8: MONOPOLY, MONOPOLISTIC AND OLIGOPOLY
(ii)
Zero Profit
Referring to Figure 8.5(b), monopoly equilibrium is reached at the level
where MR = MC that is at point E. Quantity produced is Q unit’s and
the selling price is P .
1
Total Revenue =
Total Cost
=
P RQ0
P RQ0
1
1
Total Revenue = Total Cost. Thus the monopolist’s profit is zero (normal
profit). Observe when the monopolist obtains normal profit, the AR
curve is at a tangent with AC, at equilibrium.
Production
Figure 8.5(b): Monopoly normal profit
(iii)
Below the Normal Profit (Economic Loss)
Referring to Figure 8.5(c), monopoly equilibrium is reached at a level
where MR = MC that is at point E. Quantity produced is Q unit and the
selling price is at P .
2
Total Revenue =
Total Cost
=
P MQ0
P NQ0
2
1
Total Revenue < Total Cost. Thus, firms make a loss which is
P NMP , (shaded area). Observe that the AC curve is above the AR
2
1
curve when the monopolist suffers a loss.
Usually in an industry there are a few firms that compete among one
another, and each firm has at least some power to decide the price.
Actually a lot of firms today have a combination of perfect competition
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characteristics and monopoly which the market structure for
monopolistic competition and the oligopoly market that we will discuss
in the next section.
Production
Figure 8.5(c): Monopoly below normal profit
Exercise 8.1
The graph below shows a few cost curves and revenue for a monopoly
firm.
RM
MC
AC
28
25
10
MR
..
0
AR = D
30 40
ProductionKeluaran
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TOPIC 8: MONOPOLY, MONOPOLISTIC AND OLIGOPOLY
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TOPIC 8: MONOPOLY, MONOPOLISTIC AND OLIGOPOLY
(a) Monopoly firms achieve equilibrium at
Answer:
(b) Find out the total revenue and total cost at equilibrium level.
Answer:
(c) Does the monopoly firm earn a profit or make a loss and how
much is the total?
Answer:
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8.2 Monopolistic Competition
8.2.1 Characteristics of Monopolistic Competition
(a)
There are many firms but not as many as in perfect competition.The
size of each firm is about the same. Because the numbers are great,
no firm can influence the market.
(b)
Goods produced vary. Goods produced vary from the physical aspect
like brand, packaging and shape. However, a lot of goods produced by
monopolistic firms use raw materials and the production method is
the same. Therefore goods produced by the monopolistic are not
‘perfect substitutes’ but a ‘near substitutes’.
(c)
Firms in monopolistic competition have some power to ascertain the
production price level. This is because goods that are produced can
be differentiated from one another. Therefore, even though firms raise
the price, there are still customers who are loyal and continue to
purchase the goods they produce. On the other hand, if firms reduce
the price, the level of sales can be increased but will not be able to
attract all the customers from competitors.
(d)
Monopolistic firms have the freedom to enter and exit the industry quite
easily. This is because new firms can produce different types of goods.
Usually new firms succeed in entering a monopolistic market by
producing goods that are better in quality, they run promotions and
also advertise.
(e)
Monopolistic firms face non-price competition. This is because the
characteristics of the goods produced are different and yield different
attractions to buyers. Thus, to influence consumers tastes, firms resort
to non-price competition methods such as advertising, free offers,
product for product specials and so on.
What is the difference between the perfect competition market and the
monopolistic competition market?
Examples of firms in monopolistic competition are firms that produce washing
powder, toothbrushes, toothpaste, mineral water, shoes, soap, coffee and
so on.
The personal computer industry in Malaysia can be said to be in the
monopolistic competition market. There are many brands in the market such
as Compaq, Acer, IBM, Apple, SUN, DELL, Toshiba and so on.
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TOPIC 8: MONOPOLY, MONOPOLISTIC AND OLIGOPOLY
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TOPIC 8: MONOPOLY, MONOPOLISTIC AND OLIGOPOLY
Other than the above examples, consider other examples that you can
give in of firms under monopolistic competition?
8.3 Oligopoly
The fourth market that will be discussed briefly is the oligopoly market.
Oligopoly is a market where there are a few sellers and buyers. Firms in this
market influence one another.
8.3.1 Characteristics of Oligopoly
(a)
There are not many firms in the market and the size of each firm is big.
Usually firms control a big segment of the market and they also influence
one another.
(b)
Goods that are produced are same or almost the same.
(c)
The power to decide the price depends on the cooperation among the
firms. When there is cooperation among the firms in that market, they
will have the power to decide a high price. On the other hand, without
cooperation among the firms in the market, the price in the market will
be kept lower and less stable.
(d)
There are big barriers to entry by new firms to join the oligopoly. This
doesn’t mean that new firms cannot enter the market, but those firms
will face hindrances such as the need for huge capital investment and
old firms that already have secure position in the market.
(e)
An oligopoly that produces various goods is not price based
competition. The most important method of non-price competition is
advertising. Effective advertising will produce customers who are loyal
to the goods produced and it will also increase sales. Generally the
reason there is advertising is to give an explanation about the good
produced, to maintain a good relationship with the customer and to
persuade or influence the customer to purchase the good produced.
An example of oligopoly is the petroleum industry in Malaysia. The petroleum
industry can be categorized as an oligopoly as there are few firms that control
the market. Examples are Shell, Petronas, BP, Mobil, Caltex, Esso and so
on. The competition among these firms to control the market is obvious.
Sometimes, they make offers such as collecting points to exchange for
goods; they also depend on each other to decide the selling price.
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Other than the above examples, consider more examples of firms under
oligopoly in Malaysia?
Summary
This chapter discusses the three market structures which are monopoly,
monopolistic competition and oligopoly. The difference for each market
structure can be determined by looking at characteristics such as the number
of firms in the industry, the uniformity of the good produced, the ability of the
firm to decide the price, the ease of exiting and entering by the firm and the
degree of freedom to make decisions. By understanding each characteristic,
we can identify a firm’s category and the market structure in which it operates,
and understand the behaviour of the firm.
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TOPIC 8: MONOPOLY, MONOPOLISTIC AND OLIGOPOLY