Monopoly: a market structure in
which there is only one seller of a
good or service that has no close
substitutes and entry to the
market is completely blocked.
Characteristics of a monopolistic industry
Consists of a single firm
Therefore, market demand = monopolist’s demand
Downward sloping demand curve
Can fix price at which it sells product
Quantity sold depends on the market demand.
Monopoly or not?
Depends on how narrowly the industry or market is
defined.
*Global markets
*National markets
*Regional markets
*Local markets
Services usually have narrower markets – why?
Only a monopolist if entry into the market is
blocked.
Produce where MR = MC - profit-maximising rule
Provided that AR > AVC (short run) or AC (long run) - shut-down
rule
* Cost structure same as any other firm.
* Revenue structure differs from perfectly competitive firm.
*Monopolist is only supplier of a product
*Demand curve for product = market demand curve
for market
*Downward sloping demand curve means additional
quantity of output only sold if price lowered
*Lower price applies to all units of output
*Therefore MR from sale of extra unit < price at
which all units of the product are sold
At what price should that output be sold?
*The price which consumers are willing and
able to pay - indicated by the demand
curve.
*MR = MC at a price of P1.
Does the monopolist make a profit in equilibrium?
*Compare AC with AR or TC with TR at profit
maximising point
*AR > AC at Q1 therefore economic profit
earned (C1P1M1K1)
*Perfect competition - economic profit
competed away in LR.
*Monopoly - entry blocked economic profits
can continue in LR.
*Can achieve economies of scale - ↓ average
cost curve
*Firm will produce where MR = long-run MC.
Absence of a Supply Curve
Under Monopoly
*Monopolist chooses combination of
price/output where profit is maximised.
*Subject to the demand constraint.
*Monopolist is a price maker - does not move
along supply curve as price of the product
changes.
*Profitable to sell same product to different
consumers at different prices.
*Only occurs when price differences are based on
different buyers’ valuations. NOT based on cost
differences.
*Attempts to capture all/part of consumer surplus.
Firm must be a price maker/setter
*Won’t work in perfect competition
Consumers/markets must be independent
*Consumers in the low-priced market must not be
able to resell at higher prices.
*Must be able to divide the market.
*Easier for services.
1st degree price discrimination (discrimination
among units)
* Each consumer charged maximum price they are prepared to
pay.
* Only done if firm can obtain higher price than equilibrium
market price.
* Perfect price discrimination = consumer surplus eliminated.
2nd degree price discrimination (discrimination
among quantities)
*Firm charges customers different prices
according to how much they purchase.
3rd degree price discrimination (discrimination
among buyers)
*2 or more independent markets - separate price
charged in each market
*PED must differ between the different markets
Natural Monopoly
Natural monopoly: a situation that arises where it is most cost
efficient for a single firm to produce all the output in an
industry or market.
AC
Even
More
declining
when
Even
than when
1
one
where
firm
firm
Psupplies
=
quantity
=
0,higher
D ≠ all
minimum
demanded
average
output,AC
still
cost
reaches
not
of
Eg’s: public utilities like electricity and water.
operating
(maxateconomies
minimum
a
production.
maximum.
of
efficient
scale).scale.
Government intervention?
Possibility of inefficient levels of production
and large economic profits.
Two options…
*Government can produce the good itself.
*Leave production to a private firm,
government regulates.
Price controls
Where should the price be set?
*Allocative efficiency when P = MC
*Productive efficiency where AC is minimum.
*Productive efficiency cannot be reached therefore
P = MC to ensure allocative efficiency.
*This is called the marginal pricing rule.
Marginal pricing rule will result in economic losses –
problematic if essential utility.
Alternative strategies
1. Government supply good/service - tax revenue
compensates for losses.
2. Leave production to private firm and gov. subsidise
losses.
3. Average cost pricing (P = AC). Normal profit
earned, no subsidisation would be necessary.
AC pricing gives no incentive to minimise costs.
Higher costs will = higher prices. Also disadv. of 1 &
2.
4. Price discrimination. Supplier captures consumer
surplus in certain market segments and uses this
to subsidise consumers in other market segments.