monopoly group # 1 1. group members 0 salma khan 0 saeeda mandokhail 0 yasmeen 0 ruqiyya 2
TRANSCRIPT
Monopoly Monopoly Group # 1
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Group Members
0 Salma Khan
0 Saeeda Mandokhail
0 Yasmeen
0 Ruqiyya
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Presentation Topics0 Objectives0 Introduction0 Features0 Types of Monopoly0 Demand and MR Curve0 Price and Output Decisions in Short Run0 Price and Output Decisions in Long Run0 Supply Curve of Monopolist0 Multiplant Monopolist0 Price Discrimination0 Price and Output Decisions of Discriminating Monopolist0 Regulation of Monopoly
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Objectives
0 To examine the nature and different forms of a monopoly market.
0 To analyze the pricing and output decisions of a monopolist in the short run and long run.
0 To develop an understanding of output and pricing decisions of a multi plant monopolist.
0 To explore the nuances of price discrimination by a monopolist and the different degrees of such discrimination.
0 To lay down a representation of the economic inefficiency of monopoly.
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Introduction
0 A monopoly (from the Greek word “mono” meaning single and “polo” meaning to sell) is that form of market in which “a single seller sells a product (good or service) which has no substitute”.
0 Monopoly exists when there is no close substitute to the product and also when there is a single producer and seller of the product 0 E.g. Pakistan Railway is a monopoly, since there is no other agency
in the country that provides railway service.
0 Pure monopoly is that market situation in which there is absolutely no substitute of the product, and the entire market is under control of a single firm.
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Features
0 Single sellerThe entire market is under control of a single firm.
0 Single productA monopoly exists when a single seller sells a product which has no substitute or, at least, no close substitute in the market.
0 No difference between firm and industry There is a single firm in the industry
0 Independent decision making Firm is regarded as a price maker
0 Restricted entryExistence of barriers leads to the emergence and/or survival of a monopoly
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Types of Monopoly
0 Legal Monopoly0 Created by the laws of a country in the greater public interest. 0 To prevent disparity in distribution of wealth, or imbalanced growth of
the economy
0 Economic Monopoly 0 Created due to superior efficiency of a particular producer.
0 Attainment of economies of scale leads to monopoly, often referred to as an a structural barrier.
0 Technical know-how restrained in the hold of single firm
0 Natural Monopoly0 Formed when the size of the market is so small that it can accommodate
only one producer.
0 Regional Monopoly0 Geographical or territorial aspects also help in creation of monopolies.
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Monopoly
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0The demand curve of the monopolist is highly price inelastic because there is no close substitute and consumers have no or very little choice.
0 It is not perfectly inelastic because pure monopoly does not exist in real life.
0 Hence it faces a normal downward sloping demand (AR) curve.
0The monopolist cannot set both price and quantity at its own will.
Demand and MR Curves
ARMR
Revenue, Cost
Quantity
O
Price and Output Decisions in Short Run
0 In order to maximize profit a monopoly firm follows the rule of MR=MC when MC is rising.
0 A monopoly firm may earn supernormal profit or normal profit or even subnormal profit in the short run.
0 The negative slope of the demand curve is instrumental for chances of monopoly profits in the short run.
0 In the short run, the firm would reap the benefits of supplying a product which not only is unique, but also has negligible cross elasticity.
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AR
MR
MC
B
E
PE
A
QE Quantity
Price, Revenue, Cost
O
Firm maximizes profit where (i) MR=MC (ii) MC cuts MR from
below, at point E.
Equilibrium price=OPE, Output= OQE
Total revenue =OPEBQE
Total cost = OAEQE
Supernormal profit= AEBPE, since price PE > Average cost
AC
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Price and Output Decisions in Short Run
Total revenue= OPEBQE
Total cost = OPEBQE
Profit = Nil
Firm makes normal profit.
AR
AC
MR
MC
B
E
PE
QE Quantity
O
Price, Revenue, Cost
ARMR
MC AC
CPE
E
A
QE
B
Quantity
Price, Revenue, Cost
O
Total revenue= OPECQE
Total cost = OABQE
Loss = ABCPE
Firm makes loss.
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0 A monopolist is in full control of the market price
0 It would not continue to incur loss in the long run.
0 It would try to reduce cost of production
0 Otherwise it would close down in the long run.
0 Monopolist would try to earn at least normal profit in the long run and may earn supernormal profit due to entry restrictions in the market.
Price and Output Decisions in Long Run
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If in the long run a monopoly firm earns supernormal profit
This would attract competition and high price would make it possible for a new entrant to survive.
To retain its monopoly power, the firm may have to resort to a low price and earn only normal profit even in the long run to create an economic barrier to new entrants.
Price and Output Decisions in Long Run
Supply Curve of Monopoly Firm
0A monopolist is a price maker0 The firm itself sets the price of the product it sells, instead
of taking the price as given.
0It equates MC with MR for profit maximization, but unlike perfect competition, it does not equate its price to MR.
0Supply of the good by the monopolist at a given price would be determined by both the market demand and the MC curve.
0As such, there is no defined supply curve for a monopolist.
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Multi Plant Monopoly
0 A monopolist may produce a homogeneous product in different plants.
0 different cost functions but the same demand function for the entire market.
0 hence the same AR and MR curves for the entire market.
0 A multi plant monopolist has to take two decisions:
0 how much to produce and what price to sell at, so as to maximize its profit
0 how to allocate the profit maximizing output between the plants.
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Multi Plant Monopoly
0 OQ is the profit maximizing output satisfying MR=MC, when MC is rising. QA+QB= OQ, i.e. total output
0 Price is shown by PP, which determines AR in both the plants.0 OP is the equilibrium price and RPBE is the total profit (TR-TC) of the firm
(Panel a). 0 Panel b shows the cost function of plant A, in which MC is lesser. 0 Panel c shows the cost function of plant B in which MC is greater.
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MCAC
MRAR
R E
MC=MR
B
Q
MCA MCBACA ACB
QA
B1
QB
B2
E1R1E2
R2
P P= AR
Price, Revenue, Cost
Quantity
O
Multi Plant Monopoly
Assuming that a monopoly firm produces in two plants, A and B.
Profit maximising output will be at MR= MCA= MCB
If MCA< MCB, it would increase production in A, (lower MC) and reduce production in B (higher MC), till the equality is satisfied.
The firm produces till MCA and MCB are individually equal to MR, which is same for both plants.
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Price Discrimination 0 A monopoly engages in price discrimination if it is able to sell
otherwise identical units of output at different prices.
0 “law of one price” implies that a homogeneous good must sell everywhere for the same price. Price discrimination is opposite case.
0 price discrimination schemes are doomed to failure because demanders who can buy from the monopoly at lower prices will be more attractive sources of the good—for those who must pay high prices—than is the monopoly itself.
0 Profit-seeking middlemen will destroy any discriminatory pricing scheme. However, when resale is costly or can be prevented entirely, then price discrimination becomes possible.
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Price Discrimination
0 Preconditions of Price Discrimination0 Market control
0 Market imperfection and control are necessary0 Monopoly is the most suitable market condition, because it is a
price maker. 0 Division of market
0 when the whole market can be divided into various segments, and transfer of goods between the markets is not possible
0 Different price elasticities of demand in different markets0 Separation of market is a necessary condition for price
discrimination, but the sufficient condition is that price elasticities of demand should be different in these market segments
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Bases of Price Discrimination
0 Personal0 On basis of the paying capacity and/or the intensity of needs. 0 Since this discrimination is being done on a personal basis, the good
(or service) is non transferable.0 Geographical
0 People living in different areas are required to pay different prices for the same product. 0 E.g. edible oils and many packaged food items are sold at different prices
in different States of India. 0 Time
0 The same person may be required to pay different prices for the same product. 0 E.g. off season discounts.
0 Purpose of use0 Customers are segregated on basis of their purpose of use.
0 E.g. electricity rates are lower for domestic purpose and higher for industrial purpose.
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Degrees of Price Discrimination
0 Pigou has identified three degrees of price discrimination. 0 First Degree(Perfect Price Discrimination)
0 charges a price exactly equal to the marginal utility of the consumer and leaves no consumer surplus.
0 Joan Robinson referred to it as perfect discrimination. 0 Example
0 A bidding system would be the closest example in our time. You keep putting your product up to the highest bidder until everyone who wants one gets it. That way you've charged each consumer the most you can.
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Price Discrimination
0 Second Degree
0 Divides consumers in groups on the basis of their paying capacities; a person with lower paying capacity is charged a lower price and vice versa
0 Takes away the major (but not entire) portion of consumer surplus.
0 Airlines charge different prices depending on the season and day of the week. During the peak holiday season in August and Easter, the price will be higher because demand is greater and more inelastic. Flights which occur during the week e.g. Mon to Fri, will be more expensive because these are typically taken by business travellers.
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Price Discrimination
0 Third Degree
0 Segregates consumers such that each group of consumers is a separate market, and charges the price on basis of price elasticity of different groups.
0 Takes away only a small portion of consumer surplus.
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Degrees of Price Discrimination
First Degree: Monopolist’s income is equal to the area OPEQ leaving no consumer surplus. MR curve coincides with AR.
Second Degree: divided consumers in three segments and charges price P1, P2, P3 and leaves some surplus except the third group which marginal consumer.
Third Degree: charges higher price to buyers with less elastic demand and lower price to those with highly elastic demand, and maximizes its revenue.
First degree Second degree Third degree
Q
D
E3P3
Q1
OD=MR
E
P
OQuantity
Price
Q2 Q3
P2
P1
E2
E1
A1
A2 A1
D
EP
P1
QQ1
O
E1
Price and Output Decisions of Discriminating Monopolist
0 Assume that the firm can segregate the market on basis of price elasticity of demand: M1 with high price elasticity and M2 with low price elasticity.
0 The rule is:
0 Lower price and more supply in the market with high price elasticity
0 Higher price and less supply in the market with low price elasticity.
0 The firm will charge lower price in the market M1 and higher price in the market M2 and it would supply more to the market M1 and less to the market M2.
0 Firm would determine the profit maximizing output at MC=MR while MC is increasing.
0 The upper portion of the AR curve refers to the less elastic demand and the lower portion to highly elastic demand.
Regulation of Monopoly0 Important subject in applied Economics0 Utility, transport and communications in many countries are
regulated0 Two ways to regulate monopoly0 Marginal cost pricing & Two tier Pricing system0 The process of setting an item's price at the same level as the
extra expense involved in producing another item. By using marginal cost pricing, a business helps keep their sales price down in order to encourage sales during slow periods or to gain market share.
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Regulation of Monopoly
0 Marginal Cost Pricing: The process of setting an item's price at the same level as the extra expense involved in producing another item. By using marginal cost pricing, a business helps keep their sales price down in order to encourage sales during slow periods or to gain market share.
0 Enforcing a policy of marginal cost pricing will entail operating at a loss for a monopolist.
0 Dead weight loss is minimized in Marginal Cost pricing
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Regulation of Monopoly
0 Natural monopolies, by definition, exhibit decreasing average costs over a broad range of output levels.
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Regulation of Monopoly
0 In the absence of regulation output is QA and Price is PA
0 Profits are shown by PAABC0 Regulatory agency will set price equal to PR and the
level of output at this price is QR 0 At this price MC of producing this level of output is
equal to PR0 Because of negative slope of firm’s AC curves Price is
below the AC curve
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Regulation of Monopoly
0 Because of negative slope of firm’s AC curves Price is below the AC curve
0 At this regulated price monopoly is operating at loss
0 It will not operate at this price for long
0 Monopoly firm will either abandon its goal or Government subsidize monopoly forever.
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Regulation of Monopoly
2.Two tier Pricing System: 0This is the implementation of multi price system.
0In this system monopoly is permitted to charge higher price for some while maintaining a lower price for marginal users.
0The demander paying high price subsizes the losses of low price customers
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Regulation of Monopoly
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Regulation of Monopoly
0 Relatively higher price paid by some users is P1
0 At P1, Q1 is demanded.
0 Those who cannot pay P1 are offered lower price P2
0 Lower price generates additional demand equal to Q2-Q1
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Regulation of Monopoly
0 Total output is produced at average cost of A
0 In this case profits on sales to high price demand (P1DBA) = losses incurred on low price sales (BFEC)
0 In actual it may not be as simple to regulate price in either of the ways
0 Regulatory commissions do use price schedules that intentionally discriminate against some users.
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Summary
0 A monopoly is that form of market in which a single seller sells a product (or service) which has no substitute.
0 Pure monopoly is where there is absolutely no substitute of the product, and the entire market is under control of a single firm.
0 A monopoly has a single seller, sells a single product (pure monopoly) and decides on its own price and output, based on individual demand and cost conditions and is hence regarded as a price maker.
0 In monopoly the firm and the industry are one and the same. 0 Barriers to entry are the major sources (or reasons) of monopoly power and
may include restriction by law, control over key raw materials, specialized know how restricted through patents or licences, small market and economies of scale.
0 A monopoly firm has a normal demand curve with a negative slope. The demand curve is highly price inelastic because there is no close substitute.
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Summary
0 The monopolist being a price maker does not have any supply curve.
0 A multi plant monopolist decides on how much to produce and what price to sell at so as to maximize its profit on the basis of the principle of marginalism.
0 When a seller discriminates among buyers on basis of the price charged for the same good (or service), such a practice is called price discrimination.
0 Price discrimination can be done on personal basis (demographical, paying capacity or need), on the basis of geography, on the basis of time or purpose of use.
0 The discriminating firm will charge a higher price and supply less to the market having higher price elasticity and a lower price and supply more in the market having lower price elasticity.
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Monopoly
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Monopoly
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