Monopoly

Topic 4.2Market Structure: Market Structure:

MonopolyMonopoly

Features of the four market structures

ForeignExchange

Doctors

Soft Drink

Railways

ALTERNATIVE MARKET STRUCTURESALTERNATIVE MARKET STRUCTURES• Classifying markets by degree of competition

– number of firms– freedom of entry to industry– nature of product– nature of demand curve

• The four market structures– perfect competition–MONOPOLY– monopolistic competition– oligopoly

• Structure conduct performance

PERFECT COMPETITIONPERFECT COMPETITION

• Assumptions– Many buyers and sellersMany buyers and sellers– Firms (sellers) and buyers are price takerssellers) and buyers are price takers– freedom of entry– Product is homogeneous - Product is homogeneous - identical products– perfect knowledge– Example: Stock Market, ForEx Market, Bullion, Example: Stock Market, ForEx Market, Bullion,

Agricultural marketsAgricultural markets

• Short-run equilibrium of the firm

P = MC

Perfect Competition:Perfect Competition:Short-Run EquilibriumShort-Run Equilibrium

Firm’s Demand Curve = Market Price =

= Average Revenue = Marginal Revenue

Firm’s Supply Curve = Marginal Cost

where Marginal Cost > Average Variable Cost


• Short-run equilibrium of the firm– P = MC– possible supernormal profits– short-run supply curve of firm

• Long-run equilibrium of the firm– all supernormal profits competed away

• Incompatibility of economies of scale with perfect competition


• Advantages of perfect competition– P = MC

– production at minimum AC

– only normal profits in long run

– responsive to consumer wishes: consumer sovereignty

– competition efficiency

– no point in advertising


• Disadvantages of perfect competition– insufficient profits for investment

– lack of product variety

– lack of competition over product design and specification

MONOPOLYMONOPOLY

Defining Monopoly: Single seller Single seller that produces a product with that produces a product with no close substitutesno close substitutes

Sources of Monopoly:Sources of Monopoly: What could be the cause of Monopoly What could be the cause of Monopoly to exist?to exist?

MONOPOLYMONOPOLY• Barriers to entry

–Control of an essential input to a Control of an essential input to a product, i.e. product, i.e. ownership/control over ownership/control over key factorskey factors

–Patents or copyrights - Patents or copyrights - Du Pont had Du Pont had patent on cellophane, Polaroid on instant camera patent on cellophane, Polaroid on instant camera (normally given for 17 years as incentive to innovators)(normally given for 17 years as incentive to innovators)

–Government franchise: Government franchise: e.g. Post officee.g. Post office– legal restrictionslegal restrictions

MONOPOLYMONOPOLY• Barriers to entry

–product differentiation and brand loyalty

–Economies of scale: Natural Economies of scale: Natural monopoly: monopoly: e.g. public Utilities - price generally e.g. public Utilities - price generally regulated to allow only ‘fair’ rate of returnregulated to allow only ‘fair’ rate of return

–ownership or control over outlets–mergers and take-overs–aggressive tactics & intimidation

MONOPOLYMONOPOLY

For e.g. until the W.W.II, The Aluminium Co. For e.g. until the W.W.II, The Aluminium Co. of America (ALCOA) controlled almost entire of America (ALCOA) controlled almost entire source of bauxite and had monopoly over source of bauxite and had monopoly over production of Aluminium in the U.S.production of Aluminium in the U.S.

Is at the opposite extreme of perfect competition. Monopolist is a price maker as against perfect competitor who is price taker

Case Study 9-5 (p 400):Case Study 9-5 (p 400): Government Franchise, Monopoly Power and Government Franchise, Monopoly Power and

Competition in the Telecommunication IndustryCompetition in the Telecommunication IndustryStudy discusses the developments in the U.S. Telecomm Study discusses the developments in the U.S. Telecomm market how AT&T which was a monopoly till 1982 & market how AT&T which was a monopoly till 1982 & dominated the markets. Was done to promote economies of dominated the markets. Was done to promote economies of scale. All this changed in 1982 & government decided to scale. All this changed in 1982 & government decided to promote competition in this market.promote competition in this market.

The markets is went through upheavals with changes in The markets is went through upheavals with changes in government policy. Only it is selling down more or less as government policy. Only it is selling down more or less as oligopoly wit 4 major players (AT&T, Bell Altantic, oligopoly wit 4 major players (AT&T, Bell Altantic, SBC/Ameritech, MCI/WorldCom/Sprint) emerging as SBC/Ameritech, MCI/WorldCom/Sprint) emerging as integrated providers of telecomm and related services. integrated providers of telecomm and related services. These services are likely to be available at much lower These services are likely to be available at much lower prices to customers due to the consolidation & prices to customers due to the consolidation & competitions among these players.competitions among these players.

Natural MonopolyNatural Monopoly

O Q

LRAC

Rs

D1

a

b

O Q

LRAC

Natural MonopolyNatural MonopolyRs

D2D1

a

b

O Q

LRAC

Natural Monopoly: Natural Monopoly: ((will be discussed in detail later)will be discussed in detail later)Rs

Should the Producer operate at all?

MonopolyMonopolyShort-Run EquilibriumShort-Run Equilibrium

• Demand curve for the firm is the Demand curve for the firm is the market demand curvemarket demand curve

• Firm produces a quantity (Q*) where Firm produces a quantity (Q*) where marginal revenue (MR) is equal to marginal revenue (MR) is equal to marginal cost (MC)marginal cost (MC)

• Exception: Q* = 0 if average variable Exception: Q* = 0 if average variable cost (AVC) is above the demand cost (AVC) is above the demand curve at all levels of outputcurve at all levels of output

MONOPOLYMONOPOLY

• The monopolist's demand curve– downward sloping– MR below AR

Q O

MR

AR

Profit maximising under monopolyProfit maximising under monopolyRs

MONOPOLYMONOPOLY

• The monopolist's demand curve– downward sloping– MR below AR

• Equilibrium price and output• Profit Maximisation at

– MC = MR

Q O

MC

AR

Qm

MR

AR

a

Profit maximising under monopolyProfit maximising under monopoly

Rs

Q O

AC

MC

AR

AC

Qm

MR

AR

a

b

Profit maximising under monopolyProfit maximising under monopoly

Rs

c

Monopoly - ExampleMonopoly - ExampleShort-Run EquilibriumShort-Run Equilibrium

Q* = 500

P* = $11

MonopolyMonopolyLong-Run EquilibriumLong-Run Equilibrium

Q* = 700

P* = $9

Case Study 9-6 (p 406):Case Study 9-6 (p 406): The Market Value of Monopoly Profits in the New The Market Value of Monopoly Profits in the New

York City Taxi IndustryYork City Taxi IndustryNY city requires a license (medallion) to operate a taxi. NY city requires a license (medallion) to operate a taxi. These are limited in numbers and confer a monopoly power These are limited in numbers and confer a monopoly power (I.e. ability to earn economic profits) to owners. Value of (I.e. ability to earn economic profits) to owners. Value of medallion is the PV of future streams of earnings from medallion is the PV of future streams of earnings from medallion. For example the # of medallions in NY city have medallion. For example the # of medallions in NY city have remained at 11787 since 1937 till 1996. In 1996 it was remained at 11787 since 1937 till 1996. In 1996 it was increased by only 400 to 12187 medallions. The value of increased by only 400 to 12187 medallions. The value of medallion has risen from $ 10 in 1937 to 250000 in 1999 medallion has risen from $ 10 in 1937 to 250000 in 1999 (18% p.a.). The price of medallion is lower in other cities (18% p.a.). The price of medallion is lower in other cities (e.g. $ 90000 in Boston, $ 25000 in Chicago) reflecting much (e.g. $ 90000 in Boston, $ 25000 in Chicago) reflecting much lower capacity in these cities.lower capacity in these cities.

Proposals to increase the # in NY blocked by Taxi Unions.Proposals to increase the # in NY blocked by Taxi Unions.

Case Study 9-6 (p 406):Case Study 9-6 (p 406): The Market Value of Monopoly Profits in the New The Market Value of Monopoly Profits in the New

York City Taxi Industry (York City Taxi Industry (Contd.Contd..).)

If the city authorities could give freely the medallions then If the city authorities could give freely the medallions then the price of medallions could fall to zero. Alternatively the the price of medallions could fall to zero. Alternatively the Municipality has allowed sharp increase in the radio taxis - Municipality has allowed sharp increase in the radio taxis - although they are much less flexible.although they are much less flexible.

As a result the profit of NY taxi operators has come down As a result the profit of NY taxi operators has come down from 32% to only about 11% in 1999.from 32% to only about 11% in 1999.

Case Study: Case Study: Caviar and USSR MonopolyCaviar and USSR Monopoly : : Peterson and Lewis, 4th Edition, p 330 Peterson and Lewis, 4th Edition, p 330

Text book example of Monopoly of Restricted output and Text book example of Monopoly of Restricted output and high price:high price:

Distribution of income from US consumer’s to the USSRDistribution of income from US consumer’s to the USSR

Price in NY was $ 500-1000 for 1 Kg of CaviarPrice in NY was $ 500-1000 for 1 Kg of CaviarPrice in Moscow was $ 5-10 for 1 Kg of CaviarPrice in Moscow was $ 5-10 for 1 Kg of Caviar

But not allowing more than 1500 kg of exports every month But not allowing more than 1500 kg of exports every month the Soviet authorities kept in the international market high the Soviet authorities kept in the international market high but that meant that excess supply in the local market where but that meant that excess supply in the local market where price fell very low.price fell very low.

Case Study:European Milk Export and Case Study:European Milk Export and Creation of AMUL Milk cooperativeCreation of AMUL Milk cooperative

To keep the international price of milk high many of the To keep the international price of milk high many of the surplus milk producing countries - mainly European and surplus milk producing countries - mainly European and NZL, Australia etc. dump huge amount of it in the sea or NZL, Australia etc. dump huge amount of it in the sea or give it away as aid to developing countries who cannot give it away as aid to developing countries who cannot afford it. In the 1950s India received aid in terms of Milk afford it. In the 1950s India received aid in terms of Milk powder from the EU countries. powder from the EU countries.

Government of India in stead of giving to people free Government of India in stead of giving to people free charged some nominal price and collected about Rs. 50 charged some nominal price and collected about Rs. 50 crores. crores.

This money then was used as seed money to set up AMUL. This money then was used as seed money to set up AMUL. What happened next?What happened next?

Case Study:European Milk Export and Case Study:European Milk Export and Creation of AMUL Milk cooperative (contd.)Creation of AMUL Milk cooperative (contd.)

This money then was used as seed money to set up AMUL. This money then was used as seed money to set up AMUL. What happened next?What happened next?

Now India is the biggest producer of Milk in the World and Now India is the biggest producer of Milk in the World and AMUL has emerged as a very big competitor to the AMUL has emerged as a very big competitor to the European and NZL in the international milk products European and NZL in the international milk products markets. Gulf is now an important place where Amul has markets. Gulf is now an important place where Amul has largely replaced them.largely replaced them.

In WTO, these countries are trying to create barriers for In WTO, these countries are trying to create barriers for Indian players as they might completely dislocate them Indian players as they might completely dislocate them from most places.from most places.

Estimating Monopoly PowerEstimating Monopoly PowerLearner’s IndexLearner’s Index

P - MC 1P - MC 1------------ = ---------------------- = ---------- MCMC pp

11P

MR PE

This is derived fromThis is derived from

= M CFor Perfect CompetitionP=MC

[[ [[ [[[[

MONOPOLYMONOPOLY

• Disadvantages of monopoly– high prices / low output: short run

MonopolyMonopoly

Comparison of monopolyComparison of monopolywith perfect competition:with perfect competition:

(a) same industry (a) same industry MCMC curve curve

Q O

MC

Q1

MR

AR = D

P1

Equilibrium of industry under perfect competition and monopoly:Equilibrium of industry under perfect competition and monopoly: with the same with the same MCMC curve curve

Rs

Q O

MC

Q1

MR

P1

P2

Q2


AR = D

Rs

Q O

MC ( = supply under perfect competition)

Q1

MR

P1

P2

Q2


AR = D

Rs

MONOPOLYMONOPOLY

• Disadvantages of monopoly– high prices / low output: short run– high prices / low output: long run

MONOPOLYMONOPOLY

• Disadvantages of monopoly– high prices / low output: short run– high prices / low output: long run– lack of incentive to innovate (e.g. Bajaj, Hindustan

Motors (Ambassador), PAL (Fiat), Mahindra & Mahindra (Classic), Indian Railways, Indian Postal System)

MONOPOLYMONOPOLY

• Disadvantages of monopoly– high prices / low output: short run– high prices / low output: long run– lack of incentive to innovate– X-inefficiency (managerial inefficiency)

MONOPOLYMONOPOLY

• Disadvantages of monopoly– high prices / low output: short run– high prices / low output: long run– lack of incentive to innovate– X-inefficiency

• Advantages of monopoly

MONOPOLYMONOPOLY


• Advantages of monopoly– economies of scale

MonopolyMonopoly

Comparison of monopolyComparison of monopolywith perfect competition:with perfect competition:

(b) monopoly has lower (b) monopoly has lower MCMC curve curve (i.e. it is experiencing economies of scale)(i.e. it is experiencing economies of scale)

Q O Q1

MR

P1

MCmonopoly

Equilibrium of industry under perfect competition and monopoly:Equilibrium of industry under perfect competition and monopoly:with different with different MCMC curves curves

AR = D

Rs

Q O

MC ( = supply)perfect competition

Q1

MR

P1

P2

Q2

MCmonopoly

AR = D


Rs

Q O


Q1

MR

P1

P2

Q2

MCmonopoly

x

AR = D


Rs

Q O


Q1

MR

P1

P2

Q2

MCmonopoly

Q3

P3

AR = D


Rs

MONOPOLYMONOPOLY


• Advantages of monopoly– economies of scale– profits can be used for investment

MONOPOLYMONOPOLY


• Advantages of monopoly– economies of scale– profits can be used for investment– promise of high profits encourages risk taking

Social Cost of MonopolySocial Cost of Monopoly

MONOPOLYMONOPOLY• Article by Joseph Schumpeter• Monopoly Firm have been more creative due to the

financial power and potential competition

• Arguments for Monopoly, According to him– It is not competition but THREAT OF COMPETITION

which is more important: It comes from new products, new ways of organising production etc

– Perennial gale of creative destruction

Optional Ref..: Chapter 7, & 8 in his book:

Capitalism, Socialism and Democracy.

DeadweightDeadweightwelfare loss of welfare loss of

MonopolyMonopoly

Deadweight loss under monopolyDeadweight loss under monopoly

O

£

Q

Ppc

Qpc

MC(= S under perfect competition)

AR = D

(a) Industry equilibrium under perfect competition(a) Industry equilibrium under perfect competition

ConsumerConsumersurplussurplus

a

ProducerProducersurplussurplus


O

£

Q

Ppc

Qpc


AR = D

a

Pm

Qpc

MR

b

(b) Industry equilibrium under monopoly(b) Industry equilibrium under monopoly



DeadweightDeadweightwelfare losswelfare loss


O

£

Q

Ppc

Qpc


AR = D


a

MR under monopoly

bPm

Qpc

PerfectPerfectcompetitioncompetition



O

£

Q

Ppc

Qpc


AR = D

a

Pm

Qpc

bConsumerConsumer

surplussurplus


DeadweightDeadweightwelfare losswelfare loss

MonopolyMonopoly

MR under monopoly

Practice Practice QuestionsQuestions

For ARCO corp. a monopolist foll TC For ARCO corp. a monopolist foll TC and Demand was estimatedand Demand was estimated

TC = 500 + 20QTC = 500 + 20Q22

P = 400-20qP = 400-20qi) Find Q and P at which profit is max.ii) If price goes up by Rs. 10 what will be the new q at which profit is max.

i) Find Q and P at which profit is max.ii) If price goes up by Rs. 10 what will

be the new q at which profit is max.

Critique Report

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Monopoly

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