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CHAPTER –ONE
MONOPOLY MARKET STRUCTURE

Chapter Objective
1.1 Definition and Reason for existence of monopoly
1.2 Demand & Review of monopoly tim
1.3 Equilibrium of monopoly
1.4 The Multiplan firm
1.5 Price discrimination

Section 1: Definitions and Bases of Monopoly

Introduction

We have seen about perfect competition which is the may-small-sellers extreme

of the market structure. Now, we will consider the opposite extreme: a
monopoly. This section is designed in a way that it first defines what a
monopoly is, including its basic characteristics, followed by the discussion of
factors which lead to monopoly power.

1.1 Definition and Features of Monopoly

Colleague, can you define a monopoly? Can you list the major features of a
monopoly market? Ok. By definition, a monopoly is the one seller of a product
for which there is no close substitute. It is an industry in which there is only
one firm. Monopoly in its strict sense means the concentration of economic
powers in a single hand.

The basic features of monopoly are:

1) One seller: There is a single seller in an industry, and as a result, the

monopolists is a price-marker. In fact, firm and industry are the same in
pure monopoly.
2) Price market: There are no close substitutes for the good or service the
monopolist produces.
3) Barriers to entry: The assumption of free entry into industry must not
apply, i.e., entry is blocked.

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1.1.1 Reason of monopoly power (Causes for barriers to entry)

For a monopoly to be stable there must be some barriers to entry. Monopolies

exist because barriers to entry exist in the market, and the stronger the
barriers to entry, the more complete the monopoly will be. Barriers take
various forms, legal and illegal, and some of these major

A patent is a legal protection which prevents original inventions from being

copied, and once a patent is granted it is protected by law for a period of time.
Copyright protects written work like plays, books, music, and films which are
all protected from copying by copyright laws. Trademarks can be names of
logos, and sometimes shapes. The Coca-Cola bottle, for example, is actually a
trade mark and it is illegal to copy it without permission.

Protection of patents, copyrights, and trademarks come from a country’s legal

system and from international agreements. Some countries have no such laws
and copying is, therefore, not illegal. In countries where we have these laws,
owners of the indicated intellectual property rights will have some monopoly
power on their products or services.

2. Government License

Some businesses are illegal unless a government license has been granted.
Television. Telephone, and electricity are some of the examples of businesses
that in most countries require government permission. These services, in
country for example, are monopolized by the government and no one is entity
to provide them unless licensed

3.Natural monopolies

This situation is likely to occur either when the market is small or when fixed
costs are necessarily very large. For example, if market for a given product is
very restricted in a small town with small population size, having two suppliers
of a given product may not be profitable. A good example where high fixed costs
exists is for railways or water works. Hence, it would seem to be absurd to have
two railways alongside each other or to have two sets of water pipe running
into your home.

A natural monopoly is a monopoly that exists because of economies of scale,

that is, the market demand is too small to support many firms, each producing
at minimum ATC.

4. Mergers and Takeovers

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Merging of two or more companies is an expression which implies that each

firm enters the venture on friendly terms and that the companies become one.
A takeover, on the other band, implies that one company purchases another.
These help monopolies to acquire power through growth in the market. Marger
can be horizontal merger (two or more firms in the same industry at the same
stage of production merge), vertical merger (two or more firms in the same
industry at different stages of production merge), and conglomerate merger
(two or more firms in different industries merge).

5.Internal Growth

Companies can also grow without merging, and they do this by raising money
to finance the growth. Sources of money are from retained profits, bank loans,
and issues of new shares. This will help companies to be financially strong
which in turn helps them to monopolize the market.

6. Aggressive Tactics

Aggressive tactics are just tricks, where a seller sells its products below the
prevailing market price usually less than its cost of production. What do you
think is the purpose of doing this?

A business that sells its product for less than costs of production is said to be
engaging in predatory pricing. The aim of predatory pricing is usually to force
another firm out of business before raising profits.

7. Control Over key Factors of production

Consider the possibility of one firm owning the entire supply of a raw material
input that is essential to the production of a particular commodity. The
exclusive ownership of such a strategic resource serves as a barrier to entry
until an alternative source of the raw material input is found or an alternative
technology not requiring the raw material in question is developed.

7.1.3. Demand under Monopoly

The demand curve for a monopoly is different from that of perfectly competitive
firm. In perfectly competitive industry, we have to distinguish between the
industry demand and demand for the output of an individual firm, which are
quite different. B/c of the single seler in monopoly market, there is not
distinction b/n the market demand curve and demand curve of the firm

Equilibrium under monopoly

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The equilibrium under monopoly market or monopolist maximizes it’s profit in

the short run followed by the long run situation.

A. Short run equilibrium under monopoly

In order to simplify the analysis of monopoly equilibrium let’s us assume that

the shape of cost I revenue curves in monopoly. However, the revenue price is
not constant. The shape of revenue ® and TC is

Revenue and cost curve of a monopolist

 Based on the about figure, determine the range in which profit is

negative and posilive
- When the out put is at a and at b profit is zero
- When the output is below a & above profit is negative
- When the output is with in the ranges between a tob the profit is
positive
 A monopolist, with an objective of profit maximizing, is expected to look
for the maximum gap between revenue ® and cost (TC) curves, and this
possible t an in below figure

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 At point Q the two curves are equal and 1t brings us to the condition of
profit mazimization
 At point
 Mc= NR- means the slop of cost curve is the same as the slope of
revenue curve.
 The slope of mc is grater than the slope of MR. This means mc
curve cuts MR curve from below
 At point E
- MR= MC and MC cuts MR from below
- Point “E” equilibrium point for monopolist
 To determine monopoly price, Trace up through equilibrium point to AR
line to point G. There fore the monopolist price is Pm
 In monopolist market
Revenue R= PxQ= area of rectangle O QM GPM
Cot C = Ac x Q = area of rectangle O Qm HA
TL = R- C the area of rectangle AHGPM
 Therefore – In monopolist can’t decide on both price charge and level of
sales it will achieve the market
- Monopolist constrained by demand curve & he or she can
decide the price or quantity not both
- In monopolistic the decision on price or output is
interdependent by interaction of MC and MR which will be
sold at corresponding price.

Example- if the demand curve of a profit maximizing monopolist is given Q=

40- Q.2p and cost function as C = 30+30Q. find equilibrium output level,
monopolist price and profit solving the demand equation for price we have

P = 200 – 5Q 3 rd substitute in demand equation

1st Find MR and Mc P=200-5Q

R = pQ = (200 – 5Q) Q 200-5 (17)
= 200 Q – 5Q2 = 200-35
MR = dR = 200 -10Q P= 115
dQ
MC = dc = 30
dQ

2nd Equate MR with MC, we have

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= 200-10Q= 30
200-30 = 10Q Q= 17
10 10
Profit II = R – C
= PQ – (30+30Q)
 = 115 x 17 – (30+(30x17)
1955 – 540 = 1415
Exemple 2 – if the demand curve of profit maximizing monopolist is given as P=
1200 -2Q and cost function as C = Q3 – 61.25Q2 + 1528.5Q+2000, find
equilibrium output level, monopolist price and profit
To determine whether the monopolist gets profit or not depends up on the
condition of the demand and short run average cost curves
- If Ac curves lies below the demand curve, as it is indicated, we have a
loss indicated by the rectangle PmHGA and if AC is below the demand
curve at equilibrium, we have positive profit of the shaded area.

-it is also possible that the monopolist neither makes abnormal profit or incurs
loss, but this only when the short run AC curve of monopolist tangent to AR or
demand curve and the same time MC curve cuts the me curve from below.

Long Run equilibrium of the monopoly

- Since entry is blocked the monopolist can maintain hes/her short run
abnormal profit in longrun.
- In long run the monopolist has the time to expand his/her plant or to
use the existing plant to any level which will maximize profit.
- In long run, with entry is blocked: it’s unnecessary for the monopolist to
reach an Optimal (minimum point of LRAC)
- If in long run the monopoly makes loss the business not stay and the
minimum price acceptable by monopolist can use in three different scale

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- At Sub Optimal scale- this is a falling part of LRAC. The monopolist is

not induced to expand the existing plant is under utilized and hence
there is excess capacity.

b- At Optimal Scale:- This is at minimum point of LRAC curv. Here, the

market size is just large enough to permit to monopolist to build the optimal
plant and use at full capacity

Surpass the Optimal Scale- It’s beyond the minimum point of LRAC

- The Size of the market is so large that the monopolist in order to

maximize his output
- The plant must build a than optimal and over utilize it.

D. Multi plant Monopolist

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- The multi plant monopolist is a monopolist having more than one plant. And
it’s focused for maximizing profit and decisions to be made by monopolist will
be discussed equilibrium determination by the multi plant monopolist

- it consider a monopolist with two plants each with different cost structure at
two different location.

That means we have two different marginal cost where the total marginal cost
is equal to the horizontal summations of individual marginal cost. The
monopolist now is expected to make two decision.

 How much output to produce together and at what price to sell it

so as to maximize profit
 How to allocate the production of the optimal ( Profit maximizing)
output between the two plants.
 The monopolist maximizes output by utilizing each plants up to the
level of which the marginal cost are equal to each other and to Tv
common marginal revenue

MC1 = MC2 = MR

 The monopolist maximizing output by utilizing each plant mc are equal

to common MR
 Means:-
- If MC1 is less than MC2, the monopolist would increase his
profit by increase the production in plant 1 and decrease it in
plant2, until the condition of MC1= MC2= MR is satisfied

Example – Assume that the demand equation of the multi plant monopolist is
given as Q=200-2P (P = 100- 0.5Q) and cost of the two plants are given as

C1 =10Q1 and C2 = 0.25Q22. Find equilibrium level of price and maximum level
of profit

1st Calculate marginal Revenue (MR) & marginal cost (mC1 MC 2)

R = PQ

= (100-0.5q)Q

= 100Q-0.5Q2

MR = dcR)

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d(Q)
=d(100Q -0.5Q2)

= 100-Q

MC1 = d(C1) = d(10Q1) = 10

D(Q) d(Q)

3rd . Equate MC1 = mc2 and MC1 = MR since Q1+Q2 = Q

MC1 = MC2 MC1 = MR Q = Q1+Q2
10 = 0.5Q2 10 = 100-Q Q1= Q-Q2
0.5 0.5 Q = 100-10 Q1 = 90-20
Q2 = 20 Q = 90 Q1 = 70

4th – to calculate equilibrium price substitute “Q” or 90 in demand equation

P= 100-0.5 Q
= 100-0.5 (90)
= 100 -45
= 55
th
5 – The monopolists profit can be calculated as:-
II = R-C1 –C2
= PQ – C1-C2
= (PQ) – (10Qs) – (0.25Q22)
= (58 x90) – (10x 70) – ((0.25 (20) 2)
= (4950) – (700) – (100)
= 1450
 To check MC1 = MC2 = MR
10 = 0.5 (Q2) = 100 –Q
0.5 (20) (100-90)
10 = 10 = 10