Pure Monopoly || Characteristics and much more 2023

Monopoly

Monopoly is a concept in microeconomics that describes a market structure.

A firm in a monopoly is a price maker because it has significant control over 

the price of its product in the market. In a monopoly, there is only one seller 

or producer of a particular product or service, and there are no close sub-

stitutes available to consumers. As a result, the monopolistic firm can set the 

price at which it sells its product without being controlled by competition.

This market power allows the monopoly to set prices and quantity levels

independently, often leading to higher prices and reduced consumer choice 

compared to more competitive market structures.

Why would firm in a monopoly be a price maker?

A firm in a monopoly is a price maker because it is the single producer in the

market with no competition. It has the power to set the price of its product 

since consumers have no options. Unlike in competitive markets, where 

prices are determined by supply and demand forces, a monopolist can choose

both the price and quantity of its product to maximize its profit. This price

setting ability distinguishes it as a price maker.

 

Characteristics of different markets model:

 Pure Monopoly: Characteristics

• Single seller: In a pure monopoly, there is only one firm that 

        dominates and controls the entire market for a particular product

        or service. This firm is the sole producer of a specific product or 

        single supplier of a service and there are no direct competitors.

• Price maker: The monopolist can set the price for its product 

        independently. It does not have to accept the market price, as it is

        the sole supplier, and it  can adjust prices to maximize its profit.

 

• High barrier to entry: Pure monopolies often exist due to

        challenging barriers to entry that prevent new firms from entering 

        the market. These barriers can include significant startup costs, control

        over essential resources, government regulations, or economies of scale

        that favor larger firms.

 

• No close substitutes: Consumers have no alternatives or close

        substitutes for the product offered by the monopolist. This lack of 

        substitute products gives the monopoly firm significant pricing power.

 

• Unique product: In many cases, the monopolist may offer a unique

        or differentiated product that has no direct substitutes. This further 

        increase its pricing power.

 

• Downward-sloping demand curve: The monopolist faces a downward

        -sloping demand curve, meaning that to sell more units of its product, 

        it must lower the price. This leads to a situation where the marginal 

        revenue (MR) curve lies below the demand curve.

Monopoly Output Decision & Proft Maximization:

MR=MC Rule:

The MR=MC rule is a fundamental concept in microeconomics, particularly

when analyzing a monopoly's output decision and profit maximization.

MR=MC Rule: To maximize profit, a monopoly should produce the quantity

of output where marginal revenue (MR) equals marginal cost (MC), i.e., 

MR = MC. This rule identifies the point at which the additional revenue from

selling one more unit matches the additional cost of producing that unit. At 

this equilibrium point, the monopoly is neither underproducing nor over-

producing, and it is maximizing its profit.

If MR is greater than MC (MR > MC) for a particular level of output, it means

that the monopoly can increase profit by producing and selling more units. 

If MC is greater than MR (MC > MR), it implies that the monopoly should 

reduce production to increase profit. Only when MR equals MC (MR = MC) 

is the monopoly producing the optimal quantity for profit maximization.

MR=MC

MC:  Can be derived using cost functions

MR:  Depends on demand curve

MR for Competitive Firm & Monopoly:

MR for Competitive Firm:

In a perfectly competitive market, a competitive firm is considered a price 

taker. This means that the firm has no control over the market price and can 

sell as many units of its product as it wants at the dominant market price.

     •  MR for a competitive firm is equal to the market price (P). This is 

        because when a competitive firm sells one more unit, it doesn't affect

         the market price, so its additional revenue is simply the price.

     •  MR = P for a competitive firm in perfect competition.

MR for Monopoly:

In a monopoly, the firm is the sole producer and has significant control over 

the market. This gives rise to a unique MR curve:

     •  The MR curve for a monopoly slope downward from left to right. 

        This means that in order to sell more units, the monopoly must lower

        the price. As a monopoly increases its production, it not only gains 

        revenue from selling additional units but also faces a reduction in price

        for all units sold, which decreases total revenue.

     •  The MR is less than the price (P) for a monopoly. In fact, the MR curve

         is typically below the demand curve (price) because the firm must lower 

         the price to sell more units. The MR curve can be steeper than the 

         demand curve, depending on the elasticity of demand.

     •  MR < P for a monopoly.

Graphical approach:

Market	Initial Revenue(R1)	R2	Marginal Revenue R2 – R1
Competition	A	A+B	B=p1
Monopoly	A+C	A+B	B-C = p2 -C

Marginal Revenue Curve

Relationship between the MR and AR depends on the shape of the demand 

curve.

  

Deriving the Marginal Revenue Curve:

To derive the monopoly’s marginal revenue curve, we write an equation 

summarizing the relationship between price and marginal revenue that 

panel b of graphic representation.

Monopoly’s marginal revenue is

Because the slope of the monopoly’s inverse demand curve, 

is negative. This equation show that price is greater than the marginal

revenue, which equal p plus a negative term.

MR and Price Elasticity of Demand

Monopoly’s marginal revenue is

So increasing Q has two effects on revenue

Output effect :   Higher output raises revenue

Price effect :      Lower price reduces revenue

To sell a larger Q, the monopolist must reduce the price on all units it sells.

 Hence, MR< P

Market Power

Ability of a firm to charge a price above MC and earn a positive profit.

The degree to which the monopoly raises its price above MC depends 

on the shape of the demand curve.

If highly elastic demand curve, it would lose substantial sales if it raised its 

price by even a small amount.

If highly inelastic demand curve, the monopoly would lose fewer sales from 

raising its price by the small amount.

 

Choosing Price or Quantity:

If monopoly sets its price, demand curve determines how much output it 

sells.

If monopoly picks an output level, demand curve determines the price.

 

Mathematical Approach:

    Cost = Q² + 12

    P =    24-Q

    MC = 2Q

    MR= 24-2Q

    MR=MC

    24-2Q = 2Q

    Q=6, P=18

 

Short-Run Losses & Shutdown Decision:

In a monopoly, like any other firm, short-run losses can occur due to various

factors, such as high costs, low demand, or a combination of both.

Short-run losses occur when the total cost of production (including both fixed

and variable costs) exceeds total revenue. Mathematically, if Total Cost (TC) is

greater than Total Revenue (TR), a monopoly is incurring a loss.

Short-run Loss = TR – TC.

A monopoly should compare its short-run loss with a specific benchmark to 

make the shutdown decision. The benchmark is the minimum point at which 

it should continue operating:

If the short-run loss is less than or equal to the variable costs (VC) of prod-

uction, the monopoly should continue to operate in the short run. In this 

case, it covers its variable costs and contributes something to offset fixed 

costs.

If the short-run loss exceeds the variable costs (TR < VC), the monopoly 

should consider shutting down temporarily in the short run. Operating 

would only exacerbate the losses, and it's better to minimize the loss by 

not producing.

 

Monopoly Supply Curve:

In a monopoly market, there is no supply curve in the traditional sense as 

there is in competitive markets. In a competitive market, the supply curve

represents the quantity of a good or service that producers are willing and 

able to offer at different price levels, and it typically slopes upward from 

left to right.

However, in a monopoly, a single firm controls the entire market for a 

particular product or service, and it sets both the price and quantity of 

output. As a result, there is no supply curve that relates quantity supplied 

to price.In a monopoly, the relationship between price and quantity is deter-

mined by the firm's demand curve. The demand curve for a monopoly shows 

the quantity of the product that consumers are willing to buy at different 

price levels. It slopes downward from left to right, indicating that as the 

price increases, the quantity demanded decreases.

 

Monopolist output determined by MC and Elasticity

A monopolist determines its output level by equating marginal cost (MC) 

with marginal revenue (MR), just like firms in competitive markets. 

However, the monopolist's pricing strategy takes into account both MC 

and price elasticity of demand (PED) to maximize its profit. As result, 

shifts in demand do not trace out the series of prices and quantiles that 

correspond to a competitive supply curve.

Instead, shifts in demand can lead to changes in price with no change in 

output, change in output with no change in price, or changes in both price 

and output.

Graphical Approach:

a)  Competition