The word monopoly has been derived from the combination of two words i.e., ‘Mono’ and ‘Poly’. Mono refers to a single and poly to control.
In this way, monopoly refers to a market situation in which there is only one seller of a commodity.
There are no close substitutes for the commodity it produces and there are barriers to entry. The single producer may be in the form of individual owner or a single partnership or a joint stock company. In other words, under monopoly there is no difference between firm and industry.
Monopolist has full control over the supply of commodity. Having control over the supply of the commodity he possesses the market power to set the price. Thus, as a single seller, monopolist may be a king without a crown. If there is to be monopoly, the cross elasticity of demand between the product of the monopolist and the product of any other seller must be very small.
Characteristics of a Monopoly
A monopoly can be recognized by certain characteristics that set it aside from the other market structures:
1. Profit maximizer
A monopoly maximizes profits. Due to the lack of competition a firm can charge a set price above what would be charged in a competitive market, thereby maximizing its revenue.
2. Price maker
The monopoly decides the price of the good or product being sold. The price is set by determining the quantity in order to demand the price desired by the firm (maximizes revenue).
3. High barriers to entry
Other sellers are unable to enter the market of the monopoly.
4. Single seller
In a monopoly one seller produces all of the output for a good or service. The entire market is served by a single firm. For practical purposes the firm is the same as the industry.
5. Price discrimination
In a monopoly the firm can change the price and quantity of the good or service. In an elastic market the firm will sell a high quantity of the good if the price is less. If the price is high, the firm will sell a reduced quantity in an elastic market.
Five Sources of Monopoly
There are five factors which alone or in combination can enable a firm to become a monopolist
1. Exclusive Control over Important Inputs
Complete or large control over necessary inputs for production causes some companies to be the sole power in an industry, as competitors cannot form due to the lack of inputs.
2. Economies of Scale
If the LAC is downward sloping, it is essentially wise to have only a single producer in the market. This is called a natural monopoly, as every additional competitor makes production more costly and wasteful.
A patent typically confers the right to exclusive benefit from all exchanges involving the invention to which it applies. Patents can be harmful and beneficial for a market, as they give rise to monopolistic powers, but without them some inventions would simply not occur at all.
4. Network Economics
Once the fraction of consumers owning a certain product passes a critical threshold, (especially if it has many complements like a VHS player has VHS), network economies can occur which are economies of scale which occur because of a monopoly or natural monopoly power.
5. Government Licenses of Franchises
Government or local authorities can give out licenses for firms in certain areas so they gain exclusive rights of operations for example. These licenses are for industries or areas in which more than one firm would be harmful, however they come with regulations and restrictions.
The Monopolist’s Total Revenue Curve
The main difference between a monopolist and a perfect competitor is the way in which total and marginal revenue varies with output
– As price falls, the total revenue for a monopolist does not rise linearly with output, instead it reaches a maximum value at the quantity corresponding to the midpoint of the demand curve after which it begins to fall
– Total revenue reaches its maximum value when the price elasticity of demand is unity
– The vertical distance between short-run total cost and total revenue curves is greatest when the two curves are parallel
The slope of the total cost curve at any level of output is by definition equal to marginal cost at that output level – The slope of the total revenue curve is the marginal revenue:
A profit-maximizing monopolist in the short run will choose that level of output Q* for which
– The Optimality condition for a monopolist defines a monopolist maximizes that maximizes profit by choosing the level of output where marginal revenue equals marginal cost
– The monopolist wants to sell all units for which marginal revenue exceeds marginal cost, so marginal revenue should lie above marginal cost prior to intersection.
Marginal Revenue and Elasticity
– Marginal revenue and price elasticity share links as well
– This equation tells us that the less elastic demand is with respect to price, the more price will exceed marginal revenue
– Also, it tell us that in the case of infinite price elasticity, marginal revenue and price are exactly the
Graphing Marginal Revenue
– Plugging in the price and PED in the function above, one can plot the MR curve quickly
– By doing so, one can see that the slope of the MR is twice that of the demand curve
Graphing Interpretation of the Short-Run profit Maximization Condition
– The profit-maximizing level of output for a monopolist is the one for which the marginal revenue and marginal cost curves intersect.
– At that quantity level, the monopolist can charge a price that will yield in an economic profit equal to the rectangle where price hits demand curve from the left and the ATC hits the demand curve from below.
– Monopolists often charge different prices to different buyers, a practice known as price discrimination
– When price discrimination is possible, monopolists can shift some of the consumer surplus to its own profits
The Perfectly Discriminating Monopolist
– First degree price discrimination is the term used to describe the largest possible extent of market segmentation.
– When a producer is able to charge different prices for each unit, he captures all the consumer surplus. The consumer pays the maximum he would have been willing to pay for each unit, and as a result receives no surplus
– The marginal revenue curve of a perfectly discriminating monopolist is exactly the same as is demand curve
– Because he can discriminate perfectly, he can lower his price to sell additional output without having to cut price on the output originally sold, thus price and marginal revenue are one and the same.
– Perfect discriminators produce a higher level of output because they don’t need to be concerned with the effect of a price cut on the revenue from output produced.
– There is generally a positive consumer surplus under non-discriminating monopolists, but none under the perfect discriminator.
Second-Degree Price Discrimination
– Second degree price discrimination refers to a practice by which many sellers post a schedule long which price declines with the quantity you buy (aka. Declining tail-block rate).
– The second degree discriminator offers the same structure to every consumer, which means that they make no attempt to tailor charges to elasticity differences among buyers.
– The limited number of rate categories tends to limit the amount of consumer surplus that can be captured under second degree schemes.
Third-Degree Price Discrimination
– Third-degree Price discrimination defines a producer selling his goods in two different markets at two different prices.
– The markets where the producer sells his goods should not be able to communicate with each other, otherwise all consumers will buy in the cheapest market.
– If the monopolist cannot sell his goods at different prices in the different markets, then he must see the markets as one big one.
The Hurdle Model of Price Discrimination
– The hurdle model of price discrimination is an idea in which the most elastic buyers will identify themselves.
– The hurdle model requires the buyers to first jump over a hurdle in order to get a rebate or something similar.
– The hurdle model is not perfect as some people would buy a product if it wasn’t on sale as well, but rather wait a bit if there is the chance to get it cheaper- Like first-degree price discrimination, the hurdle model tries to tailor prices to the elasticities of individual buyers, however the hurdle model cannot capture all of the consumer surplus.