Transcript PRICE DETERMINATION UNDER MONOPOLY

1. What is Monopoly?
Monopoly is that situation of market in which there is a single
seller of a product, for example: There is only one firm
dealing in the sale of cooking gas in a particular town. Hence,
monopoly is a market situation in which there is only one
producer of a commodity with no close substitutes.
1.1 Definitions
-According to Prof. Ferguson, “A pure monopoly exists when
there is only one producer in a market. There are no
direct competitors.”
-Mc Connel says, “Pure or absolute monopoly exists when a
single firm is the sole producer for a product for which
there are no close substitutes.”
1.2 Features
1.
2.
3.
4.
5.
One seller & large number of buyers: Under monopoly there should be
single producer of the commodity. The buyers of the product are in large
number. Consequently, no buyer can influence the price but the seller
can.
Monopoly is also an industry: Under monopoly situation, there is only
one firm & the difference between firm & industry disappears. There is no
difference between the study of a firm and industry.
Restrictions on the entry of new firms: There are some restrictions on
the entry of new firms into monopoly industry. There is no competitor o a
monopoly firm.
No close substitutes: The commodity produced by the firm should have
no close substitute, otherwise the monopolist will not be able to
determine the price of his commodity as per his discretion.
Price maker: Price of the commodity is fully under the control of the
monopolist. In case, the monopolist increases the supply of the
commodity, the price of it will fall. If he reduces the supply, the price of it
will rise. A monopolist may also indulge in price discrimination. In other
words, he may charge different prices of the same product from different
buyers.
2. Demand & revenue under
monopoly
In a monopoly situation there is no difference between firm &
industry. Accordingly, under monopoly situation, firm’s
demand curve also constitutes industry’s demand curve.
Demand curve of the monopolist is also average revenue
(AR) curve. It slopes downward. It means if the monopolist
fixes high price, the demand will shrink. On the contrary, if
he fixes low price, the demand will expand. Under monopoly,
average revenue & marginal revenue curves are separate
from one another. Both slope downwards.
Following facts come to light as a result of negative AR & MR:
i.
Demand rises with fall in price (AR). Hence, by lowering the
price, a monopolist can sell more units of the commodity.
ii.
AR is another name of price per unit, i.e., P=AR.
iii.
With fall in price, both AR & MR fall, but falling MR is more.
Rate of fall in MR is usually more than rate of fall in AR.
iv.
AR is never 0, but MR may be 0 or even -ve.
Fig.: Demand and revenue under monopoly
3. Determination of price and
equilibrium under monopoly
A monopolist will so determine the price of a product as to
get maximum profit. A monopolist is in equilibrium
when he produces that amount of output which yields
him maximum total profit. A monopolist is also in
equilibrium in the short period when he incurs minimum
loss. Under monopoly, price & equilibrium are
determined by 2 different approaches:
1.
2.
TR & TC Analysis
MR & MC Analysis
4. TR & TC curve analysis
Monopolist can earn maximum profit by selling that amount
of output at which difference between TR & TC is maximum.
By fixing different prices or by changing the supply of the
product, a monopolist tries to find out the level of output at
which the difference between TR & TC is maximum, i.e., total
profit is maximum. That amount of output at which a
monopolist earns maximum profit will constitute his
equilibrium situation.
Fig.: Total revenue & total cost curve analysis
5. MR & MC analysis
In case of monopoly, one can know about price determination or
equilibrium position with the help of MR & MC analysis.
According to this analysis, a monopolist will be in equilibrium
when 2 conditions are fulfilled, i.e.,
1.
MC=MR
2.
MC curve cuts MR curve from below. A monopolist earns
maximum profit when he is in equilibrium.
Price & equilibrium determination under monopoly are studied
with reference to 2 time periods:
A.
Short period
B.
Long period
Fig.: Marginal revenue & marginal cost analysis
A. Price determination under short
period or short-run equilibrium
Short-run refers to that period in which time is so short that a monopolist cannot
change fixed factors like: machinery, plant etc. Monopolist can increase
his output in response to increase in demand by changing his variable
factors. Similarly, when demand decreases, the monopolist will reduce his
output by reducing variable factors & by slowing down the intensive use of
fixed factors. A monopolist will face any of the 3 situations in the short
period:
1.
Super normal profit: If the price (AR) fixed by the monopolist in
equilibrium is more than his AC, then he will get super normal profits. The
monopolist will produce upto the extent where MC=MR. If the price of
equilibrium output is more than AC then the monopolist will earn supernormal profit.
2.
Normal profit: If in the short run equilibrium MC=MR, the monopolist
price AR=AC, then he will earn only normal profit.
3.
Minimum loss: In the short run, the monopolist may incur loss also. If in
the short-run price falls due to depression or fall in demand, the
monopolist may continue his production so long as the low price covers
his AVC. A monopolist in equilibrium, in the short period, may bear
minimum loss equivalent to fixed costs. In this situation, AR=AVC & the
monopolist bears the loss of fixed costs.
Fig.: Super normal profit
Fig.: Normal profit
B. Determination of Longrun or long-run equilibrium
In the long run, the monopolist will be in equilibrium at a
point where his long-run marginal cost is equal to marginal
revenue. In the long run, because of sufficiently long period
at the disposal of the monopoly firm, all costs can be varied &
supply can be increased in response to increase in demand.
Fig.: Determination of long run price or long
run equilibrium
Monopoly equilibrium & law
of costs
i.
ii.
1)
2)
3)
Elasticity of demand: If demand is inelastic, the monopolist will fix high
price of his product. On the contrary, if the demand is elastic, the
monopolist will fix low price per unit. Low price will not only extend
demand & increase the sales, also maximize his profits.
Effect of laws of costs on monopoly price determination: While
fixing the price, a monopolist also takes into consideration cost of
production.
Diminishing costs: It means as production increases its cost per unit
goes on diminishing.
Increasing costs: It means as production increases, the cost of
production also increases.
Constant cost: It is a situation wherein cost of production remains
constant, whether production is more or less.
Price discrimination or
discriminating monopoly
Definitions:
In the words of Koutsoylannis,“Price discrimination exists
when the same product is sold at different prices to different
buyers.”
-Dooley,“Discriminatory monopoly means charging different
rates from different customers for the same good or service.”
Price & output determination or
equilibrium under discriminating
monopoly
The aim of the monopolist in resorting to price discrimination is to
increase TR & profit. Analysis of price determination under price
discrimination can be made with reference to 2 or more market
conditions. Each discriminating monopolist, in order to maximize his
profit, will produce upto that level where MR=MC. In order to get
maximum profit, 2 conditions must be fulfilled:
1.Get same MR in both markets: If we express MR of market ‘A’ as
MR1, & MR of market ‘B’ as MR2, then MR of both the markets must be
same, i.e., MR1=MR2.
2. Equality between MR & MC: Another condition of equilibrium is that
MR earned in each market should be equal to the MC of the total output.
If MR of market ‘A’ is expressed as MR1 & that of market ‘B’ as MR2, &
marginal cost of total output as MC, then the condition of equilibrium will
be written as: MR1=MR2=MC.
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