Price Determination under Monopoly Monopoly is that market form in which a single producer controls the whole supply of a single commodity which has no close substitute. From this definition there are two points that must be noted: (i)
(ii)
Single Producer: Ther Theree must must be only only one one prod produc ucer er who may be an individual, individual, a partnership partnership firm or a joint stock stock company. company. Thus single single firm constitutes the industry. industry. The distinction between firm and industry disappears under conditions of monopoly. No Close Substitute: Subst itute: The commodity produced by the producer must have no closely competing substitutes, if he is to be called a monopolist. This ensures that there there is no rival rival of the monopoli monopolist. st. Therefo Therefore, re, the cross elastic elasticity ity of demand between the product of the monopolist and the product of any other producer must be very low.
ONOPOLY : P RICE -O -OUTPUT D ETERMINATION UNDER M ONOPOLY A firm under monopoly faces a downward sloping demand curve or average revenue curve. Further, Further, in monopoly, monopoly, since average revenue falls as more units of output are sold, the marginal marginal revenue revenue is less than the average revenue. revenue. In other words, words, under monopoly the MR curve lies below the AR curve.
The Equilibrium level in monopoly is that level of output in which marginal revenue equals marginal marginal cost. The producer will continue continue producer as long as marginal marginal revenue revenue exceeds exceeds the margina marginall cost. At the point where where MR is equal equal to MC the profit profit will be maximum and beyond this point the producer will stop producing. Y Revenue / Cost
MC
AC
P’ L
P T
AR
E MR
O
M
X Output
It can be seen from the diagram that up till OM output, marginal revenue is greater than marg margin inal al cost cost,, but beyon beyond d OM the the marg margin inal al reven revenue ue is less less than than marg margin inal al cost. cost. Therefore, the monopolist will be in equilibrium at output OM where marginal revenue is equal to marginal marginal cost and the profits are the greatest. greatest. The corresponding corresponding price price in the diagram is MP’ or OP. OP. It can be seen from the diagram at output OM, while MP’ is the
average revenue, revenue, ML is the average cost, therefore, therefore, P’L is the profit profit per unit. Now the total profit is equal to P’L (profit per unit) multiply by OM (total output). In the short run, the monopolist has to keep an eye on the variable cost, otherwise he will stop producing. In the long run, the monopolist can change the size of plant in response response to a change in demand. In the long run, he will will make adjustment adjustment in the amount amount of the factors, fixed and variable, so that MR equals not only to short run MC but also long run MC. OMPARISON OF P RICE D ETERMINATION UNDER P ERFECT C OMPETITION AND OMPETITION AND M ONOPOLY ONOPOLY : C OMPARISON The key points of comparison of price determination under Perfect Competition and Monopoly is as below:
Perfect Competition
Monopoly
(i) The demand curve or average revenue curve is perfectly elastic and is a horizontal straight line.
(i) The demand curve or average revenue curve is relatively elastic and a downward sloping from left to right.
(ii) The firm is in equilibrium at the level of output where MC is equal to MR. Since in perfect competition MR is equal to AR or price, therefore, when MC is equal to MR, it is also equal to AR or price at the equlibrium position, i.e., MC=MR=AR (Price)
(ii) The firm is in equilibrium at the level of output where MC is equal to MR.
(iii) In equilibrium position, the price charged by the firm equals to MC.
(iii) In equilibrium position, the price charged by the firm is above MC.
(iv) The firm is in long-run equilibrium at the minimum point of the long-run AC curve.
(iv) The firm is in long-run equilibrium at the point where AC curve is still declining and has not reached the minimum point.
(v) The firm is in equilibrium at the level of (v) The firm is in equilibrium at the level of output at which MR curve is sloping output at which MC curve is rising, and is downwards, and MC curve is cutting cu tting it cutting MR curve from below. from below or above. (See figure 1)
(vi) In the long run, the firm is earning normal profit. There may be super normal profit in the short run but they will be swept away in the long run, as new firms entered into the industry. industry.
(vi) The firm can earn abnormal or supernormal profit even in the long run, as there is no competitor in the industry.
(vii) Price can be set lower at greater output (vii) Price is set higher and output smaller in case of constant-cost and decreasing-cost by the monopolist. (See Figure 2) industries.
Y
Y MC
P’
P
P
T O
T L
MR
AC=MC
P’
AC
AR
L
M
MR X
O
E uili uilibr briu ium m wit with h ris risin in MC
M
AR X
E uilibrium uilibrium with constant constant MC MC
Y P’ T
P L AC AR MR
O
M
MC X
E uili uilibr briu ium m wit with h fall fallin in MC Figure 1: Equilibrium with rising, constant & falling MC under Monopoly
MPS
Y D P’ P” P P”’
SRS Price
E
S
D Q
LRS D
O
Y
D’
M
M’
M”
S
D’ X
Output Equilibrium Position in a Decreasing Cost Industry under Perfect Competition
S
D MR
O
M
L
X
Output E uilibr uilibrium ium Positi Position on under under Mono Mono ol
Figure 2: Comparison of Equilibrium Position between Perfect Competition & Monopoly
P RICE D ISCRIMINATION IN ISCRIMINATION IN M ONOPOLY ONOPOLY : Price discrimination may be (a) personal, (b) local, or (c) acco rding to trade or use: (a) Perso Persona nal: l: It is personal when different prices are charged for different d ifferent persons. (b) (b) Loca Local: l: It is local when the price varies according ac cording to locality. (c) Acc Accordi ording ng to Trade Trade or Use: Use: It is according to trade or use when different prices are charg charged ed for differen differentt uses uses to which which the commodity commodity is put, put, for example, example, electricity is supplied at cheaper rates for domestic than for commercial pu rposes.
Some monopolists used product differentiation for price discrimination by means of special special labels labels,, wrapper wrappers, s, packing, packing, etc. etc. For example, example, the perfum perfumee manufa manufactu cturer rerss discriminate prices of the same fragrance by packing it with different labels or brands. Conditions of Price-Discrimination: There are three main types of situation:
(a) When When consum consumers ers have certain certain preference preferencess or prejudi prejudices. ces. Certain consumers usually have the irrational feeling that they are paying higher prices for a good because it is of a better quality, although actually it may be of the same quality. Sometimes, the price differences may be so small that consumers do not consider it worthwhile to bother about such differences. (b) Whe When n the nature nature of the good good is such such as makes it possible for the monopolist to charge different prices. This happens particularly when the good in question is a direct service. (c) Whe When n consume consumers rs are separate separated d by distance distance or tariff barriers. barriers. A good may be sold sold in one one town town for Re. 1 and in anothe anotherr town for Rs. Rs. 2. Simi Simila larl rly y, the the monopolist can charge higher prices in a city with greater distance or a country levying heavy import duty. duty. Conditions Conditions making making Price Discrimination Discrimination Possible Possible and Profitable Profitable:: The following following conditions are essential to make price discrimination possible and profitable:
(a) The elasticities elasticities of demand in different different markets markets must be different. different. The market is divided into sub-markets. sub-markets. The sub-market will be arranged in ascending ascending order of their elasticities, the higher price being charged in the least elastic market and vice versa. (b) The costs incurred incurred in dividing dividing the market market into sub-mark sub-markets ets and keeping them separ separat atee shoul should d not not be so larg largee as to neutr neutral alis isee the the diff differ eren ence ce in demand demand elasticities. (c) (c) Ther Theree shou should ld be comp comple lete te agre agreem emen entt amon among g the the sell seller erss otherw otherwise ise the competitors will gain by selling in the dear market. (d) Whe When n goods are sold sold on special special orders orders because then the purchaser cannot know what is being charged from others. Price Determination under Price Discrimination: (i) (i) Firs Firstt of all, all, the the mon monopo opoli list st divid divides es his his tot total al mar marke kett int into o sub sub-m -mar arket kets. s. In the the following diagrams, the monopolist has divided his total market into two submarkets, i.e., A and B: Y
Market A
Y
Price
Market B
Y
Price
Total Market
Price MC
P1
E’
E” MR’
O
P2
P”
P’
M1 Output
AR’ X
O
MR” M2 Output
AR” X
CMR O
M
X
Output
Price Discrimination in Monopoly
(ii) (ii)
The mono monopo poli list st has has now now to deci decide de at wha whatt level level of of output output he shou should ld prod produce uce.. To achieve maximum profit, hence, he will be in equilibrium at output at which MR=MC, and MC curve cuts the MR curve from below. below. In the above diagram (c) it is shown that the equilibrium of the discriminating monopolist is establi establishe shed d at output output OM at which which MC cuts CMR. The output output OM is distributed between two markets in such a way that marginal revenue in each is equal to ME. Therefore, he will sell output OM OM1 in Market A, because only at this output marginal revenue MR’ in Market A is equal to ME (M1E’ = ME). The same condition is applied in Market B where MR” is equal to ME (M2E” = ME). In the above diagram diagram,, it is also also shown that in Market Market B in which which elasticity of demand is greater, the price charged is lower than that in Market B where the elasticity of demand is less.
