Monopoly
Monopolists are single suppliers to a market, with no competitors.
Monopolists can emerge in a market for several reasons, including:
- The firm has exclusive ownership of a scarce resource, such as
owning the rail track in a country.
- The firm is the first one in a market - in market economies this is
likely to be short lived as new firms enter the market. However, new
entrants can receive protection by way of time-limited patents,
copyright laws or trade marks.
- Similarly, monopolists can emerge as a result of the impact of
barriers to entry in a market, including high set-up costs, the
unavailability of economies of scale which have already been exploited
by the first firm in the market, and deliberate barriers.
- Barriers
that are deliberately designed to limit entry include 'limit pricing' -
where price is reduced to the level that limits new entrants, merging
with or taking over a potential rival, and controlling the supply chain
through exclusive contracts and other restrictive practices.
- The
firm is granted monopoly status by the country's
government.
Profits
When one or more of these conditions are met, the monopolist can derive super-normal
profits - that is, profits above normal profits. Normal profits are those
which just cover the entrepreneur's opportunity cost.
If the firm can maintain its position as a monopoly supplier it can make
supernormal profits into the long run.
Assuming the firm is a profit maximiser it will produce up to the output
where the marginal cost of producing and supplying one more unit of output
exactly equals the marginal revenue gained by the firm from selling that one
unit of output - hence the profit maximising rule: MC=MR.
Supernormal profits are shown in the graph as area P A B C.
Losses
Monopolist can also make
losses, when average costs exceed average revenue.
In this case, with an average cost curve of ATC1, losses are the area: N V A P.
Here we can see the area representing losses:
Monopoly power
Some firms that are not pure monopolies can derive a level of 'monopoly power' as a
result of having limited competition in the market. Markets with only a few
firms are referred to as oligopolies.
As well as maximising profits, features of monopoly include:
- Different pricing strategies - monopolists can charge different
prices to achieve different objectives, given that they are
price makers. Depending on market conditions, they can set various prices.
At point ‘A’ (price P) in the first diagram, maximum profits are made as marginal cost equals marginal revenue.
Point ‘K’ (price M) is the price required to maximise revenue - here, marginal revenue is zero
so any further output creates a negative marginal revenue, which reduced total
revenue below its maximum.
At point ‘L’ (price R) sales volume is maximised - maximising sales volume
occurs when the firm sells as much as it can without making a loss.
- They can retain their dominance - monopolists can retain their power
by erecting deliberate barriers to entry, including spending on
advertising, limit pricing and predatory acquisition of potential
rivals.
- Monopolists can restrict output - as well as set prices, monopolists
can restrict output, although they cannot set a price and restrict
output at the same time. Setting high prices or restricting output are
regarded as anti-competitive practices.
Example
Consider the following example of costs and revenue for a hypothetical firm.
Quantity |
P=AR |
TR |
MR |
FC |
VC |
TC |
AC |
MC |
Profit |
0 |
45 |
0 |
|
10 |
0 |
10 |
|
|
-10 |
1 |
40 |
40 |
40 |
10 |
8 |
18 |
8 |
8 |
22 |
2 |
35 |
70 |
30 |
10 |
10 |
20 |
5 |
2 |
50 |
3 |
30 |
90 |
20 |
10 |
12 |
22 |
4 |
2 |
68 |
4 |
25 |
100 |
10 |
10 |
22 |
32 |
5.5 |
10 |
68 |
5 |
20 |
100 |
0 |
10 |
42 |
52 |
8.4 |
20 |
48 |
6 |
15 |
90 |
-10 |
10 |
75 |
85 |
12.5 |
33 |
5 |
7 |
10 |
70 |
-20 |
10 |
119 |
129 |
17 |
44 |
-59 |
8 |
5 |
40 |
-30 |
10 |
172 |
182 |
21.5 |
53 |
-142 |
From the example we can observe the following:
- Profit maximisation occurs at output 4, which is where MC = MR.
- Profits are 68, shown in the table and also highlighted in the
graph.
- Revenue maximisation occurs at output 5, which is where MR = 0.
- Sales maximisation is at output 6. (The highest volume of sales
without making a loss).
- The general observation that, if demand (the AR curve) slopes
downwards, then profit, revenue and sales maximisation all occur at
different prices and outputs.
In addition to monopolies as single sellers, some firms may be single buyers, called monopsonists.
Monopsonists may be able to exert considerable market power over suppliers, by:
- Dictating the price they are prepared to pay from suppliers, who may be
much smaller, and cannot exert power in negotiations. This might include
demand discounts from suppliers.
- Dictating terms and conditions of business.
- Delaying payments - a particular problem for small suppliers.
- This means that they can reduce their costs, and if this is not passed on
to consumers, it will mean increasing their profits.
Monopoly and welfare loss
Natural monopolies
Oligopolies
Exercise
Look at the partly completed table below and answer the questions:
- Complete the table
- Draw a graph to show average revenue, marginal revenue, average cost and
marginal cost.
- Identify profit, revenue and sales maximisation points,
- Show the area for super-normal profits on your graph.
Quantity |
P=AR |
TR |
MR |
FC |
VC |
TC |
AC |
MC |
Profit |
0 |
110 |
|
|
20 |
80 |
|
|
|
|
1 |
105 |
|
|
20 |
100 |
|
|
|
|
2 |
100 |
|
|
20 |
112 |
|
|
|
|
3 |
95 |
|
|
20 |
122 |
|
|
|
|
4 |
90 |
|
|
20 |
142 |
|
|
|
|
5 |
85 |
|
|
20 |
170 |
|
|
|
|
6 |
80 |
|
|
20 |
220 |
|
|
|
|
7 |
75 |
|
|
20 |
288 |
|
|
|
|
8 |
70 |
|
|
20 |
380 |
|
|
|
|
9 |
65 |
|
|
20 |
490 |
|
|
|
|
10 |
60 |
|
|
20 |
640 |
|
|
|
|
11 |
55 |
|
|
20 |
840 |
|
|
|
|
12 |
50 |
|
|
20 |
1080 |
|
|
|
|
13 |
45 |
|
|
20 |
1380 |
|
|
|
|
go to answer
Oligopoly
What are the disadvantages of oligopoly?
Oligopoly
Game theory
How does game theory explain oligopoly?
Game theory