Monopoly

Meaning and Features of Monopoly

Monopoly sits at the opposite end of the competitive spectrum from perfect competition: it is a market structure in which there is only one seller of a product that has no close substitute, so that the firm effectively is the entire industry. The word comes from the Greek "monos" (single) and "polein" (to sell). Examples in India traditionally include public utilities such as electricity distribution or piped water supply in a given area, and, before liberalisation, several public-sector undertakings that were the sole legal supplier of a good or service.

Monopoly is defined by the following features:

1. Single seller, single control — one firm controls the entire supply of the good; "firm" and "industry" become the same thing, since there is no other seller to compare it with.
2. No close substitute — the product has no reasonably similar alternative that buyers could switch to if the monopolist raised its price; this is what truly insulates the monopolist from competition (a firm may be the only seller of a very specific brand, yet still face real competition from close substitutes — that firm would not be a true monopolist in the economic sense).
3. Price maker — because it faces the entire market demand curve alone, the monopolist can choose either the price it charges or the quantity it sells (but not both independently) — a sharp contrast with the price-taking firm under perfect competition.
4. Barriers to entry — some barrier prevents new firms from entering and competing away the monopolist's position: a legal barrier (patent, licence, government franchise), a natural barrier (sole ownership of a scarce input, such as a unique mineral deposit), a technological barrier (very large economies of scale making it uneconomical for a second firm to enter — sometimes called a "natural monopoly", as with a citywide water-pipe network), or simply a very large capital requirement that few can meet.
5. Downward-sloping demand curve for the firm — since the monopolist's demand curve is the market demand curve, it slopes downward exactly like a normal market demand curve: to sell a larger quantity, the monopolist must lower the price on all units sold (assuming a single uniform price), not just the extra units.
6. AR lies above MR at every output — because cutting the price to sell one more unit reduces the revenue earned on all the earlier units too, the Marginal Revenue from each additional unit is always less than the (average) price at which it is sold; the MR curve lies below, and falls faster than, the AR (= demand) curve.

Price-Output Determination under Monopoly

Like any profit-maximising firm, the monopolist produces the output at which Marginal Revenue equals Marginal Cost ($MR = MC$). But because the monopolist's AR curve slopes downward (unlike the horizontal AR of a perfectly competitive firm), the price it can charge for that profit-maximising output is read off the AR (demand) curve above the MR = MC point — and this price is always greater than Marginal Cost, i.e. $P > MC$, in sharp contrast to $P = MC$ under perfect competition.

<!-- FIGURE-NEEDED: Single-panel price-output determination diagram for monopoly. Price/Cost on Y-axis, Quantity on X-axis. Draw a downward-sloping Average Revenue (AR) / demand curve; below it, draw a steeper downward-sloping Marginal Revenue (MR) curve starting from the same Y-intercept as AR; draw a standard U-shaped Marginal Cost (MC) curve and a U-shaped Average Cost (AC) curve below it. Mark equilibrium point E where the MC curve cuts the MR curve from below, giving equilibrium output OQm (drop a vertical line to the X-axis). From E, draw a vertical line up to the AR curve at point P, giving equilibrium price OPm (horizontal line to the Y-axis) — visibly above the MC/MR intersection level. Shade the rectangle between the AR curve and the AC curve at output OQm (from the AC value up to price OPm) to represent supernormal (monopoly) profit. -->

Because entry is blocked, this supernormal (monopoly) profit is not competed away the way it would be under perfect competition — a monopolist can, in principle, go on earning above-normal profit indefinitely, in both the short run and the long run, as long as the barrier to entry remains effective. (If demand and cost conditions are unfavourable, a monopolist can also make losses in the short run, exactly like any firm — being a monopolist guarantees market power, not automatic profit.)

Price Discrimination

Because a monopolist has full control over price, it is often able to practise price discrimination — charging different prices for the same product to different buyers or in different markets, where the price difference is not justified by any difference in the cost of supplying them. Price discrimination is profitable for the monopolist mainly when (a) the separate markets can genuinely be kept apart, so that a buyer paying the lower price cannot resell to a buyer facing the higher price, and (b) the elasticity of demand differs between the markets — the monopolist then charges a higher price where demand is less elastic (buyers are less price-sensitive) and a lower price where demand is more elastic (buyers are more price-sensitive), extracting more total revenue than a single uniform price would allow.

Common bases on which price discrimination is practised include:

• Personal — different prices charged to different individuals based on their perceived ability or willingness to pay (a doctor charging a wealthier patient more than a poorer one for an identical consultation). …