UNIT 14 MONOPOLY Monopoly

Structure
14.0 Objectives
14.1 Introduction
14.2 Concept of Monopoly
14.3 Equilibrium in a Monopoly Market
14.3.1 Short Period
14.3.2 Long Period
14.4 Price Discrimination Under Monopoly
14.5 Monopoly and Economic Efficiency: Comparison with Perfect
Competition
14.6 Regulation of Monopoly
14.7. Let Us Sum Up
14.8 Key Words
14.9 Answers to Check Your Progress
14.10 Terminal questions

14.0 OBJECTIVES
After studying this unit, you should be able to:
• distinguish between perfect competition and monopoly
• describe short period equilibrium and long period equilibrium
• explain price discrimination under monopoly.
• appreciate the measures that government can take to regulate monopoly.

14.1 INTRODUCTION
In Unit 13, you have learnt why a perfectly competitive market is important
for a free market economy. It really enables production of commodities at
lowest possible average cost in the long period and at prices which are equal
to marginal cost of production. There is no waste of resources since
production remains at the optimum level.

When we have monopoly, all these advantages disappear. Production is

generally below optimum and the price is higher than marginal cost of
production. The monopolist controls such a substantial portion of the market
that he can dictate the price to his customers. Of course, he cannot go beyond
the limits of the demand curve nor can he charge so high a price that the
buyers are compelled to look for substitutes or his own high profits begin to
attract new rivals in the market. Within such limits, he can, however, so fix
his price that his surplus over average cost of production is maximum.

341
Theory of Price In this unit, you will learn the concept of monopoly, equilibrium of monopoly
in short and long period and price discrimination. You will also learn
monopoly and economic efficiency in comparison with perfect competition
and the ways through which the government regulates monopoly.

14.2 CONCEPT OF MONOPOLY

While discussing market structures in Unit 12, we had referred to monopoly
as a market situation with one seller only. However, such a pure or absolute
monopoly is as rare a phenomenon as pure or perfect competition. It is
possible that a particular seller commands an overwhelmingly large
proportion of the market. But it is very unlikely that he has command over
the whole market. Such a likelihood exists more in economies where the
ownership of means of production is FOR MORE CLARITY!
entirely in the hands of the state and The word monopoly has been derived from
where the Government is itself a the combination of two words i.e., ‘Mono’
and ‘Poly’. Mono refers to a single and
monopolist. This does not happen in poly to control.In this way, monopoly
mixed economy of the type we have refers to a market situation in which there is
in India. However, where natural only one seller of a commodity.
monopolies are concerned such as
suppliers of drinking water or of electricity or particular means of
communication and transport or of health, the element of monopoly can be
overwhelming.
The usual monopolies are those which do not have just a single seller but in
which one of the sellers has a large measure of control or command of the
market and, therefore, over the price at which he likes to sell his output. This
has to be contrasted with perfect competition in which a seller has no choice
in respect of the price at which he desires to sell his commodity.
We have referred to such a case as being one of normal imperfect
competition earlier. However, we should be clear that we are not referring to
absolute or pure monopoly but only to situation of a disproportionately large
seller.

The Case for and Against Monopoly

When the classical economists had suggested that the economy working
according to the principle of the free market was the best, they had clearly
implied that there would be keen competition amongst the suppliers of goods
in the market. Their idea was that once in their search for maximising their
gain, the sellers began to produce more and more of output, the situation will
serve the interests of the society best. Growing production of goods and
services will encourage division of labour, large-scale production, lower
marginal and average costs, lower prices and more wealth.

In fact, classical economists believed that things would necessarily work out
in this manner, increasing the economic welfare of both the individual and
the society, provided the market was not interfered with. Here you may ask a
question how and why the mere fact of some individual producers and sellers
making some personal gain or profit will bring about this transformation. The
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answer lies in the fact that when other people find that profits are being made Monopoly
in the production and sale of a particular commodity, they feel attracted by
the prospect of making such profit themselves. In fact, as long as profits are
made by the existing producers in the market, new producers joining the
market is a natural tendency. In consequence, the number of producers will
go on becoming larger and the competition amongst them keener with time.
You can see the advantage to the society by such a competition as each
producer will now try to outsell the other and in the process minimise his cost
of production. The gain to the society would be more division of labour,
larger scale of production, larger output, lower cost and lower prices. This is
the reason why economists have regarded perfect competition as an ideal
market situation.

The more we move away from the competitive market to the monopoly one,
the gains listed above become more unlikely. On the other hand, when fear of
competition does not exist, or has been reduced, it will lead to monopolistic
market. It is likely that the producers will not feel compulsion to go for
further division of labour or raise the scale of production or minimise the cost
or to lower their prices. Thus, the gains attributed to a free market economy
begin to disappear once we move from a competitive market to a
monopolistic one.
Economists sometimes suggest that the monopolist is an unusual creature and
may not be guided solely by profit motive. He may be given to a desire to
expand his output and his scale of production even if there are no
compulsions. You may also note that a higher profit may yield high income
while a larger scale of production provides a larger command over wealth
including capital and other assets. Thus, if a person is interested in
commanding a larger amount of economic resources, he may raise the scale
of his output by looking at this total revenue rather than on the rate of return
on his investment.

You may now ask the question; Can any producer maximise his total revenue
without keeping in mind his cost of production? In fact, a monopolist tries to
maximise his ‘net monopoly revenue’ but not really the total revenue. In this
effort, he does try to handle his cost with care. (You will study in detail about
this later in this Unit.) One of the ways in which the monopolist handles his
cost is through innovation and technological change.

What is technological change?

It is common knowledge that the different techniques of production are not
equally efficient. For example, in cooking, the cost of fuel wood is different
from the cost of kerosene. Likewise, soft coke has one efficiency, gas
another, electricity yet another and so on. A rational cook uses the technique
which helps in reducing his cost. Similarly, in all other productive activities,
different techniques have different efficiencies and costs of production
attached to them. Any rational producer, including the monopolist will
choose his technique with such a consideration in mind.

A monopolist to so change his technique of production that he is able to

control his cost not mainly because of the fears that his competitors might
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Theory of Price outsell him (he has no worthwhile competitor) but because this way he can
expand his scale of production and enjoy considerable prestige and economic
power in the market. The point to be noted is that while profit maximisation
is a desire of the monopolist like all other types of producers, he has in
addition, some other motive as well.

There can be various reasons why a producer turns a monopolist. There are,
as has been pointed out, natural monopolies resulting from exploitation of
some minerals located in small geographical areas-say a mineral like gold-
and it may not be meaningful for a large number of producers to mine and
exploit a small area. At the other end of the spectrum, there would be the
supply of a service like clean drinking water for which extensive network of
pipes is to be laid down. This is a job in which duplication by many
producers will be extremely wasteful.

Apart from natural monopolies, there are those which result from grant of
patents or other legal protections. Sometimes, the government provides
exclusive rights to particular companies to trade in particular areas and this
leads to emergence of monopoly. Lastly, there can be monopolies resulting
from progress in technology, evolution of new techniques and methods of
production or new products. It is possible that a particular firm or enterprise
has evolved a method of producing a particular commodity which no one else
knows about and this enables it to become a monopoly.

Whatever may be the reasons for the emergence of monopolies, their

existence is a departure from the conditions which perfect competition
considers ideal for society's welfare. However, there is one advantage which
could go in the favour of a monopolist. Monopolist seeking innovation and
technological change is an advantage to society. It may not be easily
available from perfect competition. It may be noted that innovation is an
activity which involves large expenditure and, therefore, requires a risk
which the monopolist may take but the perfect competitor may not. As you
know in perfect competition a producer controls an insignificant proportion
of the market and operates on a slender margin of profit. Beyond his normal
profit, he does not earn any surplus in the long period. He may, therefore, not
be able to commit large resources to innovation.
We can, therefore, say that monopoly is not an unmixed evil. And even
though the monopolist has power to manipulate his price and exploit his
buyers, he works for large-scale production and division of labour and
technological progress. He may be able to supply the commodity at a price
which is lower than the price which prevails under perfect competition. The
question, however, is whether the monopolist will work in these directions.
There is nothing inherent in the structure of the monopoly market which
would suggest monopolist will necessarily work in these directions.

Does monopoly lead to mis-allocation of resources?

Another point that has to be kept in mind and which reflects rather
unfavourably on monopoly vis-a-vis competition is that monopoly tends to
distort optimum allocation of resources. In perfect competition, as you know,
price is equal to marginal cost of production, at the point of optimum
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production. In such situations, the producer is unable to make any gains at the Monopoly
cost of his buyers. Not merelythat since all producers will be doing the same,
there will be no tendency for resources to flow from one producer to another
and conditions of optimum production all around will obtain. However, in
monopoly, prices never equal marginal cost. It is always higher. In monopoly
also marginal revenue and marginal cost have to be equal for a profit
maximising equilibrium. However, since average revenue (that is, price) will
necessarily be higher than marginal revenue, price will automatically be
higher than marginal cost. The resources are best allocated only when price is
equal to marginal cost and not when price is more than marginal cost. Hence,
allocation of resources in monopoly would be less than optimum. So we can
say that monopoly leads to allocation of resources.

As monopoly leads to mis-allocation of resources, governments have to

evolve measures of economic policy which are anti-monopoly. They may, as
in India, impose restrictions on the total investment which the monopolist can
make. They may also regulate the price or control his attempt to influence the
market through exaggerated or misleading advertisements. After all, when
the monopolist charges higher price than the marginal cost of production, he
earns surplus, which in conditions of competition would have really gone to
the buyers. Therefore, by compelling the monopolist to keep his price in
check the government reduces his surplus to benefit the society at large. Of
course, because of government's interference, he may desist from research
and innovation and thereby produce a higher cost situation. He may also not
expand his production further and cause an adverse impact on employment
and income generation.

14.3 EQUILIBRIUM IN A MONOPOLY MARKET

We have discussed the concept of monopoly. Now let us study how the
monopolist's equilibrium is determined.

As the monopolist is in a position to influence the market; he becomes a

price-maker, and not a price-taker. He is not helpless to accept the price that
is ruling in the market. He can, depending on the power or influence that he
has, change the price. There is another important characteristic of monopoly.
A monopolist does not have to fear and, therefore, bother about the price of
other commodities in the market because theoretically there would be no
substitute for his commodity. In fact, it is because of this reason, he enjoys
the power to influence the price. When we say that the monopolist can
determine his own price, it does not mean that he can determine whatever
output he wants and charge whatever price he likes. That obviously is
impossible. If the monopolist chooses to fix his price, he will have to keep
output flexible and decide upon only that output which can be sold at that
price. On the other hand, if he chooses to fix his output, he cannot decide his
price to sell that output. Thus, in spite of the fact that the monopolist is a
powerful producer, he cannot produce as much as he wants and also charge
whatever price he likes. He can either decide his output and let the price be
determined by the requirements of equilibrium or decide the price and let his
output be adjusted accordingly.
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Theory of Price But where exactly should the equilibrium price be determined? As in case of
Perfect competition, here also, the time element in respect of which
equilibrium has to be determined will be an important factor. In case, we are
determining equilibrium price for a short period, there will be one type of
consideration while in case of a long period, there will be another type. Let us
first consider the short period.

14.3.1 Short Period

First of all, a general statement about the situation in respect of the supply
curve of a monopolist may be made. In monopoly, the marginal cost curve
will not be the supply curve. We have already described the supply curve of a
producer as one which indicates various amounts of the commodity that are
intended to be supplied at various expected prices. We had also said that the
producer will like to keep in mind his cost of production, particularly
marginal cost so that (provided the price was such that he was compensated
for the marginal cost corresponding to the intended supply) he would regard
that supply as worthwhile. On this premise, the producer's marginal cost
curve could be treated as his supply curve.

In case of a monopolist, however, price is not equal to marginal cost of

production. Therefore, he will not consider himself as having been properly
compensated if he expected a price which was equal to marginal cost. For
this reason, his marginal cost curve cannot be taken to be his supply curve.

There is another aspect related to the matter of the supply curve in monopoly
which derives from the fact that as the monopolist can influence the price of
his commodity, his main interest will be in the demand curve that he
encounters in the market. We have already noted that the monopolist does not
have unlimited powers in respect of his price. He can charge the price subject
to the limits of the demand curve which he faces, the more sloping is the
demand curve which he faces, the more sharply he can vary or change his
price. On the other hand, with a flatter demand curve, the variability in price
will be smaller. The monopolist cannot charge a price which is outside these
limits.

This suggests that elasticity of demand for the monopolist's product will be
an important factor enabling him to influence the price. This does not
however mean that (only when the elasticity of demand is zero or less than
one) the monopolist will be able to charge a higher price. In order to be able
to understand this statement look at Figure 14.1 where a demand curve has
been shown.
It is clear from the above figure that as long as the monopolist's equilibrium
is determined at any point above E1 the price that he would charge would be
higher but the elasticity of demand of the product will also be more than one.
In fact, if we were to move down in some point below E the equilibrium price
would be very low and also the elasticity of demand will be much less than
unity. Thus, it would not be correct to suggest that it is only when the
demand is inelastic that the monopolist is able to charge a higher price.

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 Monopoly

Figure 14.1 : Monopolist's Equilibrium and Elasticity of Demand

Look at Figure 14.1 where at point E2 ,marginal revenue will be negative and
equilibrium will not be possible. In fact, even at point E3 where the marginal
revenue is zero, equilibrium will not be possible because it would imply that
the marginal cost of the monopolist is zero (equilibrium necessarily means
equality between marginal revenue and marginal cost) which is a ridiculous
situation.
We will thus see that the monopolistic equilibrium leading to the charging of
a higher price is best determined when the elasticity of demand for the
product is either equal to or greater than one but not so low as to be zero or
near zero.

Having seen thehe importance of the demand curve and the elasticity of demand
for the product, we may now refer to the kind of considerations that
characterise the determination of monopoly price in the short period. The
monopolist would not accept a price which does not cover his average
variable cost of production. In case the price is less than average variable
cost, his total revenue will be less than his total variable cost. In such a
situation, he will prefer not to produce the commodity.
This, of course, is possiblee when his price is equal to average variable cost
and he, therefore, continues to produce the commodity. The prices can be
either equal to or lower than or higher than his average cost (average of both
the fixed and variable costs). If the price is equal to average cost, total
revenue is equal to total cost (both variable and fixed) and monopolist will
neither be suffering a loss nor earning a surplus. On the other hand, if his
price is more than average cost, his total revenue will be more than total cost
and he will be making abnormal gains. The monopolist will be suffering a
loss only when the price is less than average cost of production and,
therefore, the total revenue is less than total cost.

347
Theory of Price The thing that has to be kept in mind is that the average and marginal cost
curves that will help in determining monopolist's equilibrium price will both
relate to a short period. Look at
Figure 14.2 where equilibrium characterised by abnormal gains has been
shown.

Figure 14.2 : Short Period Equilibrium under Monopoly by Abnormal gains

Look at Figure 14.3 where equilibrium characterised by losses has been

shown.

Figure 14.3 : Short Period Equilibrium under Monopoly by Losses

Look at Figure 14.4 where monopoly equilibrium characterised neither by

abnormal gains nor by losses has been shown.

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 Monopoly

Figure 14.4 : Short Period Equilibrium under Monopoly neither by Abnormal Gains or
any Losses

Remember that in all cases of equilibrium, the marginal cost curve has to cut
the marginal revenue curve from below otherwise as was pointed out, in Unit
12, the equilibrium achieved will not be stable. Further, the short period
equilibrium is at all one which has to remain valid only for a short period and
in course of time, shouldd change. It is because of the possibility of change
(one short period gives way to another) that the monopolist in spite of all his
power, will tolerate losses or a no-profit
profit-no-loss situation.

14.3.2 Long Period

In the previous discussion, we analysed short period equilibrium of a
monopolist suggesting that it could be characterised by either loss or profit or
by no-profit no-loss
loss situation. However, there is no question of a monopolist
suffering losses or his being in a no
no-profit no-loss situation in the long period.
After all, as a monopolist he has some influence on the price and he is bound
to use the influence at least in the long period such that he earns a surplus
over his cost of production.
How do we determine the monopoly price which reflects the real power of
the monopolist? Alfred Marshall raised this question and tried to answer it in
his own way. He said the equilibrium price of the monopolist in the long
period will have to be one which gave him maximum net monopoly revenue.
According to him,
im, net monopoly revenue corresponding to a given output is
the difference between total revenue and total cost for that output. Look at
Figure 14.5 where at OQ output and PQ price the total revenue would be OQ
� PQ.

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Theory of Price

Quantity

Price

Figure 14.5 : Long Period Equilibrium under Monopoly

On the other hand, since QC is the average cost corresponding to OQ output,

QC�OQOQ would be the total cost. We can thus say that (PQ (PQ�OQ) minus
(QC�OQ)
OQ) the shaded area in Figure 14.5 is the net monopoly revenue.
Marshall's view was that only where this difference was maximum, the
monopolist will be in equilibrium in the long period. The output
corresponding to which the difference was the maximum would indicate not
only what should be produced bu
butt also the price at which it would be sold in
the market. Both the output and price assuring maximum net monopoly
revenue will have been determined.
How is the position of maximum net monopoly revenue to be found out?
Marshall had suggested that the monopo
monopolist
list would do that through a process
of trial and error. Look at Figure 14.6 in which a number of outputs can be
considered along with their prices and average costs and the difference
between total revenues and total costs thus sound out.

Figure 14.6 : Long Period Equilibrium Under Monopoly with various Output
350
The net monopoly revenues for these outputs OQ1OQ2 and OQ are AC1, P1,F, Monopoly
BCPE and GC2 P2D respectively. Since the rectangle BCPE is the largest,
the. monopolist will produce OQ output and charge PQ price.
Post Marshall economists say that the long period equilibrium of the
monopolist can be found through intersection of marginal revenue and
marginal cost curves, which has been shown in Figure 14.7.

Figure 14.7 :Long Period Equilibrium Under Monopoly by Marginal Revenue and
Marginal Cost Curve

It can be seen from Figure 14.7 that corresponding to the point where
marginal revenue is equal to marginal cost, the monopoly output is sold at a
price which is higher than the average cost of production. And so he
necessarily earns a surplus. Not only that, since marginal revenue is equal to
marginal cost, profit is maximum. The surplus of the monopolist is also
maximum here.
In the short period at the point of intersection of the marg
marginal revenue and
marginal cost curve, the price of his commodity turns out to be higher than
the average cost, he makes a profit, he may prefer to remain at the same
position of equilibrium in the long period as well.
If he does that, the short period equi
equilibrium will also become his long period
equilibrium. He would not like to change because there is no compulsion to
do so. Look at Figure 14.8 where long period equilibrium of a monopolist has
been shown.

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Theory of Price

Figure 14.8 :Long Period Equilibrium Under Monopoly showing Maximum Net
Monopoly Revenue

Check Your Progress A

1) What do you mean by technological change?
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2) Differentiate between Short Period and Long Period Equilibrium under
monopoly.
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352 ……………………………………………………………………………
3) State whether the following statements are True or False. Monopoly

i) Besides profit maximisation the monopolists have some other motive as

well. ii) In monopoly marginal revenue and marginal cost have to be
equal for a profit maximising equilibrium.
iii) Monopolists are the price-takers and not the price-makers of the market.
iv) In monopoly, the marginal cost curve is equal to the supply curve.
v) The monopolist will not accept a price which does not cover his average
variable cost of production.

14.4 PRICE DISCRIMINATION UNDER

MONOPOLY
Price discrimination means that for the same commodity the price charged
differs from buyer to buyer as from market to market. Charging different
prices from different buyers or different groups of buyers or from different
markets is not uncommon. Lawyers or doctors can charge different fees from
different clients. Likewise, a producer can sometimes charge a lower price in
one market and higher one in another. The phenomenon of dumping in
international trade is an example of price discrimination.

The two conditions which need to be satisfied if price discrimination is to be

practised are: (i) The supplies of the commodity purchased at a lower price
should not be resalable at a higher price, and (ii) demanders paying a higher
price should not be able to transfer their demand to the market where price is
lower. It is obvious that if these conditions do not obtain, price discrimination
would not be possible. If buyers at a cheaper price can resell the commodity
to those being made to pay a higher price, why should the latter agree to pay
a high price at all? In such a situation, the seller would just not be able to
enforce a differential system of prices. Likewise, if buyers facing a higher
price can transfer their demand to a lower price market, the higher price
market would cease to exist and only one price will rule everywhere.

While ‘no resale' or ‘no transfer of demand' is a necessary condition for price
discrimination, they are not sufficient for inducing the practice. In order that
a producer does in fact charge different prices for a given commodity, he
should be assured that this way he is able to maximise his profits as well.

Of course, maximisation of profits requires equalisation of marginal cost and

marginal revenue. How shall we interpret these two variables now that we
have two markets instead of one? Shall we have two marginal cost curves
and two marginal revenue curves? The answer is we will have one marginal
cost curve and as many marginal revenue curves as there are markets in
which different prices are to be charged, so that if we are considering two
markets we shall have two marginal revenue curves, and so on.

Let us first understand why only one marginal cost curve would be
meaningful. What needs to be appreciated is that a producer would not put up
market-wise production units otherwise he will deprive himself of the
advantage of economies of scale for supplying the commodity to the two
353
Theory of Price markets. He will rather produce at one place (unless there are some very
special local advantages in respect of factors of production used) and then
distribute his supplies market-wise. And since there will be one aggregate
production for both the markets, there will be only one marginal cost curve to
be considered for determining the point of maximum profit.

However, different markets are supposed to have different demand curves. In

fact, it is because the demand curves in the markets being considered are not
identical i.e., they are not having the same elasticity of demand at the same
price, that the monopolist would be able to charge different prices in different
markets. Thus, as we come to the demand side of the picture, we will have to
postulate that the elasticity of demand for the commodity being supplied by
the monopolist is different in different markets.

Now since the demand curves are different, the average revenue curve, being
another name for the demand-price curve, will also be different in different
markets. Following this, the marginal revenue curves will also be different.
Since for reasons of analytical convenience, we are assuming two markets,
we will have two marginal revenue curves to consider along with just one
marginal cost curve. What is it that we have to do next?
Step one, is to first determine the aggregate output at which marginal cost
would be equal to marginal revenue. But how do we know the marginal
revenue for an aggregate output for the two markets? The answer is simple:
we just add up the individual marginal revenue curves of the two markets.

b
M P
Price

a
M
MR AM
MR c
Q 11 Q12
1
O Quantity Q Q
Q
u
Figure 14.9 : Price Discrimination Under Monopoly

The procedure for summation is that we take the demand in market 1

corresponding to a given marginal revenue and then the demand in market 2
corresponding to the same marginal revenue, add up the two demands and
show the aggregate with a point corresponding to the given marginal revenue.
Look at Figure 14.9 where at OM1 marginal revenue, the demand in market 1
is OQ2 while at the same marginal revenue the demand in market 2 is OQ1.
We then add up OQ to OQ and get a sum like OQ1, being the demand for an
aggregate output for the two markets, corresponding to OM. In other words,
OQ1,=OQ11, +OQ12,,. I Let the point showing the situation be ‘a'. Likewise
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we can consider marginal revenue OM2, and the aggregate output OQ2 Monopoly
corresponding to this marginal revenue. We then get another point 'b': and so
on. By joining the points a, b,...... etc., we get the curve which shows
marginal revenues at various aggregate
egate demands of the two markets.
Step two. Where ‘aggregate' marginal revenue curve intersects the marginal
cost curve, the monopolist's equilibrium will show maximum profit from the
two markets. We fix this point of intersection at M. Study Figure 14.10
carefully

Step three. Once the aggregate ou output in the two markets has been
determined, we have only to work out the distribution within the limits of the
demand curve pertaining to each of the two markets.
Step four From the point of intersection of the aggregate' marginal revenue
curve and the marginal
arginal cost curve, we draw a horizontal straight line cutting
the marginal revenue curves of market 1 and market 2 at points M1 and M2.
Step five At point M1 we draw a vertical line P, S, from the demand curve of
market 1. Likewise at point M1 we draw a vertical straight line P,S, from the
demand curve of market 2

OS1, will be the output supplied by the monopolist in market 1 at price P1, S1,
and ..:: OS2, the output supplied in market 2 at price P2,S2.
It may be noted that in market 1, the marginal revenue is MS, which is the
same as the marginal cost MS. By drawing a horizontal straight line from the
point of intersection of ‘aggregate' marginal revenue and marginal cost curve
i.e., M we have assured that MS, = MS i.e., in market 1, marginal revenue is
equal to marginal cost. Likewise, we can see that in market 2 also, marginal
revenue M11S2 = MS, the marginal cost.

Figure 14.10 :Price Discrimination of Monopolists Showing Maximum Profit

355
Theory of Price The significant thing that is to be noted is that price P1,S1,, of market 1 is
different from price P2,S2, of market 2. That is why it is a case of price
discrimination
discrimination-same
same commodity, same producer but two different prices
because the demand curves in the two markets have different elasticities.

14.5 MONOPOLY AND ECONOMIC

EFFICIENCY: COMPARISON WITH
PERFECT COMPETITION
We have already noted that price in monopoly is not equal to but higher than
marginal cost of production. Suppose it so happens that an industry which
had a large number of firms comp
competing
eting with one another gets monopolised.
Then the same falling demand curve earlier that of the competitive industry
will now be faced by the monopolist.
This demand curve becomes his price or average revenue curve and
corresponding to this average revenue curve, there is a marginal revenue
curve sloping downward but

Figure 14.11 : Short Period Equilibrium of an industry

would be lying below the average revenue curve. Another point to be noted is
that the marginal cost curve of the monopolist may either be the same as in
the case of competitive industry or different. If it is different (and there could
be valid reasons for the difference) it will have its own implications for the
equilibrium of the monopolist. However, if the margina
marginal cost is the same, the
total output supplied by the monopolist would be lower than what the
competitive industry would have supplied. (competitive industry's
equilibrium would have taken place at point P where the price is equal to the
marginal cost of pr
production.)
oduction.) The monopoly price Q1P1 will be higher than
the competitive industry's price QP.
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It may, however, be repeated that the higher monopoly price and the lower Monopoly
monopoly output (as compared to what could happen in conditions of perfect
competition) are due to the fact that the marginal cost curve of the
monopolist has been assumed to be the same as that of the competitive
industry.

Marginal cost, after monopoly has replaced competition can be different, for
the following reasons:

1) In perfect competition, there are a number of producers each managing

with a smaller output and, therefore, a smaller scale of production. In
monopoly, the output supplied are large and therefore, scale of
production will be very much larger.

2) Secondly, since there will be centralised organisation for production and

sale now, there will be further economies in cost available to the
monopolist.

3) The monopolist is given to innovation which he can afford better than

the perfect competition. Because of his larger turnover from larger
output, he can further reduce his cost by adopting better techniques of
production.

Thus, it is not always true that monopoly would result in a higher price and a
lower output.

There are other reasons also why monopoly price may not be higher than
price under perfect competition.
The monopolist may be afraid that if he charged high price, the consequent
surplus that he would earn may induce potential producers to try to produce if
not the same, then a similar commodity. In such a situation, the monopolist's
own sale and profit could be adversely affected. Therefore, the monopolist
may avoid charging a higher price for his commodity. Secondly, the
monopolist may have a name and prestige resulting from his command over
resources which he would not like to see spoiled by the impression that
would go round that he was a greedy, profit-seeking person. In order not to
be known as a producer out to exploit his customers, he may keep his price
low.

Thirdly, the monopolist could as well compel Government intervention to

regulate his price if he showed any tendency to exploit his customers. Thus, it
is as much likely that monopoly price is the same or lower than competitive
price as that may be higher. For that reason, it is as much likely that the
monopoly output is the same or higher than that in competition as that is
lower. Even if monopoly price is lower and monopoly output higher than in
perfect competition, can we say that monopoly is an efficient form of market
structure? The answer is ‘no’ for two reasons.

Firstly, since the monopoly price is always higher than marginal cost of
production, the monopolist gains at the cost of his customers. We have
already seen that in conditions of perfect competition, the producer earns no

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Theory of Price surplus at the cost of his customers because he keeps his price equal to
marginal cost.

Secondly, monopoly suffers from what may be described as technical

deficiency. This is due to the fact that in all conditions of imperfect
competition including monopoly, equilibrium tends to take place when the
average cost of production curve is falling rather than rising. In such a
situation equality between marginal revenue and marginal cost (as a number
of previous diagrams explaining equilibrium would show) necessarily takes
place before the lowest point of the average cost curve i.e., before the
optimum point. This means that monopoly output is generally less than
optimum output. Further, this would suggest that the average cost of
producing the commodity is higher than what it could be. This also shows
that the resources are not being optimally exploited and to the extent that this
is so, they are idle and being wasted.

14.6 REGULATION OF MONOPOLY

In view of the fact that the monopolist has a tendency to charge a price which
is higher than the marginal cost, the Government may regulate monopoly
price to prevent exploitation of the consumer. What happens if the
Government does that? Look at Figure 14.12 where P1, Q1, is that price
which a monopolist is charging at present and suppose further that the
Government forces the monopolist such that his price is now P2Q2. We can
easily see that not only the new price is much lower than the old one and the
new output OQ2, is higher than the old output OQ1, but also that the new
regulated price is one which is equal to the average cost of the monopolist.
This implies that his total revenue is equal to the total cost of production and,
therefore, he is not making any profit at the expense of the customers. This
price will certainly be in the interest of the consumers but it will still not be
like the one in perfect competition. In perfect competition price is equal to
marginal cost of production whereas in the diagram below that is not so. In
fact, even though the monopolist is not earning any abnormal profit, the price
is higher than the marginal cost. It is possible for the Government to bring the
price down to the level of marginal cost and fix it at the point P3. However,
in that case the monopolist will remain in a state of permanent loss because at
P3 ,the average cost of production is higher than the marginal cost and since
the price has been made equal to marginal cost, total revenue will be less than
total cost of production. Unless, a method is devised to compensate the
monopolist for this loss, he may as well stop production. The only way in
which Government can regulate monopoly, if it is desires that the consumers
do not pay a price higher than marginal cost of production is for it to provide
a subsidy to the monopolist. However, the provision of subsidy may have
other problems. But when subsidies are financed through deficit financing,
inflation would occur and this would inflict losses on the consumer in other
ways. Provided subsidies are financed through taxes, this also would affect
consumers adversely unless a neutral scheme of taxation for the purpose has
been devised, which is not quite easy.

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 Monopoly

Figure 14.12 :Regulation of Monopoly

Check Your Progress B

1) What do you mean by Price Discrimination?
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2) Distinguish between monopoly and perfect competition.
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3) State whether the following statements are Trueor False.
i) Maximisation of profits requires equalisation of marginal cost and
marginal revenue.
ii) Different markets are supposed to have different demand curves.
iii) In monopoly price is lower than the marginal cost of production.
iv) Monopoly output is generally less than optimum output. 359
Theory of Price v) Government may regulate the monopoly price because monopolist
has a tendency to charge a price which is higher than the marginal
cost.
4) Choose the appropriate answer among the following alternatives.
i) The monopolist has command over
a) whole market
b) small market
c) large market
d) none
ii) Monopolist is a
a) price taker
b) price maker
c) one who does not bother about the price of the market
d) one who is very much anxious about the market price.
iii) The price under monopoly is
a) higher than marginal cost of production
b) lower than marginal cost of production
c) higher than average cost of production
d) lower than average cost of production.
iv) In the imperfect competition including monopoly equality between
marginal revenue and marginal cost takes place
a) at the optimum point.
b) after the optimum point.
c) before the optimum point.
d) at any point.

14.7 LET US SUM UP

While perfect competition is the ideal, monopoly is a fact of life. In actual
life, we do not have perfect knowledge, perfect mobility, etc., and, therefore,
individual producers are not as helpless to influence the price of their
commodity as they are when these conditions are present. Nor is the number
of sellers in a market always so large that an individual seller may control
just an insignificant proportion of the total market.

While the forces helping to determine equilibrium price in monopoly are the
same as in perfect competition, namely, those of demand and supply, their
relative roles do change in between these two markets. For example, the
marginal cost curve which plays such a vital role in perfect competition,
ceases to be that important. It no longer serves as a supply curve because
price charged by a monopolist always tends to be higher than marginal cost.
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Thus the only use of the marginal cost curve is that it helps to fix up the point Monopoly
of intersection between itself and the marginal revenue curve. The
monopolist takingadvantage of his monopoly power likes to fix his price in a
way that his net monopoly - revenue is maximum. And such a price can be
only the one at which marginal revenue is equal to marginal cost. So a
marginal cost curve is necessary for determining a monopolist's equilibrium
but it does not truly serve as his supply curve.

Maximum net monopoly revenue, however, is something which a monopolist

must earn in the long period. In the short period, he could as well suffer a loss
in case at the point of equality of marginal cost with marginal revenue, the
average revenue was lower, than average cost. However, in the long period
the monopolist can so act on the cost and revenue curves that he is able to
reach a position of maximum net monopoly.
Monopoly leads to production which is less than optimum. To that extent,
therefore, it is inefficient, wasteful and harmful to the interest of the
consumers and the society. That is why Governments in modern economies
like to regulate the function of monopolies.

14.8 KEY WORDS

Aggregate Marginal Revenue: The marginal revenue corresponding to
aggregate demands of two or more than two markets under discriminating
monopoly.

Monopoly: The state of the market in which one seller has a

disproportionately large measure of control or command of the market and,
therefore, over the price at which he likes to sell his output.

Natural Monopoly: The situation in which it is so natural for a producer to

become a monopolist. Suppliers of drinking water or electricity are examples
of a natural monopoly.

Net Monopoly Revenue: The difference between total revenue accruing to a

monopolist from a given output and the total cost of that output.

Price Discrimination: The kind of a monopoly situation in which the

monopolist is able to charge different prices for the same commodity from
different buyers in the same market or in different markets or different prices
even for different units of the commodity from the same buyer.

14.9 ANSWERS TO CHECK YOUR PROGRESS

Check your Progress A
3 i) True ii) True iii) False iv) Falsev) True

Check your Progress B

3 i) True ii) True iii) False iv) True v) True

4 i) c ii) b iii) a iv) c

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Theory of Price
14.10 TERMINAL QUESTIONS
1) What is monopoly? How does this concept differ from that of perfect
competition?
2) Explain the case for and against monopoly.
3) What is net monopoly revenue? When is it that it is maximum?
4) Explain the determination of a monopolist's equilibrium in the long
period.
5) How will be the equilibrium be determined under degree of price
discrimination in monopoly
6) Explain with a simple diagram how government can attempt to control
the price charged by a monopolist.

Note: These questions and exercises will help you to understand the unit
better. Try to write answers for them. But do not send them for
assessment to the university. These are for your practice only.

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