What is Monopoly?
A monopolistic market is a market comprising a single seller selling a unique product. In a monopoly market, the seller, by definition, has no competition because there is no other seller of goods with a close substitute.
Features of Monopoly
- Single seller
- No close substitutes
- No entry
- No distinction between firm and industry
- Downward-sloping and less elastic demand curve
A monopolist can raise sales by cutting price. If the monopolist controls price, then the quantity sold depends on demand in the market. Demand is less elastic owing to the lack of close substitutes, because of which, the cross-elasticity of demand is almost nil.
The steeper demand curve implies that a price change influences sales only marginally, indicating low demand elasticity.
Short Run equilibrium
A monopolist can control either price or output, but not both simultaneously. A monopolist decides output based on equilibrium conditions, that is, point E, where MC intersects MR.
Output = OQ
Price = OP
TR =OQTP (output × price = OQ × OP = OQTP )
TC =OQSN (output × average cost = OQ × QS = OQSN)
TR > TC
Excess profit = NSTP
A monopolist is not guaranteed excess profit, and such an entity may even operate at loss. A monopoly firm incurs fixed and variable costs. It is essential to cover variable costs to ensure the firm can function.
Price = OP
TC = OQTL
TR = OQSP
TFC = NMTL
TVC = OQMN
TR < TVC
Loss = PSTL
The loss is only a part of TFC. The fact that the firm’s TR >TVC enables it to not only cover its TVC but also cover a part of its TFC (NMSP).
In the long-run, a monopoly firm makes all required adjustments.
Given that all costs can vary in the long-run, the firm’s TR should be equal to its TC. Long-run equilibrium output is produced at the point where the long-run MC curve intersects MR.
In the long run, a monopolist firm usually earns excess profit. Long-run output of firm is represented by OQ
Price is OP
Total revenue is represented by area OQTP
Total cost is represented by area OQSN
TR is more than TC
there is an excess profit represented by area NSTP
It is likely that a monopolist may settle for normal profit only.
Insufficient product demand may lead to such an outcome.
The distinction between Perfect Competition and Monopoly
|No. of sellers||Large ||Single
|Commodity||Homogeneous ||Homogeneous or unique
|Market position||Price taker||Price maker
|Nature of demand||Perfectly elastic (horizontal line)||Less elastic (downward sloping)
|AR and MR||AR = MR||AR > MR
|Production ||Optimum||Usually less than optimum
|Long-run profit||Normal ||Excess
|Equilibrium and nature of cost||Equilibrium is possible only under increasing cost||Equilibrium is possible only under all cost conditions - increasing, constant and decreasing
|Relationship b/w price (AR), MR, MC and AC in the long run with normal profit||Price = AR = MR = AC = MC||Price = AR = AC > MC = MR
|Nature of price||Single price||Price discrimination
Monopolistic competition is a market scenario in which there are multiple sellers offer a particular type of product but each seller’s product is distinct in some way in the consumers’ minds.
The features of such a market
- Large number of buyers and sellers
- Product differentiation
- Free entry and exit of firms
- Close substitute products
- Firms promote sales by incurring selling costs
- The demand curve of each firm is downward sloping and comparatively more elastic.
- Multiple popular and seemingly similar soaps are sold in the market: Lux, Haman, Liril, Johnsons, Pears and Dove.
- Although this paints a picture of perfect competition, the reality is different.
- All products are different from the others in one or another.
- Lux is sold as beauty soap, Dove as one for soft skin, Liril as a freshness soap, Johnson’s as baby soap and so on.
- Thus, all brands have their own markets, and the overall market is one of monopolistic competition.
- A company’s short-run equilibrium rests on the following assumptions:
- The company is rational.
- It operates under the U-shaped average cost curve.
- The demand for its product is downward sloping, that is, quantity sold and price are related inversely.
- There is no additional variation in the company’s products.
- In the short-run, the company may operate with excess profit, normal profit or loss.
A firm’s equilibrium output lies at a point where MC = MR and MC is growing.
For total output OQ and a given demand line (AR), the price arrived at based on demand and supply is OP, and this price gives the firm the most profit.
Any increase in price may cause customers to turn to other substitutes, leading to a drop in total revenue.
Lowering the price may bring in additional customers by luring them away from rivals. However, the additional quantity sold may not be enough to generate sufficient revenue to compensate for the loss accrued by lowering prices.
TR = Price ×Output = OQ × OP = OQMP
TC = Average Cost ×Output = QS × OQ = OQSN
Excess Profit= TR – TC = OQMP – OQSN = NSMP
SAC is located above the demand line (AR).
The firm’s position can be explained as follows:
Output is represented by OQ
Price is OP
AC = QH
TC = OQ × QH = OQHG
TR= OQ × OP = OQNP
Loss is shown by area PNHG
The firm incurs loss because its Total cost is more than total revenue
So long as the firm covers its TVC, it may continue to operate. The firm’s TR must not be lower than its TVC.
In the long run, a firm that cannot recoup all costs will cease to operate in the market.
Excess profit earned by existing firms will draw a greater number of firms producing close substitutes, which would diminish the market share of the existing firms.
The demand curves of the existing firms will be lowered and prices would drop as well.
Free entry and exit would leave the remaining firms with no more than normal profits.
Tangency of AC to AR at S gives the firm only normal profit.
Output = OQ
AC = QS
Total cost is shown by area OQSP
Total revenue is shown by area OQSP
Normal profits is total revenue which is same as total cost
In monopolistic competition, the concept of the industry is not relevant owing to the wide variety of products. However, although these products are from the same industry, they are not in direct competition. A group characterized by monopolistic competition offers products that are close substitutes. It will be in equilibrium in the long-run when all group firms earn normal profits.
The difference between cost and demand resulting from product differentiation may allow a firm to earn a different profit amount. To avoid such problems, Chamberlin laid down two conditions or ‘heroic assumptions’.
Both demand and cost curves for all products are the same.
The effects of an individual firm’s actions in terms of price and output adjustment are negligible on its rivals.