4.3.1. Monopoly:
Monopoly is a market in which a single seller sells a product or service which has no substitute. Economists distinguished between pure monopoly and monopoly. Pure monopoly is that market situation in which there is absolutely no substitute of the product, and the entire market is under control of a single firm. A monopoly exist if there is no close substitute to the product and also when there is a single producer and seller of the product, like Indian Railways, but it has a very remote substitute in the market, like Buss services, Flights etc.
The features of monopoly are Single Seller, Single Product, No Difference between Firm and Industry, Independent Decision Making of the Firm and Restricted Entry.
The monopolist can not set both the price and quantity at its own will. A monopolist firm is able to independently determine an optimal combination of price and quantity, and has a normal demand curve with a negative slope. The reason behind the negative slope is that although a monopoly firm is in total control of the market price, but it can sell more only when it reduces the price of its product. Here both the MR and AR curves are downward sloping. The reason is that, a monopoly firm faces a normal demand curve which is highly inelastic, therefore AR curve would be downward sloping and the MR curve would lie below the AR curve. This is because of fact that the monopolist has to lower the price of all units of products for selling an additional unit.
4.3.2. Price and Quantity Determination in Short Run
A monopolist firm will be in equilibrium where MR = MC and MC is rising. Like perfectly competitive firms, monopolist firm also may earn supernormal profit or normal profit or subnormal profit (loss) in the short run.
4.3.2.1. Supernormal Profit
In the above diagram, a monopolist firm is in equilibrium at point E where MR equal to MC and MC is rising. In equilibrium, the firm sells OQ amount of output at price OP, so the total revenue is equal to the area OPCQ. The total cost is the area OABQ and
the total profit (supernormal) is the difference of total revenue and total cost, i.e. the area APCB.
4.3.2.2. Normal Profit
In the diagram given below, a monopolist firm is in equilibrium at point E where MR equal to MC and Mc is rising. In equilibrium, the firm sells OQ amount of output at price OP, so the total revenue is equal to the area OPCQ, which is also the total cost of the firm and the total profit (normal) is the difference of total revenue and total cost, i.e. here nil or zero.
Market Structure Analysis
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4.3.2.3. Subnormal Profit or Loss
In the above diagram, a monopolist firm is in equilibrium at point E where MR equal to MC and MC is rising. In equilibrium, the firm sells OQ amount of output at price OP, so the total revenue is equal to the area OPCQ. The total cost is the area OABQ which is greater than the total revenue, so the total loss (subnormal) is the difference of total cost and total revenue, i.e. the area PABC.
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4.3.3. Price and Quantity Determination in Long Run
In the long run, a monopolist firm has full control of the market price, so the firm would not continue to incur loss. It would instead try to reduce its cost of production by increasing control of raw materials etc., else it would it would close down in the long run. Therefore, the monopolist firm would try to earn at least normal profit in the long run and may earn supernormal profit due to entry restrictions in the market. So, a monopolist firm would either earn normal or supernormal profit, but would not incur loss in the long run.
4.3.4. Price Discrimination
Price discrimination is the practice of discriminating among buyers on the basis of the price charged for the same good or service. Market imperfection and control are prerequisite for price discrimination. The monopoly market structure is the ideal market condition for price discrimination. There are three situations where price discrimination is possible: i) discrimination owing to consumers’ peculiarities, ii) discrimination owing to nature of the good, iii) discrimination owing to the distance and frontier barriers. There are many forms of price discrimination, but mainly three types or degrees of discrimination and they are First-degree, Second-degree and Third-degree discrimination. The first-degree price discrimination involves charging the maximum price possible for each unit of output. Thus the consumer who attaches the greatest value to the product is identified and charged a price of P . Similarly, the consumers are willing to pay P for second unit and P for third unit. Here, the MR curve coincides with the demand curve and the profit maximizing output is where MC and the demand curve intersect, i.e., at point B.
Second-degree price discrimination involves pricing based on the quantities of output purchased by individual consumers. In the following diagram, the first Q units sold at P price and the next (Q -Q ) units sold at P2 1 2 price etc.
Third-degree price discrimination is the most common form of price discrimination. It involves separating consumers or markets in terms of their price elasticity of demand.
This segmentation can be based on several factors. Often third degree price discrimination occurs in the markets that are geographically separated. Let us consider an example. It is often seen that books of US publication are sold in other countries at a lower price compared to US evidently; buyers in other countries have greater elasticity of demand than do US buyers. At the same time, cost of collecting and shipping books make it unprofitable for other firms to buy in foreign countries and resell in the United States.
Discrimination can also be based on the nature of use. Telephone customers are classified as either residential or business customers. The monthly charge for a phone located in a business usually is somewhat higher than for a telephone used in a home.
Finally, markets can be segmented based on personal characteristics of consumers. Age is a common basis for price discrimination. For example, most movie theatres charge for adults, though the cost of providing service to the two groups in the same.
Market Structure Analysis