Monopoly 1

Monopoly and
Market power
Siddhartha k. raStogi
iiM indore
Monopoly
• Single Provider
• Uniqueness
• Product
• Knowledge
• Information
• Human Resource
• Barriers to Entry
• Government decree
• Resource ownership
• Patents and copyrights
• High start-up cost
• Economies of scale
Profit
Maximization
Revenue
Relationship of AR and MR
Profit Maximization ?
Actually…
Total revenue and costs structure
And the profit is… in different scenarios??
Normal profit Only
Shutdown scenario
a monopolist’s supply curve
A monopolist does not have a supply curve (i.e., an optimal output for any exogenously-given price) because
the monopolist picks a preferred
price is endogenously-determined by demand:
point on the demand curve.

One could also think of the monopolist choosing output to maximize profits subject to the constraint that
price be determined by the demand curve.
Price Elasticity and Profit
• Monopolist operates at
the elastic region of the
market demand curve.
• Increasing price from PA
to PB, TR increases by
area I – area II
• At the same time, total
cost reduces because
monopolist is producing
less.
• **That region is always
before marginal revenue
hits zero**
The efficient pricing by a monopolist
• Translating (MR=MC) to a rule of thumb for application
• Since the firm faces a downward-sloping demand curve,

producing and selling this extra unit also results in a small drop
in overall price ΔP/ΔQ
• This reduces the revenue from all units sold (i.e., a change in
revenue Q[ΔP/ΔQ])
=> P(1 + (QP/PQ)) => P(1 + 1/)

The efficient pricing by a monopolist
• Given any Q* quantity, Setting MC = MR
MC (Q*)  MR(Q*) where
 1 
MC (Q*)  P * 1 
  
 Q,P 
P *  MC * 1 Higher the price

 elasticity, lower
P*  Q,P possibility of a
mark-up over MC
• Thumb Rule: Price is a markup over marginal cost, subject to Ed

Lerner Index of Monopoly Power
• Calculated as excess of price over marginal cost as a fraction of
price
• This can also be expressed in terms of the elasticity of demand
facing the firm
• Monopoly power depends on the firm’s demand curve

• The more rigid (steeper) it is, reduce production a little for a higher price
• The more flexible (flatter) it is, the less market power to increase prices
• Lerner index will always be between 0 and 1

• the closer it is to 0, the closer it is to perfect competition
• the closer it is to 1, the higher market power the seller has and hence closer
to a monopoly
Herfindahl - Hirschman Index
• The problem with Lerner Index
• An optimal P and a precise MC ?
HHI = S12 + S22 + S32 + ... + Sn2
• Where Sn is the market share of the ith firm
• The HHI number can range from close to zero to 10,000

Making sense of HHI
• A zero HHI means extremely competitive market. The number of firms is so large that
sum of the square of the market shares is 0.
• HHI of 0 to 1,000 is commonly interpreted as low concentration. Monopolistic

competition falls into the bottom of this with oligopoly emerging near the upper end.
• HHI of 1,000 to 1,800 is considered an industry with medium concentration. These

industries are approaching close to oligopoly.
• An industry with HHI of 1,800 to 10,000 is viewed as high concentration. Government

regulators are usually most concerned with industries falling into such oligopoly.
• 10,000 HHI means monopoly, implying one firm has a market share of 100 percent
Measuring Monopoly Power
Three factors determine a firm’s elasticity of demand
• The elasticity of market demand

• Since the firm’s own demand will be at least as elastic as market demand,
the elasticity of market demand limits the potential for monopoly power
• The number of firms in the market
• If there are many firms, the higher competition reduces the firms’ ability to
affect price significantly
• The interaction among firms
• Even if only two or three firms are in the market, each firm will be unable
to profitably raise price very much if the rivalry among them is aggressive,
with each firm trying to capture as much of the market as it can
Perfect Competition vs. Monopoly
Cost and Price
INEFFICIENCY IN MONOPOLY 15
MC
14
13
Price in Monopoly = 11 12
Quantity in Monopoly = 9 11 eM
10
9
X ePC
X
Price in Perfect Market = 9 8
7
Quantity in Perfect Market = 11 6
AR
5
Revenue in each market = 9*11 = 99 4
3
2 MR
Profit in Perfect Market = 0 1
Since (MC = AR) 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Profit in Monopoly = ? Quantity Demanded
Since (MC = MR; P = AR)
Question: Quantify Deadweight Loss.
Policy Considerations
• Benefits of Monopoly
• Inefficiencies in monopoly
• Deadweight Loss (and elasticity scenarios)
• Preventive action
• Preventive Action in Monopolistic Competition

Monopolistic Markets
• Characteristics
• Equilibrium in the short run

• Monopoly power leads to supernormal profits
• Equilibrium in the long run

• Only normal profits, monopoly power diminishes due to competition
• Some deadweight loss does exist – what to do?

• It has to be balanced against the gains to consumers from competition and
price diversity
Devsena is a producer in a monopoly industry. Her demand curve, total revenue curve, marginal
revenue curve, and total cost curve are, respectively, as follows:
(Q = 160 - 4P) (TR = 40Q - 0.25Q2) (MR = 40 - 0.5Q) TC = 4Q
How much output units will Devsena produce?
The price of her product will be
If too many sellers are operating with the

How much profit will Devsena make? same market demand in a competitive
market instead of a monopoly, what would be
the values of total Q, P, revenue, and profit
Ans. 72, 22, 1296 Ans. 144, 4, 576, 0

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Monopoly and

point on the demand curve.

• Since the firm faces a downward-sloping demand curve,

=> P(1 + (QP/PQ)) => P(1 + 1/)

P *  MC * 1 Higher the price

• Thumb Rule: Price is a markup over marginal cost, subject to Ed

• Monopoly power depends on the firm’s demand curve

• Lerner index will always be between 0 and 1

HHI = S12 + S22 + S32 + ... + Sn2

• Where Sn is the market share of the ith firm

• The HHI number can range from close to zero to 10,000

• HHI of 0 to 1,000 is commonly interpreted as low concentration. Monopolistic

• HHI of 1,000 to 1,800 is considered an industry with medium concentration. These

• An industry with HHI of 1,800 to 10,000 is viewed as high concentration. Government

• The elasticity of market demand

• Deadweight Loss (and elasticity scenarios)

• Preventive Action in Monopolistic Competition

• Equilibrium in the short run

• Equilibrium in the long run

• Some deadweight loss does exist – what to do?

(Q = 160 - 4P) (TR = 40Q - 0.25Q2) (MR = 40 - 0.5Q) TC = 4Q

How much output units will Devsena produce?

The price of her product will be

If too many sellers are operating with the

Ans. 72, 22, 1296 Ans. 144, 4, 576, 0

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