monopoly

Characteristics of Monopoly

• A monopoly is a market structure in which there is a single seller

• There are no substitute products

• The firm has complete market power and is able to set prices and control output

  • This allows the firm to maximise supernormal profit in the short-run

  • There is no long-run erosion of supernormal profit as competitors are unable to enter the industry

• High barriers to entry exist

  • One of the main barriers is the ability of the monopoly to prevent any competition from entering the market

    • E.g. by purchasing companies who are a potential threat

• The UK Competition and Markets Authority defines a legal monopoly as any firm having more than 25% market share

  • It acts to prevent this from happening in most industries

Profit Maximising Equilibrium

• As a single seller of goods/services, the firm in a monopoly market is also the entire market. Its concentration ratio is CR1=100%

  • There is no differentiation between the firm and the industry

• It is a price maker or price setter

  • This means that its demand and revenue curves are downward sloping

• In order to maximise profits, it produces at the point where marginal cost (MC) = marginal revenue (MR)

Diagram analysis

• The firm produces at the profit maximisation level of output, where MC = MR (Q₁)

  • At this level, the AR (P₁) > AC (C₁)

  • The firm is making supernormal profit 

Third Degree Price Discrimination

• Price discrimination occurs when a firm charges a different price for the same good/service in order to maximise its revenue

  • There are different types (degrees) of price discrimination

• Third degree price discrimination occurs when a firm charges different prices to different consumers for the same good/service e.g. rail fares are priced differently depending on the time of travel

• Markets are often sub-divided based on time, age, income and geographic location

  • Some airline ticket portals charge higher prices to customers using an Apple computer as they are likely to have higher income

The Following Conditions Must Be Met for Third Degree Price Discrimination to Occur

Illustrating third degree price discrimination

• In order to illustrate third degree price discrimination diagrammatically, the different sub-market diagrams are placed side by side

• The total market diagram is a combination of the sub-market diagrams

  • The total profit is a combination of profits from the sub-markets

• The diagram below illustrates the market for rail travel in the UK, where price inelastic demand is ‘peak’ hour demand and price elastic demand is any other time of the day, i.e. ‘off-peak’

Diagram analysis

• Each train route has an effective monopoly provider

• The overall firm is producing at the profit maximising level of output where MC=MR

  • This point is extrapolated to both sub-markets on the left by using the lower dotted line

  • The average cost is extrapolated across both sub-markets using the upper dotted line (C₁)

• A higher price for peak travel has been set at P_a and a lower price for off-peak travel has been set at P_b

• Following the revenue rule, total revenue increases in both markets

• The profit for sub-market A = (P_a-C₁) * Q₁

• The profit for sub-market B = (P_b-C₁) * Q₂

• The firm’s total profit is the average selling price – the average costs

  • Total profit = (P_t-C₁) * Q₃

• The firms’ total profits are higher than if they had charged a single price to all customers

Costs and benefits of third-degree price discrimination

Costs and Benefits of Third-Degree Price Discrimination to Consumers and Producers