PRICING UNDER MONOPOLY

Monopoly may be described as a market situation in which there is a single seller, with no close substitutes for the commodity it produces and there are barriers to entry. A monopolist faces a downward-sloping demand curve for the market. For a firm to continue as a monopolist in the long run, there must be factors that prevent the entry of other firms. Absence of close substitutes means that the product of the monopolist must be highly differentiated from other goods.  The monopolized firm constitutes the whole industry and therefore, equilibrium of the monopoly firm signifies the equilibrium of the industry. According to Joel Deal, a monopoly market is one in which ‘ a product of lasting distinctiveness is sold. The monopolized product has distinct physical properties recognized by its buyers and the distinctiveness lasts over many years’

The following salient features of monopoly may be enumerated:

• A single firm produces and sells a particular commodity or a service.
• There are no direct competitors of the firm.
• No other seller can enter the market for whatever reasons legal, technical or economic.
• Monopolist is a price maker. He tries to take the best of demand and cost conditions without the fear of new firms entering to compete away his profits.

Types of Monopoly

One might wonder why a monopoly ever arises. Why other firms do not enter the industry in an attempt to capture a portion of the monopoly profit. Many different factors that prevent the entry of other firms into the industry and eliminate the existing ones may lead to the establishment of a monopoly or near monopoly. The major bases of monopoly are:

(i) Control Over Key Raw Materials
One of the most important bases for monopoly lies in the control of key raw material supplies. A firm may acquire control over certain key and scarce key raw materials and establish its monopoly of the products it produces. Suppose input X is required to product output Y and a firm acquires exclusive control over or ownership of X, it can easily establish a monopoly over Y by refusing to sell X to any potential competitors. For example Aluminum Company of America (Alcoa) owned almost every source is bauxite (a necessary ingredient in the production of aluminum) in the United States. The control of resource supply provided Alcoa with an absolute monopoly in aluminum.

(ii) Patent, Copy Rights and Licenses

These laws are another important source of creating monopoly that make it possible for a person to apply for and obtain the exclusive right to produce a certain commodity or to produce a commodity by means of a specific process. These rights may be acquired through innovation of new products, new processes, new devices through sustained efforts and enormous expenditures on research and development. Such exclusive rights can easily lead to a monopoly. Alcoa, E.I.Du Pon de Nemours & Co, the Eastman Kodak, the Minnesota Mining and Manufacturing Company (3M) enjoyed patent monopolies.

(iii) Efficiency

 The economy of scale has been recognized as a primary and technical reason for monopolies. In some industries, economies of scale are so particularly pronounced that competition is impractical, inconvenient or simply unworkable. The size of the market may be such that does not require more than a plant of optimal size. The technology may be such that in order to reap the economies of scale it requires only a single plant. Transport, electricity, water and communications, railways, gas facilities (and most of the so-called public utilities) are examples of industries in which substantial economies can be realized only at large scales of output. In these conditions the market creates a ‘natural monopoly’. In such cases usually the government undertakes the production of the commodity or of the service in order to avoid the exploitation of consumers.

(iv)Limit Price Policy

Sometimes, the existing firm adopts a limit-pricing policy combined with other policies such as heavy advertising or continuous product differentiation aiming at the prevention of entry of new firms.

(v) Fiscal Monopoly

Certain monopolies such as printing of currency notes and stamps, minting of coins are created by the government itself. The nature of these services is that they cannot be entrusted to private enterprises.

Pricing and Output Decisions -Short Run

            Pricing under monopoly, like that under perfect competition, is determined by demand and supply conditions in the market. Since the number of consumers is large even under monopoly, the monopoly is similar to the pure competitive market so far as the demand side as a whole i.e. industry demand is concerned. The difference lies in the demand curve facing a firm. Under monopoly, there is no difference between the industry and the firm, and thus the demand curve facing the monopolist firm is the one faced by the purely competitive industry, which is downward sloping. Further, the downward sloping demand curve implies that more could be sold only at a lower price and vice verse, thus the firm is a price maker. Given the consumer’s demand, the monopolist could either set the price or the output, and the remaining of the two variables will be determined by the demand function. Since the monopolist takes part in pricing his product and the demand for its product varies with the product price, Accordingly under monopoly, the relevant curves are revenue curves

            The monopolist hires his factors of production from the factors market just as a purely competitive firm does. Thus, there is no significant difference with regard to cost curves between the two market structures. Accordingly, the cost curves of the monopolist would be of usual shapes.

            Given the revenue and cost curves, and firm’s objective of profit-maximization price-output determination can easily be explained.

The monopolist maximizes his short-run profits at the point where marginal cost is equal to the marginal revenue and the slope of the marginal cost is greater than the slope of the marginal revenue at the point of intersection. In the above figure the monopolist attains his equilibrium at point E where the MC intersects the MR curve from below. Price is OA and the quantity is OQ. The monopolist enjoys supernormal profit equal to the shaded area PBCD. A change in either the demand curves or in cost curves or in both would cause a change in the equilibrium price and output. It is easy to see that while an increase in demand, which would cause an upward shift in AR and MR curves, ceteris paribus, would lead to an increase both in price and quantity, and an increase in supply, causing cost to shift downward, ceteris paribus, would lead to an increase in quantity but a decline in price.

            In the perfectly competitive market situation the individual firm takes the market-determined price and it only determines its output. But a monopolist determines his price and his output. However, given the downward sloping demand curve, the monopolist will either set his price and sell the amount that the market will take at it, or he will determine the output defined by the intersection of MC and MR, which will be sold at the corresponding price P. The monopolist cannot decide independently both the quantity and the price at which he wants to sell it.
 

                                         Price and Output Determination in the Long Run

In the long run the monopolist has enough time to expand the size of his plant, or to use his existing plant at higher level in order to maximize his profit. Since the monopolist does not face the threat of entry of new firms, it is not necessary for him to reach an optimal scale.  A monopolist will not stay in business if he makes losses in the long run. He will most probably continue to make supernormal profits even in the long run, given that entry is barred.  However, the size of his plant and the degree of utilization of any given plant size depend entirely on the market demand. He may reach the optimal scale or remain at sub-optimal scale or surpass the optimal scale depends on the market conditions.
 
 Figure 3 portrays the situation in which the market
 size is such that does not allow the monopolist to
 reach the optimal scale.
Thus, above we have discussed the nature, types of monopoly,
 and price and output determination in the short and
long run.