Unit-4 Pricing Under Monopoly POE | BBA First Year

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Pricing Under Monopoly

• A market can be structured differently depending on the characteristics of competition within that market. At one extreme there is perfect competition. In a perfectly competitive market, there are many producers and consumers, no barriers to entry and exit from the market, completely homogeneous goods, perfect information, and well-defined property rights. This creates a system in which no individual economic actor can influence the price of a commodity –In other words, producers are price takers who can choose how much to produce, but not the price at which they can sell their output. There are few industries that are truly perfectly competitive, but some come very close.
• For example

• commodity markets (such as coal or copper) typically have many buyers and many sellers. There are some differences in quality between providers so that goods can be easily replaced, and the goods are so simple that both buyer and seller have complete information about the transaction. It is unlikely that a copper producer can raise its prices above the market rate and still find buyers for its product, so sellers are price takers.
  

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• On the other hand, monopoly exists when there is only one producer and many consumers. Monopoly is characterized by a lack of economic competition to produce the good or service and a lack of viable substitute goods. As a result, a single producer has control over the price of a good – in other words, the producer is a price maker who can set the price level by deciding how much of a good to produce. Public utility companies are monopolistic. For example, in the case of electricity distribution, the cost of laying power lines is so high that having more than one provider is inefficient. There is no good alternative for power distribution so consumers have less options. If the electricity distributor decided to raise its prices it is likely that most consumers would continue to buy electricity, so the seller is a price maker.

Source Power or Monopoly

• Monopoly power comes from markets that have high barriers to entry. This may be due to various factors:

1. Increasing returns to scale across a larger range of production
2. High capital requirements or large research and development costs
3. Production requires control over natural resources
4. Legal or regulatory barriers to entry
5. Presence of network externalities meaning that the use of a product by one person increases the value of that product to other people

Monopoly Excellent Vs Competition

• Monopoly and perfect competition mark two extremes of market structures, but there are some similarities between firms in a perfectly competitive market and monopoly firms. Both face similar costs and production tasks, and both seek to maximize profits. The shutdown decisions are similar, and both are assumed to have perfectly competitive factor markets.
• However, there are several key differences. In a perfectly competitive market, price equals marginal cost and firms earn economic profit of zero. In monopoly, the price is set above marginal cost and the firm earns positive economic profit. Perfect competition produces an equilibrium in which the price and quantity of a good is economically efficient. Monopoly produces an equilibrium at which a good’s price is higher, and The quantity is less, which is economically efficient. For this reason, governments often seek to regulate.

Price and Output Under Pure Monopoly

• A monopolist can take the market demand as its demand curve.
• The firm is a price maker but it cannot charge a price that consumers will not bear.
• A monopolist has market power which is the power to raise the price above marginal cost without fear of losing supernormal profits to new entrants into the market.
• In this sense, price elasticity of demand acts as a constraint on the monopolist’s pricing power.
• Assuming that the monopolist aims to maximize profits (where MR=MC), we establish short run price and output equilibrium as shown in the figure below.

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