All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 1

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 2 Monopoly 10 CHAPTER

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 3 DEFINITION OF A MONOPOLY Definition A monopoly is a market structure in which there is a single seller and large number of buyers that sell products that have no close subsitutes. The entry and exit barriers are also high.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 4 Characteristics One seller and large number of buyers. A monopolist is a price maker since there is only one seller and it has the power to control the prices in the market. CHARACTERISTICS OF A MONOPOLY

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 5 No close subsitutes: Monopolies firm would sell products in which there are no close substitutes. Restriction of entry of new firms. Advertising: Advertising in a monopoly market depends on the products sold. CHARACTERISTICS OF A MONOPOLY (CON’T)

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 6 TYPES OF MONOPOLIES Natural Monopoly Exist due to economies of scale. Natural monopoly arises when one firm can produce at a lower cost compared to two or more firms within the market.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 7 Government-Created Monopolies Legal monopoly is also referred to as government-created monopoly. Government creates monopolies to prevent firms from entering a market. This can be done through: Government franchise Government license Patent TYPES OF MONOPOLIES (CON’T) Copyright Control over raw material

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 8 TOTAL REVENUE – TOTAL COST APPROACH Using Table: Profit maximization is determined by scanning through the profit at each level, and the level which gives the highest profit is the profit maximizing output. (1) Quantity (Q) (2) Price (P) (3) Total Revenue (TR) (4) Total Cost (TC) 5) Profit (TR-TC)

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 9 TR, TC Quantity TC TR Highest vertical difference TOTAL REVENUE – TOTAL COST APPROACH (CON’T) Using Graph: TR curve is increasing and after the profit maximizing output, the curve starts to decline. Maximum profit is where the vertical difference between TR and TC is the highest.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 10 MARGINAL REVENUE – MARGINAL COST APPROACH Using Table: The profit maximizing output level is obtained following the MR = MC rule. Quantity (Q) Price (P) Marginal Revenue (MR) Marginal Cost (MC)

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 11 MR, MC Quantity MC MR P* Q* AR=P MARGINAL REVENUE – MARGINAL COST APPROACH (CON’T) Using Graph: MR curve under imperfect market is downward sloping as output increases. The profit maximization level occurs at MR = MC, where the MC curve intersect with the MR curve.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 12 The demand function for a product sold by a perfect competitor is given as Q d = 700 – 0.5P and the marginal cost is constant at RM400 per unit. Calculate the profit maximizing price and quantity. PROFIT MAXIMIZATION USING THE EQUATION METHOD

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 13 Solution For profit maximization to take place, we use the MR = MC rule. Firstly, we need to derive the demand curve. GivenQ=700 − 0.5P P = 1400 − 2Q MR = 1400 – 4Q MR = MC 1400 − 4Q= 400 4Q= 1000 Q= 250 PROFIT MAXIMIZATION USING THE EQUATION METHOD (CON’T)

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 14 Substitute Q =250 into P = 1400 − 2Q P= 1400 − 500 P=900 PROFIT MAXIMIZATION USING THE EQUATION METHOD (CON’T)

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 15 Monopoly firm earns economic profit ATC Price (RM) Quantity DD = AR Q* P* A MR AC PROFIT MAXIMIZATION IN THE SHORT RUN Economic profit or supernormal profit is the profit earned by a monopolist when TR>TC. MC The profit maximization level occurs where MR curve and MC curve intersect at point A. At output, Q the firm earns economic profit or supernormal profit equal to the area shaded. PROFIT To find the price, we use the same vertical line with output up to the demand curve. The profit maximizing price and output are P* and Q*.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 16 Monopoly firm at breakeven The profit maximization level occurs where MR curve and MC curve intersect at point A. ATC Price (RM) Quantity DD = AR MC Q* A MR AC/P* The profit maximizing price and output are P* and Q*. At output, Q monopolist is at the breakeven or earns normal profit. PROFIT MAXIMIZATION IN THE SHORT RUN (CON’T) Economic profit or supernormal profit is the profit earned by a monopolist when TR>TC.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 17 The profit maximization level occurs where MR curve and MC curve intersect at point A. Monopoly firm suffers economic losses ATCPrice (RM) AC Quantity DD = AR MC Q* P* A MR The profit maximizing price and output are P* and Q*. Economic losses or subnormal profit is the loss incurred by a monopolist when TR<TC. PROFIT MAXIMIZATION IN THE SHORT RUN (CON’T) At output, Q monopolist suffers economic losses or subnormal profit equal to the area shaded. LOSSES

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 18 Monopoly firm earns supernormal profit in long run A monopoly firm earns economic profit or supernormal profit in the long run due to barrierst of entry for new firms. LRATC PROFIT MAXIMIZATION IN THE LONG RUN Price (RM) Quantity DD = LRAR LRMC Q* P* AC A LRMR PROFIT

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 19 PRICE DISCRIMINATION AND ITS CONDITIONS Definition Price discrimination refers to the selling or charging of different prices by a firm to different buyers for the same product. Necessary Conditions Existence of monopoly power: Price discrimination can occur only if monopoly power exists and there are no competitors in the market.

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 20 Existence of different markets for the same commodity: A firm should be able to separate customers according to price elasticity of demand. Prevent resale: Products purchased in the low- priced market should not be resold in the high- priced market. Legal sanction: Government allows public utility firms such as electricity to charge different prices from different consumers. PRICE DISCRIMINATION AND ITS CONDITIONS (CON’T)

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 21 First-Degree Price Discrimination Occurs when a firm charges each consumer the maximum price that the consumer is willing to pay for each unit. This type of price discrimination is also known as perfect price discrimination. The best example of first-degree price discrimination is an auction. TYPES OF PRICE DISCRIMINATION

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 22 Second-Degree Price Discrimination Occurs when products are grouped into blocks and each block is charged at a different price. This type of price discrimination is charged by public utilities such as electricity charges, water charges, and telephone charges. TYPES OF PRICE DISCRIMINATION (CON’T)

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 23 Third-Degree Price Discrimination Occurs when markets are divided into many submarkets or subgroups. Each group is considered as a different market. The price charged on products depends on the price elasticity of demand. TYPES OF PRICE DISCRIMINATION (CON’T)

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 24 An example of third-degree price discrimination is the sale of movie tickets where the adults are charged higher price and children a charged at lower price. Other examples are transportation such as air, railway, bus, medical, legal and entertainment. TYPES OF PRICE DISCRIMINATION (CON’T)

All Rights ReservedMicroeconomics © Oxford University Press Malaysia, – 25 COMPARISON BETWEEN PERFECT COMPETITION AND MONOPOLY  Large number of sellers selling homogenous products.  Price takers.  Earns a normal profit in the long run due to free entry and exit.  In the long run, perfect competitive firm produces at the lowest point on the minimum of average cost and is more efficient.  Only one seller who sells products that have no close substitutes.  Price makers.  Earn a supernormal profit since there are barriers to entry for new entrants.  Price charged is always higher than price charged in perfect competitive market.  Monopolist does not operate at the minimum point of ATC curve. Perfect Competition Monopoly