Business Essays – Definition of Monopoly

Definition of Monopoly

Monopoly is a well defined market structure where there is only one seller who controls the entire market supply, as there are no close substitutes for his product and there are no barriers to the entry of rival producers. This sole seller in the market is called “monopolist”. The term monopolist is derived from the Greek word “mono”, meaning “single”, and “polist” meaning seller. Thus the monopolist may be defined as the sole seller of a product which has no close substitutes. The monopolist is faced by a large number of competing buyers for his product. Evidently monopoly is the antithesis of competition on. In a monopoly market, the producer, being the sole seller, has no direct competitors in either the popular or technical sense. Thus, the monopoly market model is the opposite extreme of competition.

Features of Monopoly

The features of a monopoly are:

• The monopolist is the sole producer in the market. Thus, under monopoly, firm and industry are identical.
• There are no closely competitive substitutes for the product. So the buyers have no alternative or choice. They have either to buy the product or go without it.
• Monopoly is a complete negation of competition.
• A monopolist is a price maker and not a price taker. In fact his price fixing power is absolute. He is in a position to fix the price for the product, as he likes. He can vary the price from buyer to buyer. Thus in a competitive industry, there is a single ruling price, while in a monopoly, there may be differentials.
• A monopoly firm itself being the industry, it faces a downward-sloping demand curve for its product. That means it cannot sell more output unless the price is lowered.
• A pure monopolist has no immediate rivals due to certain barriers to entry in the field. There are legal, technological, economic or natural obstacles which may block the entry of new firms.
• Since a monopolist has a complete control over the market supply in the absence of a close or remote substitute for his product, he can fix the price as well as quantity of be sold in the market.

Abuses of Monopoly

Though a monopolist has complete freedom in determining his own price, there are some limits to his power. These are listed below:

• The demand curve of a monopolist slopes downwards.

This is shown as demand curve DD of the monopolist in Figure. On such a curve, a monopolist cannot choose both Price and Output to be sold. He has to determine one of these quantities. If he chooses higher price P1 he has to be satisfied with smaller sales of quantity Q1. If he prefers larger output Q2 he will have to charge lower price P2.

• The second constraint on monopoly power arises out of the income and willingness of consumers. If the monopolist attempts to charge a price as high as Pn his sales fall to zero. So even though a monopolist has complete freedom to charge any high price this freedom is restricted by the consumer’s ability to purchase goods.
• Finally, monopoly power also depends upon elasticity of the demand curve. If the demand curve is rigid or less elastic the monopolist has a greater degree of control. As the demand curve becomes more flexible or flatter the monopolist’s control starts declining.

This can be explained with the help of Figure. In the figure there are two demand curves. DD1 is rigid or less flexible showing greater monopoly control. DD2 is flatter or more flexible and depicts a lower degree of monopoly control. On rigid demand curve DD1 if the monopolist increases the price from P to P1 the fall in the quantity sold is as small as QQ1. On the flatter demand curve DD2 with the same rise in price, a fall in the quantity sold is as large as NN1. In case of a flexible demand curve there is a danger that even at a higher price, the total revenue of a monopolist may be smaller. This has been further explained in the table below:

A monopolist attempts to raise his price from 2 to 4 to 6. As a result of this quantity demanded goes on falling. Yet in the case of Rigid Demand D1, with a fall in the demand from 6 to 5 to 4 Total Revenue TR1 increases from 12 to 20 to 24. With the Flexible Demand condition D2 the quantity demanded falls sharply from 20 to 8 to 5 causing Total Revenue TR2 to fall from 40 to 32 to 30. Hence the slope or the degree of flexibility of the demand curve governs the degree of monopoly power

• Monopoly market is restrictive and hence considered as an evil form of market. Monopoly is also a source of wastage. It underutilizes productive capacity and reduces Consumer’s Surplus. Underutilization of capacity may cause some workers to remain unemployed. These and other shortcomings can be analyzed and explained with the help of a comparative diagram.

We find both competitive and monopoly equilibrium positions marketed by point e1 and e2 respectively. A competitive firm produces output Q1 and sells at price P1. A monopolist produces smaller output Q2 (Q2<Q1) and charges higher price P2 (P2>P1). Competition allows only normal profits to a firm as part of the average cost of production. A monopolist earns extra monopoly profits of the size CSRP2. Under competition output is produced at point e1 which is the lowest point on the average cost line. Therefore competition makes fuller utilization of the productive capacity. Under monopoly output is produced at point S which is on the falling phase of AC. This shows underutilization of the productive capacity. Finally, the size of the Consumer’s Surplus under competition is as large as De1P1 while that under monopoly is only DRP2. Hence under monopoly there is higher price, lower output, underutilization of productive capacity or wastage of resources and reduction in Consumer’s Surplus.

Differences between Monopoly

Equilibrium & Competitive Equilibrium

There are typical differences between the two types of market models & their equilibrium positions. A comparative account of their differences is presented below:

• The demand curve of a competitive firm for its product is perfectly elastic. It is a horizontal straight line. It implies that the firm can sell any level of out put at the ruling market price. While the demand curve of the monopolistic for his product is relatively inelastic, it is a downward sloping curve. It suggests that the monopolist can sell more output only by lowering the price.
• To a competitive firm, price is given in the market. So at this price, average and marginal revenue will be the same. Hence, AR & MR curves coincide and are represented through the demand curve which is a horizontal straight line. In the case of a monopoly, the downward sloping demand curve represents the AR curve. The MR curve also slopes downwards but it lies below the AR curve. If it is linear, then it lies half the distance between the price-axis and the demand curve.
• Under both perfect competition and monopoly, the equilibrium output is set at the point of equality between MC and MA. The competitive firm attains equilibrium only when the MC curve intersects the MR curve below. Thus, it is essential that MC must be rising at and near the equilibrium output. In fact, the falling cost curves caused by increasing returns to scale are incompatible with competitive equilibrium output, for the firm’s MR curve being horizontal, the falling MC curve can never lead to a competitive equilibrium position because as the firm will be inclined to expand its size until it becomes so large that its AR and MR curves ultimately begin to fall in order to cut the continuously falling MC curve. This means that the firm will become so large that competition will become imperfect and the individual firm would be in a position to influence the price of its product by altering its own output. In short, perfect competition will cease to exist when a firm increases its output to a very large extent in order to attain equilibrium under falling cost conditions. It may, therefore, be concluded that increasing returns to scale or a continuously downward sloping MC curve & perfect competition are incompatible.

It follows, thus, that a major difference between competitive equilibrium & monopoly equilibrium is that while in the case of the former, the MC curve of the firm must be rising at or near the equilibrium level of output, in the case of the latter, this is not essential. A monopoly firm can attain equilibrium under any state of returns to scale or cost conditions, whether constant, rising or falling. The fundamental condition of monopoly equilibrium that must be satisfied is: MC=MR, and the MC curve must intersect the MR curve from below (yet it need not necessarily be rising).

• Again, when we compare the equilibrium conditions of the two models, we find that the fundamental rule of profit maximization is the same, i.e., equating MC with MR, the characteristic difference lies with respect to price as average revenue and MC. Under perfect competition, price=AR=MR; thus, at equilibrium output, MC=price. In monopoly, on the other hand MR<AR or price, at all levels of output; at equilibrium point, thus, MC=MR, but it will be less than price. Briefly, thus, under competition price=MC, under monopoly price>MC.
• In a perfect normal equilibrium condition of a firm under competition in the long run only, normal profit is realized. In the case of a monopoly, excess monopoly profit can be earned even in the long-run. In fact, the positive difference between price and MC in a monopoly gives excess profit.
• In the long run, when the competitive firm gets only normal profit, it operates at the minimum point of the LAC curve. Hence the competitive firm tends to be of optimum size. A monopoly firm, on the other hand, attains equilibrium at the falling path of the AC curve, which means it doesn’t utilize its plant capacity to the full extent. The “excess capacity” in a monopoly firm thus causes it to be of less than optimum size.
• Usually, the monopoly price tends to be higher while the monopoly output smaller than that under perfect competition. A direct comparison of price and output under monopoly and competition is however difficult because a competitive firm is just a part of the industry as a whole, while a monopoly firm is an industry itself.

MONOPOLY EQULIBRIUM UNDER DIFFERENT COST CONDITIONS

Firms under all market condition achieve equilibrium at a point where MC=MR and MC is increasing or MC>MR if an additional unit is produced. Under Perfect competition this is possible only if the firm is operating with increasing cost i.e. marginal cost curve is sloping upward. Equilibrium cannot be determined if the marginal cost is decreasing or constant.

Equilibrium is possible only in fig A where both necessary and sufficient conditions are fulfilled, whereas in B only the necessary condition is fulfilled and in C neither necessary nor sufficient conditions are satisfied.

Unlike perfect competition, equilibrium of a monopoly is possible under

• increasing
• constant and
• decreasing cost as shown in Figure

FIGURE shows equilibrium of a monopoly firm with increasing cost. The firm’s AC and MC curves are sloping upward. MC cuts MR at E. Here MC=MR and for any additional production MC>MR. Therefore firm A reaches equilibrium at point E. TR=OQ1 TP. TC=OQ1SN.

Pie=NSTP

Figure B, the firm reaches equilibrium at point E1 under constant cost. At point E1 MC=MR and thereafter MC>MR therefore the firm stops its production. At E1. TR=OQ2T1P1. TC=OQ2E1N1.

Therefore Pie=N2S2T2P2

Figure C explains the equilibrium under decreasing cost. Equilibrium output is determined at point E2. Where MC=MR and MC>MR for any additional output. TR=OQ3T2P2. TC=OQ3S2N2

Therefore Pie=N2S2T2P2

The firm however will not be able to decide its output if under decreasing cost its marginal cost is always below the MR curve as shown in the figure.

Fig shows the indetermination of Equilibrium under decreasing cost. Here the MC is all the times below MR hence it is not possible to determine the Equilibrium output. However the case shown in the above diagram may not be practical as the marginal cost cannot continuously decline and become zero.

CONTROL OF MONOPOLY

Evaluating the economic effects of pure monopoly or partial monopoly form the standpoint of society as a whole, on income distribution, price, output, resource allocation, technological advancement, distribution of economic power, it has been commonly observed that there are more evils aspects than benefits in a monopolistic industry as compared to a competitive industry.

THE FOLLOWING POINTS MAY BE ENLISTED IN THIS CONTEXT:

• The monopoly price is generally higher than the competitive price. Evidently, the consumer is exploited under a monopoly.
• Output under monopoly is restricted with a view to earning the maximum economic profits. Thus, there is inefficient allocation of resources in a monopolistic industry. It entails waste of excess capacity. Only in a competitive industry there can be optimum utilization of existing plant capacity .In short, under a monopoly a higher price is charged, a smaller output is produced & the system of allocation of resources is inferior to that under perfect competition.
• Usually, excess profit is reaped by a monopoly firm even in the long run. A purely competitive firm, on the other hand reaps just a normal profit in the long run. By virtue of their control over market supply, monopolists can export high prices to make substantial economic profits .Excessive price charged by the monopolists is regarded as a “PRIVATE TAX” on consumers.
• On account of high profiteering by the monopolists, society’s income distribution tends to be unequal & unjust .The owners of monopoly business tend to become richer at the cost of the consumers. Big monopoly houses may acquire concentration of economic power ion their hands which also endangers political democracy in the country.
• A monopolist is supposed to be very conservative in the matter of innovation & technological advancement .Since there is no threat of competition from rivals in a monopoly market, the firm has no impulse to develop new products or introduce new techniques in production. The monopolist is satisfied with the status quo. In fact sometimes monopolists may buy up new scientific inventions & patents & destroy them so to avoid rivalry. They do so in order to save loss arising from the sudden obsolescence of existing plant & machinery. This tactic obviously obstructs technical progress of the country.
• Monopoly & monopolistic competition tend to aggravate the problem of unemployment due to under allocation of resources. The actual production frontier of the country is kept unduly much below its potential level. This results in a low pace of economic growth in creating poverty in the midst of plenty
• Monopoly firm quite often resort to unfair practices like price discrimination or cut throat competition infringement of trade marks of rivals .etc with a view to eliminating or killing potential rivals in the market.
• Many big monopoly houses have tended to spread political & economic corruption. It has been alleged that some political parties & even govt. officials in India always have a soft corner for certain big business houses.

METHODS OF CONTROL

They are as follows:

• Restriction on entry of new firms
• Restriction on output
• Monopolists hold on price determination

MEASURES OF CONTROL

They are as follows:

• Legislative measures
• Promotion of competition
• Consumers resistance
• Publicity drive
• Control of price & output
• Fiscal measures
• Nationalization
• Co-operative movement

Misconceptions about Monopoly Pricing & Profits

It is commonly alleged that a monopolist can charge a very high price and earn high profits because he has the control over market supply and is a price-maker. This is really not so. A monopolist cannot determine price on the basis of his supply alone. He has to consider the demand aspect as well. In fact, the monopoly price is determined by the relative strength of the forces of demand and supply. Again, while determining the equilibrium price and output, the monopolist is interested in maximum sale because he wants to maximise total profits and not unit profits. So if the demand is slack, he will have to set a low price corresponding to profit maximising condition : MC = MR. Again, it is also erroneous p take it for granted that the monopolist’s price is always higher than the competitive price. It, in fact, depends on various considerations. If the demand is highly inelastic, while the supply is under conditions of increasing costs, ben the monopolist will restrict output in order to produce at a lower cost anchearn a higher profit. Under these circumstances, obviously, the monopoly price will be very high compared to the competitive price. For example, private monopoly is socially harmful in respect of production and sale of essential agricultural commodities like food-grains for which the demand is highly inelastic while the supply is under increasing costs on account of the law of diminishing returns operating on land.

If, on the other hand, the demand is highly inelastic, but the supply is under increasing returns or decreasing costs condition, the monopoly price would tend to be nearer the competitive price. In such cases, monopoly can be socially tolerated. For instance, in producing comforts and luxury items, if a private monopolist invests huge capital, thereby enjoying the economies of scale so that he may supply goods at a low price at a competitive rate, then, such monopoly can be tolerated. Again, when there is a very limited market for a product, a monopolist can supply it at a lower price on account of its low cost of production due to large-scale economies than what is feasible in a competitive market by a large number of firms producing the goods on a small-scale. The competitive market price in such a case will tend to be high because though P – AC, under competition, the AC itself tends to be high due to lack of economies of scale and the small-scale of production adopted by each firm. If, however, there is a monopoly which has to cater to the entire market, it would resort to a large-scale production. Hence, the output will be produced at a much lower cost, so even if the monopolist sets a higher price than AC for the sake of high profit, it may relatively turn out to be lower than that of the competitive firm.

Similarly, it is also incorrect to say that the monopolist can always earn abnormally high monopoly profit due to his advantageous position in the market. In many cases, demand and cost situation may not be very favourable to the monopolist, so that he cannot make profits. In the long run, the monopolist may be under the threat of new entry in his line of production, so that he may resort to price limit which gives him a lower profit but not a high maximum profit. Potential competition thus serves as a significant constraint on the behaviour of the monopolist. Again, in some cases, the demand situation may be such that the demand curve or the average revenue curve in the long run may be just tangent to the LAC curve. In this case, the monopolist would earn only a normal profit (see Fig. to understand the situation).

In Fig., the monopolist decides an equilibrium output OM, and charges PM price. Since the AR curve is tangent to the LAC curve at point P, Price = Average Revenue = Average Cost. Hence, the monopolist simply earns a normal profit.

The only difference between such normal-profit monopoly equilibrium and competitive equilibrium is that the monopolist is producing at less than optimum size, i.e., at a higher average cost, while a competitive firm, earning normal profit, would be producing at a minimum average cost, i.e., it has an optimum size. In other words, under monopoly, even though there is just a normal profit earned, there is unutilised capacity of the plant and resources, while in a competitive firm’s equilibrium, the normal capacity is fully utilised.

Anyway, it can be concluded from the above discussion that the monopolist cannot always earn high monopoly profits. Again, the monopolist in the long run should earn at least normal profits, otherwise he cannot survive. A monopolist finding the cost situation much above the demand consideration in the long run has no alternative but to wind up his business.