Monopoly Homework Help
Monopoly is that form of market in which a specific person or the enterprise is the only seller in the market. Such a person or enterprise enjoys the independence of fixing the price. The monopoly can occur due to any one or a combination or all of the reasons:
- Lack of Economic Competition to produce the goods and services,
- Absence of any substitute product,
- Monopoly price well above the seller’s marginal cost which earns him very high profits.
Thus the monopolist enjoys ruling the dominant position in the market. He can charge whatever he wishes.
Characteristics of a Monopoly:
- Single Seller: A monopolistic market has a single seller who rules the market. There are a large number of sellers in the perfect competition and very few sellers in the Oligopolistic Market. It is the number of sellers in the market that distinguishes a monopoly and gives it the exclusive benefits of running the market as per its discretion.
- Profit Maximization: A monopoly is the best form of market where the profit can be maximized. Monopoly being the only seller in the market can sell the products at a price it deems fit. It can sell the goods at a higher price and the buyers will have to pay the price because of unavailability of substitute seller or substitute of the product. Thus the monopolist maximizes his profits.
- Price Maker: a Monopoly is not affected by any competition or any other market forces. The monopolist is free of any competition. Thus he can choose the price of the products he is selling without taking into consideration anything else. If he wants to sell more goods, he will just reduce the prices and vice versa.
- Entry Barriers: There are entry barriers in the monopolistic market. The new entrants are either restricted by law to be a part of the market or other barriers are created by the existing monopoly which makes it impossible for other firms to enter the market. These entry barriers could be:
- The business enjoying economies of scale,
- Large investment requirement,
- Less marginal cost
- Price Discrimination: A monopoly enjoys the price discrimination in the market. It can charge any amount from anyone. They are under the obligation to pay the amount as the monopolist wishes. Whereas in case of Perfect Competition if a seller is charging higher than what others are charging, the buyer can change the seller. This is a benefit enjoyed by the monopoly.
How is a monopoly formed?
- Economies of Scale: Once the market achieves the economies of scale, it can produce the goods at a much lower cost than others. If an entity has achieved that stage in the business, it will be hard for the other entities to achieve that economy of scale in the initial stage of its business. Thus, the lower price will be the guiding force for the business to become a monopoly.
- Product Differentiation: In case of Monopoly, the product of the monopolist does not have any substitute. In monopoly’s products, there is great to absolute product differentiation which distinguishes it from other products in the market and creates a hindrance for the others to imitate the product. Whereas in case of a perfect competition market, there is zero product differentiation.
- Excess Profits: If an entity has excessive profits in the business i.e. profits more than what others earn in the normal course of the business or the rate of return on investments is more than the expected. In such conditions, the entity is in a position to create a monopoly.
- Number of Competitors: A monopoly market does not have any competitors as compared to the perfect competition. The monopoly creates barriers when other entities try to create competition.
- Law Applications: Sometimes Law itself imposes entry barriers in the certain sectors and creates the monopoly of the government. This is generally done in the critical sectors that require huge care and cannot be left to the public for operations. For e.g. Defense, Space etc.
The Inverse Elasticity Rule:
A monopoly chooses that price that maximizes the difference between total revenue and total cost. The basic markup rule (as measured by the Lerner index) can be expressed as
, where Ed is the price elasticity of demand the firm faces.The markup rules indicate that the ratio between profit margin and the price is inversely proportional to the price elasticity of demand. The implication of the rule is that the more elastic the demand for the product the less pricing power the monopoly has.
Monopolies can be widely categorized into two:
- Natural Monopoly: A natural monopoly is a business or entity that enjoys the benefit of increasing returns to scale against the costs. They are able to produce the goods at a much lower cost than other which gives them an upper hand in the market. The creation of monopolistic conditions in the market to restrict others in the market is illegal. Thus no business can attempt to create a monopoly on its own. It can be formed only if it is natural. Regulation of such natural monopolies is difficult.
- Government- Granted Monopoly: Government granted monopolies are the monopolies created by the government coercively. The law itself lays down the restriction upon the entry into such market by any person or entity other than the one whom the government gives exclusive right to operate in that territory. These are generally the areas requiring intensive care and are critical to the Nation’s security. For e.g. Defense and Space.
A monopoly curve is presented in the figure above. It is evident from the graph that the monopoly market will aim to set the output where the MC is equal to MR. i.e. (Marginal Cost=Marginal Revenue). Here the monopolistic firm will be able to maximize its profits. The blue portion of the image shows the profits and the red portion shows the cost to the business.
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