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How is Price Determined under Monopoly Market?
Meaning of Monopoly Market
Monopoly means absence of competition. A monopolist is the sole seller of a good, which has no close substitutes. Suppose all the steel products are supplied by a single firm, then we can say it is a monopoly. An important difference between perfect completion and monopoly is that under perfect competition, there will be several numbers of sellers but under monopoly, there will be only one seller. Under perfect competition, there will be several numbers of firms in an industry. But under monopoly, the difference between firm and industry goes. The firm is the industry. So the power of a monopolist depends on his control oversupply.
Price Determination Under Monopoly Market
A monopolist is the sole seller of a commodity. The aim of a monopolist is to get maximum profits. Of course, everyone who enters business aims at getting maximum profit. But there is no scope for getting abnormal profit under competition for there are several number of sellers. But the monopolist is the sole seller of a commodity. So he will take advantage of the situation and try to get maximum profits. For, all those who want the good should buy it only from him. They have no other way. So in determining the price of a commodity, he will be guided by only one motive, that is, to maximize his profits.
We know in a market, price is determined by the interaction of supply and demand. Under monopoly too, the price of a good is determined by the interaction of supply and demand, but in a different way. Under perfect competition, there will be several number of sellers. But under monopoly, the monopolist is the sole seller of a commodity. So he can control the supply of his good. But he cannot control demand for there are several number of buyers as in the case of competition.
The aim of a monopolist is to maximize his profits. For that, he can do one of the following two things. He can fix the price for his good and leave the market to decide what output will be required. Or he can fix the output and leave the price to be determined by the interaction of supply and demand. In other words, he can fix the price or the output; he cannot do both. The amounts he can sell at any given price depend upon the conditions of demand for his good.
Just because the monopolist is the sole seller of the commodity, we should not think he can fix whatever price he likes. Of course, he can do it but he will not make profits. Benham has put it will in the following lines: “The fortunate monopolist can fix what price he chooses, but if he cannot sell enough, he doesn’t gain; he loses.” The monopolist, therefore, has to study the conditions of supply and demand. He must carefully estimate the demand for his goods. He has to see first whether his commodity has got elastic demand or inelastic demand. If the demand for the commodity is elastic, the monopolist cannot fix a very high price because a rise in price may result in a fall of demand. So he cannot sell much and he may not get large profits. In such a case, the monopolist will fix a low price. If the good in question has inelastic demand, the monopolist may fix a high price. It is so because even if the price is high, there will not be a fall in demand. Then the monopolist will get maximum profits by fixing a high price.
The monopolist should also study the conditions of supply. He must estimate the cost of production for different quantities of his goods. If his firm is producing under the conditions of the Law of Diminishing costs, cost of production per unit will fall as output increases. Then the monopolist will try to fix a low price and sell more units. Thereby he will try to get maximum profits. On the other hand, if his firm is working under conditions of increasing costs, cost of production per unit will rise as output increases. Under such circumstances, the monopolist will generally restrict his output and sell his goods at a high price. Thereby he will try to get maximum profits. Suppose his firm is working under conditions of constant costs, the price he fixes will depend largely on the conditions of demand for his goods.
The monopolist will get maximum profit at the output at which his marginal cost and marginal revenue are equal to one another.
In the earlier stages of production, marginal cost may be much less than the marginal revenue and the monopolist may make huge profits. But after a certain stage is reached the marginal cost will rise and it may tend to be higher than the marginal revenue. The monopolist will stop producing additional units at that point. So price is fixed by the monopolist at that point where his marginal costs and marginal revenue are equal to one another. There is one more thing we should note. Under perfect competition too, marginal revenue = marginal cost = price. In other words, marginal revenue is equal to price. Under monopoly, it is true that marginal cost is equal to marginal revenue. But marginal revenue is not equal to price. Marginal revenue is always less than price. This is so because in order to expand his sales, the monopolist must reduce his price. This will result in a fall in his marginal revenue. So marginal revenue is less than price. Since marginal cost is equal to marginal revenue, marginal cost is also less than price. In other words, price is higher than marginal cost. We may summarize it as follows:
Under monopoly, marginal cost = marginal revenue; but marginal revenue is less than price, therefore marginal cost is less than price. In other words, price is greater than marginal cost.
Diagrammatic Representation of Price Determination under Monopoly Market
In figure 1, output is measured along the ‘X’ axis and receipts and costs are represented up the ‘Y’ axis. The monopolist will get the maximum profit when his output is OQ because at this output, marginal revenue and marginal cost are equal. The marginal revenue curve and the marginal cost curve are represented as straight lines for the sake simplicity. The marginal cost is represented as a horizontal straight line because it is assumed that the firm is working under conditions of the Law of Constant Costs.
The graph tells that eventually marginal costs will exceed marginal revenue. (In our graph, MC cuts MR “from below” at point ‘P’.)
Sometimes, the monopolist may find it possible and profitable to charge different prices to different buyers for the same good. This is known as ‘price discrimination’ or ‘discriminating monopoly.’ For example, a doctor may charge a rich man more than a poor man for a similar operation. Sometimes, the monopolist may sell his good at lower price in a foreign market than in his home market. His is known as ‘Dumping’. Of course, price discrimination is possible only when there is no possibility of resale from one consumer to another. That is, it should not be possible for people to buy goods in a cheaper market and sell them in a dearer market.
Causes of Monopoly Market
- A monopoly may arise because of some natural causes. Some minerals are available only in certain regions. For example, almost all the nickel in the world is available in Canada. So the International Nickel Corporation of Canada has the monopoly of nickel. Similarly, South Africa has the monopoly of diamonds.
- Some crops, which require special conditions of climate and soil are found only in one or two areas. For example, jute is grown in India and Pakistan.
- Some products are produced by a secret process in some firms. This is particularly true of most of the chemical industries. Such firms have monopoly of some goods.
- Some firms enjoy legal rights such as patent rights, copyright and so on. This leads to legal monopoly.
- The manufacture of some goods requires a large amount of capital. All firms cannot enter the field because they cannot afford to invest a large amount of capital. This may give rise to monopoly.
- Lastly, the government will have the sole right of producing and selling goods. For example, we have ‘public utilities.’ They are state monopolies.
Types of Monopolies
- Natural Monopolies: Natural monopolies arise on account of the limited supplies of raw materials in particular regions. For example, India and Pakistan have the monopoly of jute; South Africa has the monopoly of diamonds.
- Social Monopolies: Social monopolies are generally owned and managed by the State. They are also known as state monopolies. Examples of State monopolies are railways, harbors, canals and the central bank. Some of these things like post offices and railways are known as ‘public utilities’.
- Legal Monopolies: Legal protection will be given by the State to certain firms by way of patents, trade marks, copyright and so on. Such firms may be considered as legal monopolies.
- Voluntary Monopolies: Voluntary monopolies arise chiefly from combinations between different producers. There are two kinds of combination: (1) Horizontal combination and (2) Vertical combination. Examples of such combinations are cartels and trusts.
- Monopolies of Services: There are monopolies in the supply of service also. Suppose there is only one great surgeon in a city who has the ability to perform the most difficult operations. He is in the position of a monopolist.
Limits on Monopoly Market
Under monopoly, generally, prices will be higher than under perfect competition. It is true that the cost of production may be low under monopoly. But it does not benefit the consumers because it is the monopolist that gets maximum profits. However, in the actual world we do not have pure monopoly. It is only in theory that the monopolist can charge a very high price. In practice, he cannot do that. For, there are many reasons, which prevent a monopolist from charging a high price. For instance, there may be potential competition or threat of foreign competition. Further, if he fixes a very high price, there may be consumer resistance and the government will be maximum price. That is, it will tell the monopolist not to sell above a certain price. In the U.S.A., for instance, series of anti-trust laws were passed to control the monopolies.
Advantages and Disadvantages of Monopoly Market
A monopoly has some advantages. For instance, it enjoys the economies of large-scale production and there is no wasteful competition. In some cases, production or distribution can be carried out more efficiently under monopoly. Rationalization, which reorganizing an industry to secure greater efficiency, is relatively easy under monopoly. Competition in the supply of certain goods such as electricity and water would be wasteful and results in higher prices to consumers. A reduction in the number of retail shops would make possible a reduction in the prices of many consumer goods. Further, standardization is the basis of cheaper production. And under monopoly, it becomes possible to reduce the number of varieties or products. A reduction, for example, in number of models of motor cars would reduce the cost of production of cars considerably. Of course, it would also reduce consumer’s choice. But all these advantages benefit only the monopolist. A monopoly has many abuses.
- High prices: Normally under monopoly, prices will be higher than under competition. There is exploitations of buyers by means of “price discrimination”.
- Exploitation of workers: This is a serious criticism against monopoly. A monopolist will exploit the labor by paying low wages. He can do it by restricting output. He will keep a part of his plan and machinery idle. He may deliberately keep some workers unemployed.
- Unfair practices: The monopolist often adopts unfair methods to eliminate competitors. He may do all sorts of things to prevent the entry of new firms.
- Restrictive methods: The sole aim of a monopolist is to maximize his profits. If he finds it possible to get more profits by restricting his output, he will not hesitate to do so. For instance, during the world depression of 1930’s, the Brazil Institute of Coffee destroyed large quantities of coffee by dumping them into the sea.
- Concentration of wealth: Monopolies result in the concentration of wealth in the hands of a few people. Such a thing will affect the smooth working of democracy.
- A check on the economic growth: Competition is a necessary condition of economic growth. Monopolies may act as a check on economic growth. Since there is no competition for their goods, they may not be so much interested in doing research and all that.
© 2013 Sundaram Ponnusamy