Pricing Under Monopoly Firms And Level Of Price Discrimination
Pricing under monopoly is different from the other market structure due to the single seller in the market, and it leads to many advantages when it comes to pricing. Before, we move to the concept of pricing under monopoly lets understand the meaning of monopoly market in economics.
Monopoly Meaning In Economics
Monopoly Meaning In Economics: A monopoly market is where there is only a single seller. Since, there is a single seller in the market, who runs the entire industry, that is why it is called a monopoly market.
Government license, ownership of resources, copyright, patent, and high starting cost are a few of the reasons behind which gives rise to the monopoly market. So, these become the restrictions in the entry of specific industry for other sellers. Monopolies are the only firm in the industry, so a monopoly firm constitute an entire industry. In other words, a monopoly firm is equal to one sector. Monopoly Sellers has two most significant advantages which they enjoy are: being a price maker and profit maximization.
Now, we understood the meaning of a monopoly market, so let’s know about the pricing under a monopoly market and how price discrimination works in the market.
Pricing Under Monopoly
The equilibrium point of the firm determines to price under monopoly. The firm will attend to its equilibrium when it maximizes profit or produces a profit maximising level of output. To determine the equilibrium and pricing under a monopoly firm, there are two approaches:
- Total Revenue (TR) and Total Cost (TC) Approach
- Marginal Revenue (MR) and Marginal Cost (MC) Approach
Let’s understand pricing under monopoly from both of these approaches.
Total Revenue (TR) and Total Cost (TC) Approach
Total Revenue (TR) and Total Cost (TC) Approach: As per this approach a monopoly firm will reach it’s equilibrium when the difference between TR and TC is maximum, and it will define the pricing under monopoly.
To maximize its profits, a monopoly firm sells its product at the maximum possible price and adjusts the supply of the commodity in the market accordingly.
However, a monopoly firm would not set the price of its product at such a high level so that its profitability will adversely be affected due to a decline in market demand. Thus, to attend equilibrium or to maximize profit, the firm tries to produce output at which there is a maximum gap between the TR and TC.
Both TR and TC curves under monopoly are upward sloping; TR starts from the point of origin where total output is equal to zero and TC begins from a point above the origin on Y-axis i:e fixed cost even in the case when the output is zero in the short run.
- According to the TR and TC approach graph 1&2 elaborates on the situation of monopoly equilibrium and the determining pricing under monopoly.
- TR and TC curves and corresponding Part B shows the total profit of the monopolist with the help of the total profit line.
- In graph 1, TR is an upward sloping curve that begins at point O, and it increases with an increase in the level of output. TC is also shown as an upward sloping curve starting from R, a point on Y-axis above the origin.
- Both TR and TC curve initially intersect each other at point E, which is the breakeven point.
- Corresponding to the intersection point E, OQ is the level of output. Up to point E, TC lies above TR, showing a negative profit for the monopoly firm.
- In graph 2 total profit shows the negative trend from point K to T. After point E, when the monopoly firm reaches the breakeven, TR increases faster rate compared to TC and leads to TR > TC. Thus, the firm can generate profit.
- Positive profit starts from point T and rises up to point L, where the profit is maximum.
- Corresponding to this point of maximum profit, the gap between TR and TC in graph 1 is maximum, and the gap is indicated as MN.
- The gap between TR and TC is maximum when the tangent drawn on TR and TC curves are parallel to each other.
- TR and TC curve at point M and N points are parallel to each other.
- The corresponding level of output is OQ1 which is the profit-maximizing level of output. Beyond the OQ1 level of output, the profit will decline as shown by the LS segment of the total profit line.
- TR and TC curves again intersect each other at point E1, which corresponds to the OQ2 level of output and zero profit level as indicated by point S.
- Then, TC > TR indicating negative profit for the monopolist. Thus, a monopolist maximizes its profits when it produces the OQ1 level of output at which the gulf between TR and TC is maximum.
Any other level of output does not maximize the profit of the monopolist.
Marginal Revenue (MR) and Marginal Cost (MC) Approach
Marginal Revenue (MR) and Marginal Cost (MC) Approach: A monopoly firm will attend equilibrium and determine pricing under monopoly; it will maximise its profit when the following two conditions are satisfied:
- At the point of equilibrium, MC must be equal to MR, i.e. MC = MR. This is the first-order condition of equilibrium.
- At the point of equilibrium, MC must cut MR from below, i.e. slope of MR < slope of MC. In other words, MR must be rising less rapidly than the MC corresponding to the equilibrium output. This is the second-order condition of equilibrium.
The slope of MR is less than the slope of MC Monopoly equilibrium through MR and MC approach can be explained regarding both short runs as well as long run. It may be recalled that the short run is the period when a producer can increase the level of its output by changing the variable factors of production, keeping fixed factors remain unchanged.
On the other hand, in the long run, a producer can increase the level of output by changing both the fixed as well as variable factors. Thus, there is no fixed and variable cost dichotomy in the long run as all factors are treated as a variable in the long run.
Short-Run Equilibrium in Pricing under Monopoly Firm
The short-run concept states a certain period in the future, where at least one input is fixed while other inputs are variable. Now, let’s read about the monopoly meaning in economics by defining the short-run equilibrium and determine pricing under a monopoly firm.
Like in perfect competition, there are three possibilities for a firm’s Equilibrium in Monopoly. These are:
- The firm earns normal profits – If the average cost = the average revenue
- It earns supernormal profits – If the average cost < the average revenue
- It incurs losses – If the average cost > the average revenue.
In the case of normal profits pricing under monopoly is explained. A monopoly firm earns normal profits when the average cost of production is equal to the average revenue for the corresponding output.
the monopoly firm attends equilibrium at point E where both the first-order condition, i.e. MR = MC and second-order condition, i.e. MC cuts MR from below. Corresponding to the equilibrium point, OQ is the equilibrium output, and OP is the equilibrium price.
The above figure shows the equilibrium point E, where the MC curve cuts the MR curve. Also, the AC curve touches the AR curve at the point corresponding to E. Therefore, the firm earns normal profits.
In the case of supernormal profits pricing under monopoly is explained. A firm that earns super-normal profits occurs when AC is less than the AR for the corresponding output. Gives you a better understanding of Monopoly meaning in economics.
In the figure above, you can see that the price per unit = OP = QA. Also, the cost per unit = OP’. Therefore, the firm is having a small cost and earning huge profits. In this case, the per-unit profit is OP – OP’ = PP’.
In the case of super losses pricing under monopoly is explained. A firm earns losses when the average cost of production is higher than the average revenue for the corresponding output.
In the above figure, for the same quantity, the AC cost curve lies above the AR curve. The AR = OP and the AC = OP’. Therefore, the firm is incurring an average loss of PP,’ and the total loss is PP’BA. A monopoly firm sometimes sets a lower price and incurs losses to keep new firms away in the short-run.
Long-Run Equilibrium In pricing under Monopoly
In the long-run equilibrium and pricing under monopoly is done when the following two conditions are satisfied:
i. Long-run marginal cost curve (LMC) must be equal to MR, i.e. LMC = MR at the point of equilibrium. ii. The long-run marginal cost curve (LMC) must cut MR from below, i.e. MC < MR at the point of equilibrium.
Unlike in the short run where the monopoly firm may face situations of extra normal profit, normal profit and loss; in the long run, it will only earn an extra normal profit. It is due to restriction on the entry of other firms into the market.
In the case of pricing under monopoly, all costs are variable in the long run; a monopoly may able to adjust the supply of output to changes in demand in the market. In the long run, a monopoly firm always charges a price higher than its average cost production; otherwise, it should close down the business instead of incurring losses.
Therefore, a monopoly firm in the case of the long-run earns extra-normal profits. Though in the long run, a monopoly operates with supernormal profit, it doesn’t need to utilize its full capacity of plants and machinery. It is due to the restriction to enter into the market and the lack of availability of substitute products in the market.
Whether a monopoly will utilize its full capacity or not is entirely depends on the market demand for the goods it produced. Accordingly, it can operate at an optimal level or suboptimal level or more than the optimal level in the long run.
Price discrimination in price under monopoly
A monopoly firm can charge different prices from different buyers for its product. This act selling the same product at different prices to other buyers is known as price discrimination, and it differentiates the pricing under monopoly.
A monopoly that pursues the policy of price discrimination is called a discriminating monopoly. Pricing under monopoly is different prices from different individuals in the same market or can charge different prices in other markets. Also, it can charge different fees based on the use of goods.
Accordingly, there may be different types of price discrimination such as personal price discrimination, geographical price discrimination. Price discrimination based on time and price discrimination which differentiate pricing under monopoly frim.
Degrees of Price discrimination in pricing under monopoly
There are three different degrees of price discrimination. The details are as follow:
Price Discrimination of First Degree
In the case of first-degree price discrimination or perfect price discrimination, the monopoly firm may differentiate every consumer in the market in terms of price. Pricing under monopoly may charge one price from one consumer and another price from others. It can also set the maximum price for a consumer if the consumer is willing to pay. Thus, in the case of the first degree of price discrimination, the consumer surplus is zero.
Price Discrimination of Second Degree
When a monopoly is able to sell different units of a commodity at different prices to other buyers, it is a case of second-degree price discrimination. Electricity tariff in India is a classic example of second-degree price discrimination.
Price Discrimination of Third Degree
In the case of third-degree pricing under monopoly, the firm divides the market into different sub-markets and charges different price into other submarkets. However, the submarket where the monopolist will charge more. The submarket where it will charge less depends on the price elasticity of demand for the commodity produced by it in different sub-market.