hello and welcome back to the foundation course in managerial economics uh till the last week
we discussed about uh we uh started our discussion on different kinds of market structures and
we discussed in details about the perfect competition we uh we understand that perfect
competition has certain assumptions we went through the assumptions of perfect
competition that it has large number of buyers the products are homogenous so basically they
so the products are highly substitutable across different sellers and that leads to almost
zero market power of all the sellers as a result of which all the sellers and buyers
in the market are price takers so and then we went on to when we looked at
the profit maximizing condition and where the perfectly competitive firm chooses its
output we saw that the final final market outcome or the market equilibrium that is
reached in a competitive market that is highly efficient we saw that there was productive
efficiency uh that is the products were getting produced at the minimum cost across all firms
the most efficient of the firms produces first and we also saw that there is allocative efficiency
that is the willingness to pay for the marginal unit is equal to the cost of producing that
marginal unit so that was our discussion of perfect competition
and since the market outcome is efficient uh it is the most desirable outcome for the
economy but uh does perfectly competitive market perfect competition does it exist in
reality although it is desirable but do we find enough perfectly competitive markets
in the real world and what we are going to when we look around we see that uh the assumptions
of perfect competition are far from fulfilled in any of the markets that we see around
so we are going to see that in most of the markets most of the markets for different
kinds of products that we see around us the markets have few number of sellers or very
few number of sellers the products are highly differentiated and because of and so they
are not perfectly substitutable products as a result of which uh the sellers have some
amount of market power that is they have some control over the price that they can charge
and the most extreme case of this situation is the monopoly
as we discussed when we discussed about the different market structures we already discussed
this that the other extreme of perfect competition is monopoly where we have one single seller
so uh in this week we are going to discuss about uh what happens in a how does a firm
become a monopoly and what happens what what does the market equilibrium look like what
is the final market outcome and is it efficient these are the kinds of questions that we are
going to ask this week and lets see . so we ask the following questions how does
a firm become a monopoly what is the relation between marginal revenue and price for a monopoly
how do price and quantity produced get determined in a monopoly market how efficient is the
monopoly market outcome what role can the government play in a monopoly market so uh
since perfectly competitive market outcome we found out that it was efficient so so if
we see some kind of inefficiency in a monopoly market outcome can the government have some
role to play there to correct it that is the question that we are going to ask and finally
we are going to ask what is price discrimination since we say that the monopoly uh seller has
is a price maker has some control over price can he price discriminate that is can he charge
different prices to different of its buyers so these are the questions that we are going
to ask this week . to quickly a quick recap of the what a monopoly
basically what we mean by monopoly so monopoly we have a single seller very high barrier
to entry very very high barrier to entry and that is the reason that we have a single seller
because others are not being able to enter the market and the monopoly uh seller knows
that substitutes are not available and so price is determined by the seller and hence
the seller is kind of a price maker he is not a price taker but he is a price maker
so the question that next comes to mind is how does a firm become a monopoly how does
it happen that one firm emerges as a monopoly player how does it happen that if the barrier
to entry is so high one firm is there in the market others are not being able to enter
so what uh how does a firm basically become a monopoly and we are going to see that there
are very broadly there are 3 reasons because of which a firm can end up becoming a monopoly
. the first is the firm is major holder of a
key resource the firm is a major holder of key resource so it often happens that let’s
let’s take the example of the uh the the biggest diamond raw diamond company uh which
is de beers company they have owned most of the diamond mines uh all over the world mostly
in africa since the 19th century and they have been the single largest seller of raw
diamond uh during this entire period from late 19th century to almost the beginning
of 21st century so and they have held their position as the
largest owner of most of the raw diamonds across the world through various of their
business strategies and that is how they ended up being the single largest seller or the
kind of they they were able to attain a monopoly status in the market for uh raw diamonds so
that is how they became uh they emerged as the as a monopoly player in the market and
another example is although this is not a natural resource that i am talking about but
i would also take the example of microsoft so when microsoft came up with uh a extremely
user friendly uh operating system during a time when there were not too many user friendly
operating system existing in the market so as a result they were the major holder of
this key resource although this is not a natural resource like diamonds but this is a key holder
of a resource which everyone was looking for there were it is not that operating system
did not have uh major substitutes in the market obviously linux and all were there but not
everyone could use these operating system as easily as the windows so basically having
come up with something like the windows was something which made the microsoft uh a monopoly
player in the market for operating systems now the second way by which a firm can emerge
as a monopoly player is monopoly by law that is the law gives the firm a status to be the
single seller in the market so how can how can that happen that can happen through say
patents through copyright laws and the example of public monopoly so let me give examples
uh i discussed in the previous uh when when in the earlier weeks when i was discussing
about sunk cost i had taken the example of pharmaceutical companies i had said that pharmaceutical
companies have immense sunk cost in the sense that they are uh they are investing a lot
of money on research to come up with come up with new drugs uh new formulas new compositions
so they a spending a whole lot of money for it and the end result may or may not bring
any returns to them so there is a huge sunk cost for the pharmaceutical
companies so what happens if fearing this kind of sunk cost the pharmaceutical companies
stop spending on research and development so uh that is not something very desirable
and hence we have the patent laws which kind of gives a protection against uh protection
to the pharmaceutical companies that if they come up with something really useful they
will have the sole right to sell that composition for some period of time
so that is by law uh the the law is giving the power to that firm to be the single seller
in the market or giving the monopoly status to the firm so that is the patent and copyright
laws and on the other hand we have public sector companies uh public sector monopolies
like the indian railways in india so indian railways although it although the
railway network as i discussed again in the during when i was discussing about cost i
said that certain businesses have very high fixed costs and railway setting up railway
networks etc obviously it has huge fixed cost and which has been basically borne by the
government and we have the single uh indian railways but it is not that many many countries
actually have private railways also running in the in the country
so so basically the status of the monopoly status to the railways or to the postal service
has been given the monopoly status has been given by the law by the government by the
law of the land that it says that the postal service is completely uh it’s its a monopoly
player another kind of monopoly is the natural monopoly
natural monopoly is why do we call it natural monopoly because it makes sense for a single
firm to produce for the entire market to utilize economies of scale and bring down price for
the buyer so natural monopoly basically means that the market is such or the nature of the
product is such and the production process and costs are such that it makes sense for
one single large firm to produce the output for the entire economy for all the consumers
because in that case when the the amount of output is very high the firm is able to get
economies of scale as a result of which prices will also come down for all the consumers
so this is called a natural monopoly a example is uh an example of natural monopoly is say
setting up a power generation plant so in case of power generation plant the initial
cost of setting up the plant the fixed cost is enormously high say for example its a uh
coal fired thermal power plant so the initial fixed cost of setting up the power generation
unit is extremely high and not only the generation unit the distribution the network the towers
the lines the electric lines that have to be set up to distribute the powers to reach
the power to the final consumers the entire setup is extremely costly
so uh the the initial fixed cost of such a unit is extremely high and in comparison the
variable cost is low so the variable cost for generating power is what it is primarily
the say the fuel cost and some other incidental cost to uh produce the uh electricity so the
so the initial fixed cost is extremely high and the variable cost is extremely low so
that gives a typical uh shape to the average cost which i am going to show here on the
board which will may clear that why why it makes sense why such kind of setup actually
makes uh this kind of uh output or this kind of market a natural monopoly .
so one more thing uh it’s a very uh which i would like to point out is that i said in
the previous uh previous week that we are going to distinguish between the firm and
the market the the quantity produced by the firm we are going to denote it as small q
and the output produced in the market as big q but since in the monopoly the firm is the
single sole producer or seller in the market so small q is equal to big q for a monopoly
so i am going to use it synonymously so i am going to use q here so what does the average
total cost then look like so in a typical any typical firm we said that average total
cost is a u shaped curve but in case of the natural monopoly that we have described here
and we said that the fixed cost is extremely high so the average total cost takes the shape
of the average fixed cost and if you may remember the average fixed cost keeps on falling with
rise in output so the average fixed cost so the average total
cost looks very similar to the average fixed cost so this is the average total cost and
so if the price if the total so if this is the single large power generating unit in
the economy and it is catering to all the households in the economy then say it is being
able to sell over here say it is able to sell around uh 100 units of power
so when it is selling such a huge amount of uh units its average cost comes down its average
cost is as low as here and in such a situation it is possible to charge a price it is it
is possible to charge a price somewhere here and even then make a profit because average
cost is here lower than the price here or even bring down the price even lower
now what happens if we say that okay we dont want a monopoly and we want lot of firms to
produce electricity then we are going to have lot of small firms we are going to have lot
of small firms who again have to incur the fixed cost because they cannot avoid the fixed
cost of uh before they want to start producing power they have to incur the fixed cost and
for them also the average cost will look like this but now
but now since they have split up the market amongst themselves so they will be each of
them will be selling to only a part of the market
so earlier 100 units were getting sold so now maybe every so there are uh 10 such small
power power plants each of them is say uh selling around 10 units so each of them if
they are selling around 10 units which is maybe here so the cost becomes very high for
all the small power plants so they are able to so they are able to sell only a small amount
of power that is around 10 units per uh power plant and so their cost becomes very high
and they will not be able to sustain at a low price
so they will have to charge a very high price which will be somewhere here and the buyers
will also have to pay for this very high price because there are too many uh sellers in the
market who are all operating with very huge fixed costs so this is called a natural monopoly
where it makes sense to not have so many small power plants and have a single big power plant
which caters to the entire economy and thus produce a huge amount of output and having
economies of scale which brings down the cost for this firm and hence the price for the
entire uh economy and price for the all the buyers in the economy
so this is called a natural monopoly where it makes sense to have a single firm but we
will however this is a very atypical case where you have very huge cost and this is
but it is uh it is not the only case where you have monopoly in the economy there can
be various others reasons of having a monopoly in the economy so we are going to stick to
the usual uh usual cost diagram where we have the fixed cost the average cost and the marginal
cost so we are going to stick with these typical
cost curves and see what is the monopoly outcome what is the monopoly combination of price
and output that happens in the market when the monopolist is trying to maximize its profit
so that is what we are going to do in the following modules of this uh of this week
thank you