Monopoly

3. Control of a scarce input. Ownership of the only deposit of a mineral, or of the only spring.

4. Natural monopoly. Where the average cost of production falls continuously as output rises, because the fixed cost is very large and the additional cost of serving one more customer is small, one firm can always supply the whole market more cheaply than two can. Electricity distribution, water supply, gas pipelines and railway track are the standard examples. Competition here is not merely difficult, it is wasteful, which is why these industries are regulated rather than opened.

5. Amalgamation and combination. Firms merge or agree until one remains. This is why merger control exists: sections 5 and 6 of the Competition Act 2002 require combinations above prescribed thresholds to be notified to and approved by the Competition Commission.

6. Superior efficiency or a first mover advantage, sometimes reinforced by network effects, where a service becomes more useful to each user as more people use it.

How the monopolist fixes price and output

The rule is the same as for any firm: produce where marginal cost equals marginal revenue. What differs is that marginal revenue is not the price.

A worked schedule. A monopolist's demand and cost schedule.

Reading the table. Marginal revenue falls faster than price, exactly as feature 5 says: at three units the price is 80 but the third unit added only 60 to revenue. Profit is greatest at three units, and that is also where marginal revenue, 60, is closest to marginal cost, 50, before marginal cost overtakes it. At four units marginal revenue is 40 and marginal cost is 60, so the fourth unit reduces profit.

Two conclusions to state in an answer.

1. The monopolist charges a price above marginal cost. Here the price is 80 and the marginal cost of the third unit is 50. Under perfect competition price equals marginal cost. The gap is the measure of monopoly power.
2. The monopolist never produces in the inelastic range of its demand curve. Where demand is inelastic, marginal revenue is negative, and no firm adds output that reduces total revenue while adding to cost. This connects the topic directly to [Elasticity of Demand].

A monopolist can make a loss. Being the only seller does not guarantee profit; if demand is too small to cover average cost at any price, the firm closes. A monopoly on a product nobody wants is worth nothing.

Price discrimination

The meaning. Charging different prices to different buyers for the same good, where the difference is not explained by a difference in cost.

The three conditions. All three must hold.

1. The seller must have some market power, otherwise buyers charged the higher price go elsewhere.
2. The markets must be separable, by geography, by time, by age, by the nature of the buyer, or by a device that sorts buyers.
3. Resale must be impossible or costly. If the low price buyers can resell to the high price buyers, the scheme collapses. This is why discrimination is easiest in services, which cannot be resold.

The three degrees, in the classification of A. C. Pigou.

• First degree, also called perfect discrimination: every buyer is charged the maximum they would pay. A doctor in a small town who quietly charges what each patient can afford approaches it.
• Second degree: prices vary by quantity or by block, as with a telephone tariff or a slab based electricity charge.
• Third degree: buyers are sorted into groups with different elasticities and each group is charged a different price. Railway classes, student concessions, off peak cinema tickets, and the differential pricing of the same medicine in different countries.

The rule. The group with the more inelastic demand is charged the higher price.

Is it always bad? No, and a good answer says so. Third degree discrimination can allow a service to be supplied to a poor group at a price that would never cover its share of fixed costs, financed by a rich group who pay more. Railway fares are the standing example. What Indian law regulates is not discrimination as such but discrimination by a dominant enterprise: section 4(2)(a)(i) and (ii) of the Competition Act 2002 make it an abuse for a dominant enterprise to impose unfair or discriminatory conditions or prices in purchase or sale, including a predatory price, with an explanation that a condition or price adopted to meet the competition is not caught.

What the law does about monopoly in India

The old regime. The Monopolies and Restrictive Trade Practices Act 1969 attacked size itself, requiring large undertakings to obtain approval before expanding. It fitted the licensing system described in [Industrial Policy Before 1991] and was dismantled with it. Section 66 of the Competition Act 2002 repealed it.

The present regime attacks conduct, not size. Three limbs.

• Section 3 prohibits agreements that cause an appreciable adverse effect on competition, and by section 3(2) such an agreement is void. Section 3(3) presumes that agreements between competitors which fix prices, limit production or supply, share markets or rig bids have such an effect. This limb belongs mainly to [Oligopoly].
• Section 4(1) provides that no enterprise or group shall abuse its dominant position, and section 4(2) lists the abuses: unfair or discriminatory conditions or prices including predatory prices; limiting production or technical development to the prejudice of consumers; denial of market access; tying, that is making a contract conditional on accepting unconnected supplementary obligations; and using dominance in one market to enter or protect another. The explanation defines a dominant position as a position of strength in the relevant market in India enabling the enterprise to operate independently of competitive forces or to affect its competitors, consumers or the relevant market in its favour.
• Sections 5 and 6 regulate combinations, so that a monopoly is not created by merger.

Section 19(4) lists the factors by which dominance is judged, and they are worth knowing because they are economics in statutory form: market share, size and resources of the enterprise, size and importance of competitors, economic power including commercial advantages, vertical integration, dependence of consumers, monopoly acquired as a result of a statute, entry barriers, countervailing buying power, market structure and size of market, and social obligations and costs.

Section 27 sets out what the Commission may order on finding a contravention: it may direct the enterprise to discontinue the conduct, impose a penalty, and direct that agreements be modified.

The key point for an exam. Dominance is not unlawful in India. Abuse of dominance is. A firm that gains the whole of a market by being better than everybody else has broken no law.

A worked example: the only cement plant in a district

The facts. Deccan Cement is the only cement manufacturer within 400 kilometres. Bringing cement from further away adds 18 per cent to the delivered cost. It charges builders in the district 420 rupees a bag where the price 500 kilometres away is 340.

Is it a monopolist? On the economics, it is the sole seller within a radius set by transport cost, and transport cost is the barrier that keeps others out. On the law, the question is the relevant geographic market, and section 19(6) of the Competition Act 2002 directs attention to transport costs and to adequate distribution facilities among other things. A district sized geographic market is arguable precisely because of the 18 per cent.

Is the price an abuse? Not by itself. A high price is evidence, not an offence. The inquiry under section 4(2)(a) is whether the price is unfair or discriminatory, and the usual comparators are the firm's own costs, its prices in other markets and the prices of comparable producers. If Deccan Cement also refuses to supply builders who buy any cement from outside the district, that is much more serious: it is denial of market access under section 4(2)(c) and probably an exclusionary condition under section 4(2)(a)(i).

What a remedy would look like. Under section 27 the Commission could direct the practice to stop and impose a penalty. What it cannot sensibly do is order a second plant into existence, which is why the durable answers to a natural or transport based monopoly are regulation of conduct and the reduction of the barrier itself, here by better roads and rail freight.

Monopoly against perfect competition

What beginners get wrong

"A monopolist charges the highest possible price." No. It charges the price that maximises profit, which is a point on the demand curve. Charging more sells less and can reduce profit.

"Monopoly means a large firm." It means a sole seller in a relevant market. A single chemist in a remote village is a monopolist; a very large company competing hard with three others is not.

"Monopoly is illegal in India." Being dominant is lawful. Abusing dominance is not. The MRTP Act, which did attack size, was repealed by section 66 of the Competition Act 2002.

"A monopolist always earns supernormal profit." Only if demand is large enough to cover average cost. Otherwise it makes a loss or shuts.

Limits, criticism and the case in favour

The case against monopoly. Price above marginal cost, so output is below the level buyers would have paid for, which is the deadweight loss; a transfer from consumers to the producer; no pressure to reduce costs, which Leibenstein called X inefficiency; and the possibility of resources being spent on defending the monopoly rather than on producing.

The case in favour, which a complete answer must give. Where average cost falls with size, one firm is genuinely cheaper than many, and forcing competition raises costs for everybody. Monopoly profit funds research, and Schumpeter argued that the prospect of temporary monopoly is the reward that drives innovation. A patent is exactly that argument in statutory form. And a regulated monopoly can be made to serve social objectives, such as universal supply at a uniform price, that a competitive market would not.

The Indian policy answer has therefore been neither to prohibit monopoly nor to ignore it, but to open industries where entry was artificially barred, which is the story of [The New Industrial Policy 1991], to regulate the ones that are natural monopolies through sectoral regulators, and to police conduct under the Competition Act 2002.

Quick revision

1. Monopoly: one seller, no close substitute, blocked entry. The firm is the industry.
2. Six sources: statute or licence, patents, control of an input, natural monopoly from falling average cost, amalgamation, and efficiency or network effects.
3. MR lies below AR because the price must be cut on every unit to sell one more. Equilibrium where MC equals MR, with price above marginal cost.
4. The monopolist never produces where demand is inelastic, because MR is negative there.
5. Price discrimination needs market power, separable markets and no resale. Pigou's three degrees. The more inelastic group pays more.
6. Indian law: MRTP Act 1969 attacked size and was repealed by section 66 of the Competition Act 2002. Section 4(1) prohibits abuse of dominance, section 4(2) lists the abuses, section 19(4) lists the factors for dominance, sections 5 and 6 control combinations, section 27 gives the remedies.
7. Dominance is lawful; abuse is not.
8. Against monopoly: high price, restricted output, deadweight loss, X inefficiency. For it: economies of scale in natural monopolies, funding of innovation, and the possibility of regulated universal service.

Test yourself

1. Define monopoly and state its features. Monopoly is a market structure with a single seller of a commodity for which there is no close substitute and into which entry by other firms is barred. Its features are the single seller, so that the firm is the industry; absence of a close substitute, which is what gives the seller power; barriers to entry, which allow the position to last; the firm's position as a price maker, though it can fix either price or quantity and not both; a downward sloping demand curve with marginal revenue lying below it; the possibility of price discrimination; and the possibility of supernormal profit persisting in the long run.

2. Why does marginal revenue lie below average revenue under monopoly? Because the monopolist faces the whole market demand curve and can sell an additional unit only by lowering the price, and the lower price must be given on every unit sold, not merely on the extra one. The addition to total revenue is therefore the price of the extra unit minus the loss on all the earlier units, which is less than the price. Under perfect competition the firm need not lower its price to sell more, so marginal revenue equals price.

3. How does a monopolist determine price and output? By producing the output at which marginal cost equals marginal revenue, and then charging the price which the demand curve shows buyers will pay for that output. Because marginal revenue is below price, the resulting price exceeds marginal cost, which is the essential difference from perfect competition. The monopolist will never choose an output in the inelastic range of its demand curve, since marginal revenue is negative there and a further unit would reduce total revenue while adding to cost.

4. What is price discrimination? State its conditions and its degrees. Price discrimination is the charging of different prices to different buyers for the same commodity where the difference does not correspond to a difference in cost. It requires that the seller have market power, that the markets be capable of separation, and that resale from the cheaper market to the dearer one be impossible or too costly. Pigou distinguished first degree discrimination, where each buyer is charged the maximum they will pay; second degree, where the price varies by quantity or block; and third degree, where buyers are grouped by elasticity and each group charged differently. The group with the more inelastic demand pays the higher price.

5. How does Indian law deal with monopoly today, and how did that change? Under the Monopolies and Restrictive Trade Practices Act 1969 the law attacked size itself, requiring large undertakings to seek approval before expanding. That Act was repealed by section 66 of the Competition Act 2002, which regulates conduct instead. Section 4(1) provides that no enterprise or group shall abuse its dominant position, section 4(2) lists the abuses, and the explanation defines dominance as a position of strength in the relevant market in India enabling the enterprise to operate independently of competitive forces or to affect its competitors, consumers or the market in its favour. Section 19(4) lists the factors relevant to dominance, sections 5 and 6 control combinations, and section 27 sets out the remedies. Dominance itself is lawful; only its abuse is prohibited.

6. What is a natural monopoly, and why is it not simply broken up? A natural monopoly exists where the average cost of supply falls continuously as output rises, because fixed costs are very large and the cost of serving an additional customer is small, so that one firm can always supply the whole market more cheaply than several can. Electricity distribution, piped water and railway track are examples. Duplicating the network would raise total costs and prices, so competition is wasteful rather than merely difficult, and the usual answer is regulation of price and of service obligations by a sectoral regulator rather than the introduction of rival suppliers.

7. "Monopoly is always against the public interest." Discuss. Not always. The case against is strong: price exceeds marginal cost so output is restricted below the level consumers would have paid for, producing a deadweight loss; there is a transfer from consumers to the producer; and the absence of competitive pressure permits inefficiency. But where average cost falls with scale, a single supplier is genuinely the cheapest arrangement; monopoly profit can finance research, which is the reasoning behind the grant of patents; and a regulated monopoly may be required to supply everybody at a uniform price, which a competitive market would not do. Indian policy reflects this by permitting dominance, prohibiting its abuse, and regulating natural monopolies rather than dismantling them.