Managerial Economics | Micro and Macro Economics

Explain micro and macro economics including their scope.

Micro-economics :
The term micro has been derived from the Greek word micros. Which means small .in micro-
economics attention is concentrated on a very small part of individual units. The micro-
economics is the study of “the particular firms, house hold, individual prices, wages, incomes
ext. it studies for example the motive of a business man in diverting his capital from the cotton
textile industry to the Weller industry for increasing the production of commodity A rather than
B. WIKKIAN FELLNER has termed micro economics as the study of individual decision
making units. It implies that an individual buyer or seller’s behavior in the marketing the face
condition of demand or supply of a particular commodity, is the object of study in micro-
economics
Scope of Micro Economics :
Micro-economics analysis explains the allocation of resources assuming that the total resources
are given. The following chart given of view of the scope of micro-economics.
Macro Economics :
This also derived from Greek word macros, meaning large. It implies the study of economics
aggregates or the wholes. The problems like full employment, unemployment, economic stability
and economic growth cannot be accurately investigated through the examination of
infinitesimally Small units like individual consumer, producer, workers or firms. The action of a
single employer cannot have a perceptible impact upon the employment situation of a country.
The production or investment by a single firm is unlike to generate cyclical fluctuations. The
proper analysis of such problem requires an aggregated thinking. Full employment, economic
growth and instability are concerned with entire economic system. Their analysis and solution in
the right perspective can be possible only if a macro approach and aggregative instrument of
analysis and policy are employed.
HANSON has interpreted macro economics as “that branch of economics which considers
relationship between large aggregated such as volume of employment, total amount of saving
and investment, the national income, etc.
This indicates that the scope of our analysis is not simply restricted to the investigation of the
total magnitude of the economic variable but their inter relations too are essential part of the
macro-economic analysis
What is managerial economics? Support your own answer with the various definitions :
Answer: managerial economics is an applied branch of micro economics, which studies the topic
which are of great interest and importance to a manager these topics involve component like
demand, supply, production. Cost revenue, government regulation etc. managerial economics is
the application of the economic analysis to evaluate business decisions. It concentrates on the
decision process, decision model and decision variable at the firm level is viewed as a micro-
economics unit located within as industry, which exists in the context of a given socioeconomic
environment of business.
Managerial economics is concerned with economics with economics behavior of the firm it is
assumed that firm maximizes profit. In general managerial economics can Be used by the goal
oriented manager.
Definitions :
There are many managerial economics, some of them are
1. Prof Spencer Siquelman
“Managerial economics deals with integration of economics theory with business practice for the
purpose of facilitating decision making and forward planning”.
2. Prof Hague
“Managerial economics is concerned with using logic of economics mathematics and statistics to
provide ways of thinking about business decision problem”.
3. Mc Nair and Meriam
“Business economics and managerial consists of the use of economic”.
Managerial Economics | Demand
Define demand and explain various types of demand.
Demand:the demand for the product is the desire for that product
backed by willingness as well as ability to pay for it. It is always defined
with reference to a particular time, place price and given values of other
variables on which it depends.
Demand for the product implies
(a) Desire to acquire it.
(b) Willingness to pay for it.
(c) Ability to pay for it.
Various type of demands are
1) Direct and derived demands.
Direct demand refers to demand for goods meant for final consumption. By contrast, derives
derived demand refers to demand for goods which are needed for further production. It is the
demand for producer’s goods like industrial raw material, machine tools and equipments.
2) Autonomous and induced demand
When the demand foe the product is tied to the purchase of some parent product, its demand is
caved induced or derived. For example the demand of cement is derived from demand for
housing. Autonomous demand, on the other hand is not derived or induced. All direct demand
may be loosely called autonomous.
3. Perishable and durable goods demand
Both consumer’s goods and producer’s goods are classified into perishable and non durable,
single use goods, durable, non perishable, repeated use goods. Non-durable goods meet
immediate demand, but durable goods are designed to meet current as well as future demand as
they are used than ones. When durable items are purchased, they are considered to be an addition
to stock of assets or wealth. Due to continuous use, durables suffer depreciation and thus call for
replacement. Thus the demand for durable goods has two aspects-replacements of old products
and expansion of total stock.
4. New demand and replacement demand
If the purchase of an item is meant as an addition to stock, it is a new demand. If the purchase of
an item is meant for maintaining the old stock of capital/asset intact, it is replacement demand.
Such replacement expenditure is to overcome depreciation in the existing stock.
Explain consumer’s surplus with support of figure diagram. What difficulties one faces in
measuring consumers surplus
consumer surplus is equal to the difference between the amount of money that a consumer
actually pays to buy a certain quantity of a commodity x, and amount that he would be willing to
pay for this quantity rather than do without it.
Graphically the consumer’s surplus may be found by his demand curve for commodity x and the
current market price, which is assumed, he cannot affect by his purchases of this commodity.
Assume that the consumer’s demand for x is a straight line (AB in below fig) And the market
price P. at this price consumer buys q units of x and pays an amount (p) for it. However, he
would be willing to pay p1 for q1.P2 for q2, p2 for q3 and so on. the fact that the price in the
market is lower than the price he would be willing too pay for initial units of x implies that is
actual expenditure is less than he would willing to spend to acquire the quantity q. the difference
is the consumer’s surplus, and is the area of the triangle PAC in the fig. below
Thus consumer surplus may be defined as the excess of utility or satisfaction obtained by the
consumer and is measured by the difference between what we are prepared to pay and what we
actually pay.
DIFFICULTIES IN MEASURING CONSUMER’S SURLUS:
1. The cardinal measurement of utility is difficult
Because it is close to impossible for a consumer to say that the first unit of commodity gave him
10 units of satisfaction and the second unit of commodity gave him 5 units of satisfaction.
2. Marginal utility for the same commodity id different to different consumers
. Marginal utility for a particular commodity varies from person to person depending upon their
income, tastes and preferences.
3. Existences of substitutes:
In the real world a number of substitutes for a commodity exist, thus making the work of
measuring consumer’s surplus a complicated task.
4. Marginal utility of money is not constant:
Marshall based his concept of consumer’s surplus on the simplifying assumption that the
marginal utility of money is constant. As the consumer buys more and more units of a
commodity x, the amount of money with him diminished, in this case, the marginal utility of
money is bound to increases rather than remain constant.
5. Lack of awareness of different price
It is not possible for a consumer be t aware of the entire demand schedule.

Demand Forecasting
Define demand forecasting .explain types of forecast and steps to be followed in forecasting.
Demand forecasting is a specific type of forecasting, which enables the manager to minimize
elements of risk and uncertainty. The likely future event has to be given form and content in
terms of projected courses of variable, i.e. is forecasting. The manager can conceptualize the
future in definite terms. If he is concerned with future events in its order, intensity and duration,
he can predict the future. If he is concerned with the course in like of future variable of future
variables like demand, price or profit, he can project the future.
Types of Forecasts :
1. ECONOMIC AND NON-ECONOMIC FORECASTS: ‘SOCIAL’ technological and ‘political
‘forecasts are all example of non economic forecasts, for example, one can forecast the crime
rate, technological obsolescence, election result and so on.
2. MICRO AND MACRO-FORECASTS:
Micro-forecasts are at firm level. E.g. a demand or sales forecast. On the other hand, macro-
forecasts are at the industry level or the economy level for e.g. five year plan projections.
3. ACTIVE AND PASSIVE FORECASTS
If the firm extrapolates the demand of previous years to yield the likely estimated demand for the
coming year, it is and example of passive forests. if the firm, on the other hand ,tries to
manipulate demand by changing price, product quality promotional efforts ,etc. then it is an
example of active forecast.
4. CONDITIONAL AND NON-CONDITIONAL FORECASTS IN ‘conditional ‘ forecasting
we estimate the likely impact of certain known or assumed changes in the independent variable
on the dependant variables. ‘Non conditional ‘ forecasting, in contrast, requires the estimation of
the change in the independent variable themselves.
5. SHORT-RUN AND LONG RUN FORECASTS In a long term forecast, one has to consider
long-term changes in population, tastes preferences of the buyers, technology, and product life –
cycle etc. by contrast short-run forecasting concentrates on a few selected variables, here simple
techniques based o analysis of past experience and information give fairly accurate forecasts.
DEFINE LAWS OF VARIABLE PROPORATION? WHAT IS THE ASSUMPTION OF THE
LAW?
The law of variable proportions is a short-run production function. Where some factors are fixed
and other variable, like land may be fixed and labour may be variable. Variable means its
quantity can be changed.
STATEMENT OF THE LAW:
As equal increment of one point are added , the inputs of other productive services being held,
constant, beyond a certain point the resulting increment of products will decrease i.e. the
marginal product will diminish .
The law of variable proportion is also know as “the law of diminishing returns” this law refers to
the amount of extra output secured by adding to a fixed input more and more of variable inputs.
If, for example we add increasing quantities of some variable factors (say labour) to a fixed
factor (say land) and as ea result we get production more than proportionately, then it is known
as increasing return to scale. When, however, the resulting production is in the same proportion it
is known as constant returns and when he output is less than input it is the decreasing returns of
scale.
ASSUMPTION OF THE LAW
1. There is only one varialble factor. All the others are constant.
2. The units of variable factors are homogeneous in character.
3. It is possibile to change the proportion in which the various factors are combined together.
4. The state of technology remains unchanged.
5. The time period is short.
Managerial Economics | Cost Function
DESCRIBE COST FUNCTION, ALSO MENTION THE CONCEPT OF COST.
Cost functions are derived functions. They are derived from the production function .they are
derived from the production function, which describes the an actable efficient methods of
production at any one time. Short run costs are the cost over a period during which some of
production factors (usually capital, equipment and management) are fixed The long –run term
costs are the costs over a period long enough to permit the change of all factors of production. In
long run, all factors become variable. Both in short run and in long run, total cost is multivariate
function. That is total cost is determined by many factors. Symbolically we may write the long-
run function as
C=f(X, T, ,K)
And short run cost function as
C=f(X, T, ,K)
WHERE
C=TOTAL COST
X=output
T=technology
K=PRICE OF FACTORS=FIXED FACTORS(S)
Cost is the function of output c=f(X)
Concepts of Costs
There are many types of concepts where coats are concerned
1. Money Cost
Cost is not unique concepts on the contrary there are various types of costs. The most accepted is
the money value or the money cost of production which means the total money involved in
production of a commodity. For example money spends on rent, machinery interests’ salary of
the employee etc, from a producer’s point of view this is the most important cost concept.
2. Opportunity Cost
This is a very important concept in modern economic analysis. We can understand this concept
best by an example say if a person goes to market he has many things to buy he can buy a watch
or a book or a T.V anything for that matter he will choose one out of all the items. The cost of
foregoing the other items in known as opportunity cost. We could say that the alternative or
opportunity cost of any factor in the production of a particular commodity is the maximum
amount which the factor could have cared in some alternative use.
3. Real Cost:
According to marshall , the real cost of production of a commodity express not in terms of
money but in efforts and the scarifies undergone in the making of a commodity. Money is paid to
factors of production to compensate them for their effort and sacrifice. Weather this money is
adequate or not is entirely a different question the main difficulty with this concept is that is
purely subjective and psychological.
4. Accounting cost and Economic cost
Accounting cost is also know as explicit costs or expenditure cost. We can say that these costs
are contractual payments which are paid to the factors of production which do not belong to the
employer himself. For example payments made for raw materials, power, light, and wages.
Economical costs are also known as implicit costs or non-expenditure costs. This arises in the
case of those factors which are possessed and supplies by the employer himself. For example, an
employer may contribute his own land, his own capital and may work as the manager of the firm.
So he is entitled to Interest and salary for himself.
5. Fixed cost and variable cost:
VARIABLE COST REFERS TO THOSE FACTORS WHICH ARE VARIABLE IN SHORT –
RUN.THESES COSTS NATURALLY VARY WITH the changes in the level of output of the
firm, increasing with an increase and diminishing with decrease in the output. For example if
affirm plans to increase the number of labour it will have to increase the expenditure of the
salary of the workers. They are direct costs because all the units produced by the firm depend
directly upon them. Fixed costs are those costs which cannot be increased in short-run even if the
employer wishes to do so. They are called fixed costs because they do not change with every
change in output, for e.g. if the output is doubled the rent of the land where the firm is operating
will not change. it is important for a firm to cover the variable costs
(a)JOIN STOCK COMPANY
IT is also know as association of individuals knows as shareholders who are authorized by the
government to run a particular business. This system has become a popular type of business
organization large scale commercial and industrial enterprise and generally run under the stock
company system. The capital of the firm is contributed by large number of shares holders, who
are the real owner of the business firm. The policy making job of the firm is entrusted to aboard
of directors who are elected among the shareholders. The joint stock company invariably carries
on production on a large scale. Consquentis, all the economics of large scale production accure
to it which finally result in cutting down its production costs The board of members simply lays
down the general policy of the company. But the actual implementation of the policy is left to the
well trained and highly paid specialists. Compare to partnership, join stock can raise capital on
much larger scale, by selling shares of various types it can raise adequate capital to meet its own
requirement. The share of the joint stock company can be easily bought and sold on the stock
exchange. If any shareholders are not satisfied with the working, he can get out of the company
by selling his shares But there are some demerits due to delays in decision, lack of interest in
company matters, difficulty of establishment.
(E)ISOQUANTS
Isoquants are a geometric representation of the production function. The same level of output can
be produced by various combinations of factor inputs. Assuming continues variation in the
possible combination of labour and capital, we can draw a curve by plotting all these alternatives
combinations for a given level of output. This curve which is the locus of all possible
combinations is called isoquants or iso-product curve.
Properties of isoquants:
1. Each isoquants correspondence to a specific level of output and shows different ways of
technological efficiency,for producing that quantity of output. 2. The isoquants are downward
sloping and convex to the origin. The slope of isoquants is significant because it indicates the
rate at which factors K and L (where L is labour , K is capital) can be substituted for each other
while a constant level of output is maintained. 3. Two isoquants do not interest each other as it is
not possible to have two output levels for a particular inputs combination. ISOQUANT MAP
Q=production function K=capital L=labour Q=f (K, L)
For a given value of Q, alternative combination of K and L can be possible because labour and
capital are substitute to each other to some extent. The alternative combination of factors for a
given output level will be such that if the use of one factor input is increased, the use of another
factor decreases, and vice versa.
(H) KEYNE’S LIQUIDITY PREFERENCE THEORY
According to Keynes, money is the perfect liquid asset. The main motives which impel an
individual or business firm to demand money or hold liquid assets are transaction motive,
precautionary motive and speculative motive.
1. Transaction motive:
A substantial amount of money is required by the community for carrying out day to day
transactions.
2. Precautionary motive.
Most of the spending units hold some of cash in excess of the minimum required to meet the day
to day transactions. this surplus amount is held in part to deal with emergencies unforeseen
contingencies like illness, accidents, unemployment and any other economic misfortune or to
take advantage of bargains when the goods can possible be purchased on attractive terms with
pavements ,made in terms of cash.
3. Speculative motive:
The speculative motive for the holding of money relates to the taking advantage of future market
movements. It involves holding of money balances with the objective of “securing profit from
knowing better than market what the future will bring forth”.
The relationship between liquidity preference and the rate of interest is inverse. The liquidity is
maximum when the rate of interest is zero because the individual will not lose anything even if
they keep all their money in liquid form. As the rate of interest increases, people will prefer to
hold less and less amount of money as liquid cash.
(C)LONG RUN COSTS
In the ling run cost managers have enough time to change the scale or size of the production unit.
There are no fixed factors in long-run. If suppose there is increases in The demand for the
product, there is time to increase the production of the firm. In long run every thing is variable
including management, labour or be it machinery, when the scale of operation is changed, we
need to draw new short run curve of the firm, because the old cost curve becomes outdated due
to change in the scale of operations. Now I m going to explain on long run average cost curve
(LAC) LAC is the sum of various short run cost curves depicting different production plan A at
different time periods. Let’s understand the long run average cost. lets assume three different
short term average cost curve(SAC),lets denote them by SAC1,SAC2,and SAC3.there are three
minimum points e1,e2,e3.firm always selects the minimum points of the SAC, because at this
point it incurs the least cost. The LRAC curve to the short-run average cost curve.
The LAC is flatter than SAC, it also known as envelope curve. The firm will choose the point e2
because it is ideal point of production. At e1 the cost of production is still decreasing in long run
and at e3 the cost of production increases which means that output is less than the cost beard by
the firm. (d)OLIGOPOLY AND ITS MAIN FEATURES: Oligopoly means “competition among
the few”. There is no limit between few and many but generally when numbers of seller are
between two to ten. In an oligopolistic market there are a small number of firms, so that sellers
are conscious of their interdependence. Thus each firm must take into account the rivals
reactions. The competition is not perfect, yet the rivalry among firms in high unless they make
collusive agreement. The seller must guess the rivals reactions. Their decision depends upon on
the ease of entry and time lag, which they forecasts to intervene between own action and the
rival’s reactions. We can broadly divide oligopology into 2 parts collusive and non collusive
oligopology . Collusive is the one which the producers come together and determine a fixed price
or output or share of the market etc. Non collusive oligopology is the one which the competition
applies own managerial skills to capture the market and is always alert of what the rival producer
is planning
THE MAIN FEATURES
1. Interdependence: The producers are interdependence on each other for decision making .this is
because the numbers of competitors are few so any change in price, output, product etc. by firms
can have some effect on the other producer
. 2. Importance of advertising and selling cost: To occupy the bigger share of market the
producer plans a layout for advertising. For this various firms have to incur a good deal of costs
on advertising.
3. Group behaviors: in this type of market the producers come together to take decisions in every
members common interest.
In economics, a monopoly (from Greek monos / μονος (alone or single) + polein / πωλειν (to
sell)) exists when a specific individual or an enterprise has sufficient control over a particular
product or service to determine significantly the terms on which other individuals shall have
access to it. (This is in contrast to amonopsony which relates to a single entity's control over a
market to purchase a good or service. And contrasted with oligopoly where a few entities exert
considerable influence over an industry)[1][clarification needed] Monopolies are thus characterised by a
lack of economic competition for thegood or service that they provide and a lack of
viable substitute goods.[2] The verb "monopolise" refers to theprocess by which a firm gains
persistently greater market share than what is expected under perfect competition.

A monopoly must be distinguished from monopsony, in which there is only one buyer of a

product or service ; a monopoly may also have monopsony control of a sector of a market.
Likewise, a monopoly should be distinguished from a cartel (a form of oligopoly), in which
several providers act together to coordinate services, prices or sale of goods. Monopolies,
monopsonies and oligopolies are all situations where one or a few entities have market
power and therefore must interact with their customers (monopoly), suppliers (monopsony) and
the other firms (oligopoly) in a game theoretic manner - meaning that expectations about their
behavior affects other players' choice of strategy and vice versa. This is to be contrasted with the
model of perfect competition where firms are price takers and do not have market power.
Monopolists typically produce fewer goods and sell them at a higher price than under perfect
competition, resulting in abnormal and sustained profit. (See
also Bertrand, Cournot or Steckelbergequilibria, market power, market share, market
concentration, Monopoly profit, industrial economics).

Monopolies can form naturally or through vertical or horizontal mergers. A monopoly is said to

be coercivewhen the monopoly firm actively prohibits competitors from entering the field or
punishes competitors who do (see Chainstore paradox).

In many jurisdictions, competition laws place specific restrictions on monopolies. Holding a

dominant position or a monopoly in the market is not illegal in itself, however certain categories
of behavior can, when a business is dominant, be considered abusive and therefore be met with
legal sanctions. A government-granted monopoly or legal monopoly, by contrast, is sanctioned
by the state, often to provide an incentive to invest in a risky venture or enrich a
domestic interest group. Patents, copyright, and trademarks are all examples of government
granted and enforced monopolies. The government may also reserve the venture for itself, thus
forming a government monopoly.
Market structures

In economics, monopoly is a pivotal area to the study of market structures, which directly
concerns normative aspects of economic competition, and sets the foundations for fields such
as industrial organization and economics of regulation. There are four basic types of market
structures under traditional economic analysis: perfect competition, monopolistic competition,
oligopoly and monopoly. A monopoly is a market structure in which a single supplier produces
and sells the product. If there is a single seller in a certain industry and there are no close
substitutes for the goods being produced, then the market structure is that of a "pure monopoly".
Sometimes, there are many sellers in an industry and/or there exist many close substitutes for the
goods being produced, but nevertheless firms retain some market power. This is
called monopolistic competition, whereas in oligopoly the main theoretical framework revolves
around firm's strategic interactions.

In general, the main results from this theory compare price-fixing methods across market
structures, analyse the impact of a certain structure on welfare, and play with different variations
of technological/demand assumptions in order to assess its consequences on the abstract model
of society. Most economic textbooks follow the practice of carefully explaining the perfect
competition model, only because of its usefulness to understand "departures" from it (the so
called imperfect competition models).

The boundaries of what constitutes a market and what doesn't, is a relevant distinction to make in
economic analysis. In a general equilibrium context, a good is a specific concept entangling
geographical and time-related characteristics (grapes sold in October 2009 in Moscow is a
different good from grapes sold in October 2009 in New York). Most studies of market structure
relax a little their definition of a good, allowing for more flexibility at the identification of
substitute-goods. Therefore, one can find an economic analysis of the market of grapes in
Russia, for example, which is not a market in the strict sense of general equilibrium theory.
[edit]Characteristics

 Single seller: In a monopoly there is one seller of the monopolised good who produces
all the output.[3] Therefore, the whole market is being served by a single firm, and for
practical purposes, the firm is the same as the industry.
 Market power: Market power is the ability to affect the terms and conditions of
exchange so that the price of the product is set by the firm (price is not imposed by the
market as in perfect competition). [4][5] Although a monopoly's market power is high it is still
limited by the demand side of the market. A monopoly faces a negatively sloped demand
curve not a perfectly inelastic curve. Consequently, any price increase will result in the loss
of some customers.
[edit]Sources of monopoly power

Monopolies derive their market power from barriers to entry - circumstances that prevent or
greatly impede a potential competitor's entry into the market or ability to compete in the market.
There are three major types of barriers to entry; economic, legal and deliberate.[6]

 Economic barriers: Economic barriers include economies of scale, capital requirements,

cost advantages and technological superiority.[7]
Economies of scale: Monopolies are characterised by declining costs over a relatively
large range of production.[8] Declining costs coupled with large start up costs give
monopolies an advantage over would be competitors. Monopolies are often in a position
to cut prices below a new entrant's operating costs and drive them out of the industry.
[8]
 Further the size of the industry relative to the minimum efficient scale may limit the
number of firms that can effectively compete within the industry. If for example the
industry is large enough to support one firm of minimum efficient scale then other firms
entering the industry will operate at a size that is less than MES meaning that these firms
cannot produce at an average cost that is competitive with the dominant industry. Finally,
if long run average cost is constantly falling the least cost way to provide a good or
service is through a single firm.[9]
Capital requirements: Production processes that require large investments of capital, or
large research and development costs or substantial sunk costs limit the number of firms
in an industry.[10] Large fixed costs also make it difficult for a small firm to enter an
industry and expand.[11]
Technological superiority: A monopoly may be better able to acquire, integrate and use
the best possible technology in producing its goods while entrants do not have the size or
fiscal muscle to use the best available technology.[8] In plain English one large firm can
sometimes produce goods cheaper than several small firms.[12]
No substitute goods: A monopoly sells a good for which there is no close substitutes.
The absence of substitutes makes the demand for the good relatively inelastic enabling
monopolies to extract positive profits.
  Control of Natural Resources: A prime source of monopoly power is
the control of resources that are critical to the production of a final good.
 Legal barriers: Legal rights can provide opportunity to monopolise the
market in a good. Intellectual property rights, including patents and
copyrights, give a monopolist exclusive control over the production and
selling of certain goods. Property rights may give a firm the exclusive
control over the materials necessary to produce a good.
 Deliberate Actions: A firm wanting to monopolise a market may engage
in various types of deliberate action to exclude competitors or eliminate
competition. Such actions include collusion, lobbying governmental
authorities, and force.
In addition to barriers to entry and competition, barriers to exit may be a source of market power.
Barriers to exit are market conditions that make it difficult or expensive for a firm to leave the
market. High liquidation costs are a primary barrier to exit. [13] Market exit and shutdown are
separate events. The decision whether to shut down or operate is not affected by exit barriers. A
firm will shut down if price falls below minimum average variable costs.
Monopoly versus competitive markets

While monopoly and perfect competition mark the extremes of market structures [14] there are
many point of similarity. The cost functions are the same.[15] Both monopolies and perfectly
competitive firms minimize cost and maximize profit. The shutdown decisions are the same.
Both are assumed to face perfectly competitive factors markets. There are distinctions, some of
the more important of which are as follows:

Market Power - market power is the ability to control the terms and condition of exchange.
Specifically market power is the ability to raise prices without losing all one's customers to
competitors. Perfectly competitive (PC) firms have zero market power when it comes to setting
prices. All firms in a PC market are price takers. The price is set by the interaction of demand
and supply at the market or aggregate level. Individual firms simply take the price determined by
the market and produce that quantity of output that maximize the firm's profits. If a PC firm
attempted to raise prices above the market level all its "customers" would abandon the firm and
purchase at the market price from other firms. A monopoly has considerable although not
unlimited market power. A monopoly has the power to set prices or quantities although not both.
[16]
 A monopoly is a price maker. [17] The monopoly is the market [18] and prices are set by the
monopolist based on his circumstances and not the interaction of demand and supply. The two
primary factors determining monopoly market power are the firm's demand curve and its cost
structure.[19]

Price - In a perfectly competitive market price equals marginal cost. In a monopolistic market
price is greater than marginal cost.[20]

Marginal revenue and price - In a perfectly competitive market marginal revenue equals price.
In a monopolistic market marrgianl revenue is less than price.[21]

Product differentiation: There is zero product differentiation in a perfectly competitive market.

Every product is perfectly homogeneous and a perfect substitute. With a monopoly there is high
to absolute product differentiation in the sense that there is no available substitute for a
monopolized good. The monopolist is the sole supplier of the good in question. [22] A customer
either buys from the monopolist on her terms or does without.

Number of competitors: PC markets are populated by an infinite number of buyers and sellers.
Monopoly involves a single seller.[22]

Barriers to Entry - Barriers to entry are factors and circumstances that prevent entry into
market by would be competitors and impediments to competition that limit new firms from
operating and expanding within the market. PC markets have free entry and exit. There are no
barriers to entry, exit or competition. Monopolies have relatively high barriers to entry. The
barriers must be strong enough to prevent or discourage any potential competitor from entering
the market.

Elasticity of Demand; the price elasticity of demand is the percentage change in demand caused
by a one percent change in relative price. A successful monopoly would face a relatively
inelastic demand curve. A low coefficient of elasticity is indicative of effective barriers to entry.
A PC firm faces what it perceives to be perfectly elastic demand curve. The coefficient of
elasticity for a perfectly competitive demand curve is infinite.

Excess Profits- Excess or positive profits are profit above the normal expected return on
investment. A PC firm can make excess profits in the short run but excess profits attract
competitors who can freely enter the market and drive down prices eventually reducing excess
profits to zero.[23] A monopoly can preserve excess profits because barriers to entry prevent
competitors from entering the market.

Profit Maximization - A PC firm maximizes profits by producing where price equals marginal
costs. A monopoly maximises profits by producing where marginal revenue equals marginal
costs.[24] The rules are not equivalent. The demand curve for a PC firm is perfectly elastic - flat.
The demand curve is identical to the average revenue curve and the price line. Since the average
revenue curve is constant the marginal revenue curve is also constant and equals the demand
curve, Average revenue is the same as price (AR = TR/Q = P x Q/Q = P). Thus the price line is
also identical to the demand curve. In sum, D = AR = MR = P.

P-Max quantity, price and profit - If a monopolist obtains control of a formerly perfectly
competitive industry, the monopolist would raise prices, cut production, and realise positive
economic profits.[25]

Supply Curve - in a perfectly competitive market there is a well defined supply function with a
one to one relationship between price and quantity supplied. In a monopolistic market no such
supply relationship exists. As Pindyck and Rubenfeld note a change in demand "can lead to
changes in prices with no change in output, changes in output with no change in price or
both." [26] Monopolies produce where marginal revenue equals marginal costs. For a specific
demand curve the supply "curve" would be the price/quantity combination at the point where
marginal revene equals marginal cost. If the demand curve shifted the marginal revenue curve
would shift as well an a new equilibrium and supply "point" would be established. The locus of
these points would not be a well defined supply curve.[27]

The most significant distinction between a PC firm and a monopoly is that the monopoly faces a
downward sloping demand curve rather than the "perceived" perfectly elastic curve of the PC
firm.[28] Practically all the variations above mentioned relate to this fact. If there is a downward
sloping demand curve then by necessity there is a distinct marginal revenue curve. The
implications of this fact are best made manifest with a linear demand curve, Assume that the
inverse demand curve is of the form x = a - by. Then the total revenue curve is TR = ay - by2 and
the marginal revenue curve is thus MR = a - 2by. From this several things are evident. First the
marginal revenue curve has the same y intercept as the inverse demand curve. Second the slope
of the marginal revenue curve is twice that of the inverse demand curve. Third the x intercept of
the marginal revenue curve is half that of the inverse demand curve. What is not quite so evident
is that the marginal revenue curve lies below the inverse demand curve at all points. [28] Since all
firms maximise profits by equating MR and MC it must be the case that at the profit maximizing
quantity MR and MC are less than price which further implies that a monopoly produces less
quantity at a higher price than if the market were perfectly competitive.

The fact that a monopoly faces a downward sloping demand curve means that the relationship
between total revenue and output for a monopoly is much different than that of competitive
firms. [29]Total revenue equals price times quantity. A competitive firm faces a perfectly elastic
demand curve meaning that total revenue is proportional to output.[30] Thus the total revenue
curve for a competitive firm is a ray with a slope equal to the market price. [31] A competitive firm
can sell all the output it desires at the market price. For a monopoly to increase sales it must
reduce price. Thus the total revenue curve for a monopoly is a parabola that begins at the origin
and reaches a maximum value then continuously falls until total revenue is again zero. [32] Total
revenue reaches its maximum value when the slope of the total revenue function is zero. The
slope of the total revenue function is marginal revenue. So the revenue maximizing quantity and
price occur when MR = 0. For example assume that the monopoly’s demand function is P = 50 -
2Q. The total revenue function would be TR = 50Q - 2Q 2 and marginal revenue would be 50 -
4Q. Setting marginal revenue equal to zero we have

50 - 4Q = 0
-4Q = -50
Q = 12.5
So the revenue maximizing quantity for the monopoly is 12.5 units and the revenue maximizing
price is 25.

A company with a monopoly does not undergo price pressure from competitors, although it may
face pricing pressure from potential competition. If a company raises prices too high, then others
may enter the market if they are able to provide the same good, or a substitute, at a lower price.
[33]
 The idea that monopolies in markets with easy entry need not be regulated against is known
as the "revolution in monopoly theory".[34]

A monopolist can extract only one premium, [clarification needed] and getting into complementary
markets does not pay. That is, the total profits a monopolist could earn if it sought to leverage its
monopoly in one market by monopolizing a complementary market are equal to the extra profits
it could earn anyway by charging more for the monopoly product itself. However, the one
monopoly profit theorem does not hold true if customers in the monopoly good are stranded or
poorly informed, or if the tied good has high fixed costs.

A pure monopoly follows the same economic rationality of firms under perfect competition, i.e.
to optimise a profit function given some constraints. Under the assumptions of increasing
marginal costs, exogenous inputs' prices, and control concentrated on a single agent or
entrepreneur, the optimal decision is to equate the marginal cost and marginal revenue of
production. Nonetheless, a pure monopoly can -unlike a competitive firm- alter the market price
for her own convenience: a decrease in the level of production results in a higher price. In the
economics' jargon, it is said that pure monopolies "face a downward-sloping demand". An
important consequence of such behaviour is worth noticing: typically a monopoly selects a
higher price and lower quantity of output than a price-taking firm; again, less is available at a
higher price.[35]
Price Discrimination and Capturing of Consumer Surplus

Improved price discrimination allows a monopolist to gain more profit by charging more to those
who want or need the product more or who have a higher ability to pay. For example, most
economic textbooks cost more in the United States than in "Third world countries" likeEthiopia.
In this case, the publisher is using their government granted copyright monopoly to price
discriminate between (presumed) wealthier economics students and (presumed) poor economics
students. Similarly, most patented medications cost more in the U.S. than in other countries with
a (presumed) poorer customer base. Perfect price discrimination would allow the monopolist to
charge a unique price to each customer based on their individual demand. This would allow the
monopolist to extract all the consumer surplus of the market. Note that while such perfect price
discrimination is still a theoretical construct, it is becoming increasingly real with the advances
in information technology, data mining, and micromarketing. Typically, a high general price is
listed, and various market segments get varying discounts. This is an example of framing to
make the process of charging some people higher prices more socially acceptable. (see
also behavioral economics, decision biases).

It is important to realize that partial price discrimination can cause some customers who are
inappropriately pooled with high price customers to be excluded from the market. For example, a
poor student in the U.S. might be excluded from purchasing an economics textbook at the U.S.
price, that she might have purchased at the China price. Similarly, a wealthy student in China
might have been willing to pay more (although naturally it is against their interests to signal this
to the monopolist). These are deadweight losses and decrease a monopolist's profits. As such,
monopolists have substantial economic interest in improving their market information, and
market segmenting.

There are important points for one to remember when considering the monopoly model diagram
(and its associated conclusions) displayed here. The result that monopoly prices are higher, and
production output lower, than a competitive firm follow from a requirement that the monopoly
not charge different prices for different customers. That is, the monopoly is restricted from
engaging in price discrimination (this is called first degree price discrimination, where all
customers are charged the same amount). If the monopoly were permitted to charge
individualised prices (this is called third degree price discrimination), the quantity produced, and
the price charged to the marginal customer, would be identical to a competitive firm, thus
eliminating the deadweight loss; however, all gains from trade (social welfare) would accrue to
the monopolist and none to the consumer. In essence, every consumer would be just indifferent
between (1) going completely without the product or service and (2) being able to purchase it
from the monopolist.
As long as the price elasticity of demand for most customers is less than one in absolute value, it
is advantageous for a firm to increase its prices: it then receives more money for fewer goods.
With a price increase, price elasticity tends to rise, and in the optimum case above it will be
greater than one for most customers.
Monopoly and efficiency

Surpluses and deadweight loss created by monopoly price

setting

According to the standard model,[citation needed] in which a monopolist sets a single price for all
consumers, the monopolist will sell a lower quantity of goods at a higher price than would firms
under perfect competition. Because the monopolist ultimately forgoes transactions with
consumers who value the product or service more than its cost, monopoly pricing creates
adeadweight loss referring to potential gains that went neither to the monopolist or to consumers.
Given the presence of this deadweight loss, the combined surplus (or wealth) for the monopolist
and consumers is necessarily less than the total surplus obtained by consumers under perfect
competition. Where efficiency is defined by the total gains from trade, the monopoly setting is
less efficient than perfect competition.

It is often argued that monopolies tend to become much more efficient and innovative over time,
becoming "complacent giants", because they do not have to be efficient or innovative to compete
in the marketplace. Sometimes this very loss of demographic efficiency can lower a potential
competitor's value enough to overcome market entry barriers, or provide incentive for research
and investment into new alternatives. The theory of contestable markets argues that in some
circumstances (private) monopolies are forced to behave as if there were competition because of
the risk of losing their monopoly to new entrants. This is likely to happen where a
market's barriers to entry are amazingly large. It might also be because of the strength in the
longer term of substitutes in the same markets. For example, a canal monopoly, while worth a
great deal in the late eighteenth century United Kingdom, was worth much less in the late
nineteenth century because of the introduction of railways as a substitute.
Natural monopoly
A natural monopoly is a firm which experiences increasing returns to scale over the relevant
range of output.[36] A natural monopoly occurs where the average cost of production "declines
throughout the relevant range of product demand." The relevant range of product demand is
where the average cost curve is below the demand curve. [37] When this situation occurs it is
always cheaper for one large firm to supply the market than multiple smaller firms, in fact,
absent government intervention in such markets will naturally evolve into a monopoly. An early
market entrant who takes advantage of the cost structure and can expand rapidly can exclude
smaller firms from entering and can drive or buy out other firms. A natural monopoly suffers
from the same inefficiencies as any other monopoly. Left to its own devices a profit seeking
natural monopoly will produce where marginal revenue equals marginal costs. Regulation of
natural monopolies is problematic.[citation needed]Breaking up such monopolies is by definition
inefficient. The most frequently used methods dealing with natural monopolies is government
regulations and public ownership. Government regulation generally consists of regulatory
commissions charged with the principal duty of setting prices.[38] To reduce prices and increase
output regulators often use average cost pricing. Under average cost pricing the price and
quantity are determined by the intersection of the average cost curve and the demand curve.
[39]
 This pricing scheme eliminates any positive economic profits since price equals average cost.
Average cost pricing is not perfect. Regulators must estimate average costs. Firms have a
reduced incentive to lower costs. And regulation of this type has not been limited to natural
monopolies.[39]
Government-granted monopoly
A government-granted monopoly (also called a "de jure monopoly") is a form of coercive
monopoly by which a government grants exclusive privilege to a private individual or firm to be
the sole provider of a good or service; potential competitors are excluded from the market
by law,regulation, or other mechanisms of government
enforcement. Copyright, patents and trademarks are examples of government-granted
monopolies.
Monopolist Shutdown Rule
A monopolist should shutdown when price is less than average variable cost for every output
level.[40] In other words where the demand curve is entirely below the average variable cost
curve.[41]Under these circumstances at the profit maximum level of output (MR = MC) average
revenue would be lower than average variable costs and the monopolists would be better off
shutting down in the short run.[42]
Breaking up monopolies

When monopolies are not broken through the open market, sometimes a government will step in,
either to regulate the monopoly, turn it into a publicly owned monopoly environment, or forcibly
break it up (see Antitrust law and trust busting). Public utilities, often being naturally efficient
with only one operator and therefore less susceptible to efficient breakup, are often strongly
regulated or publicly owned. AT&T andStandard Oil are debatable examples of the breakup of a
private monopoly: When AT&T, a monopoly previously protected by force of law, was broken
up into the "Baby Bell" components in 1984, MCI, Sprint, and other companies were able to
compete effectively in the long distance phone market.
Law

The existence of a very high market share does not always mean consumers are paying excessive
prices since the threat of new entrants to the market can restrain a high-market-share firm's price
increases. Competition law does not make merely having a monopoly illegal, but rather abusing
the power a monopoly may confer, for instance through exclusionary practices.

First it is necessary to determine whether a firm is dominant, or whether it behaves "to an

appreciable extent independently of its competitors, customers and ultimately of its consumer".
[43]
 As with collusive conduct, market shares are determined with reference to the particular
market in which the firm and product in question is sold.

Under EU law, very large market shares raises a presumption that a firm is dominant, [44] which
may be rebuttable.[45] If a firm has a dominant position, then there is "a special responsibility not
to allow its conduct to impair competition on the common market". [46] The lowest yet market
share of a firm considered "dominant" in the EU was 39.7%.[47]

Certain categories of abusive conduct are usually prohibited under the country's legislation,
though the lists are seldom closed.[48] The main recognised categories are:

 Limiting supply
 Predatory pricing
 Price discrimination
  Refusal to deal and exclusive dealing
 Tying (commerce) and product bundling
Despite wide agreement that the above constitute abusive practices, there is some debate about
whether there needs to be a causal connection between the dominant position of a company and
its actual abusive conduct. Furthermore, there has been some consideration of what happens
when a firm merely attempts to abuse its dominant position.
Historical monopolies

The term "monopoly" first appears in Aristotle's Politics, wherein Aristotle describes Thales of

Miletus' cornering of the market in olive presses as a monopoly (μονοπωλίαν).[49][50]

Common salt (sodium chloride) historically gave rise to natural monopolies. Until recently, a
combination of strong sunshine and low humidity or an extension of peat marshes was necessary
for winning salt from the sea, the most plentiful source. Changing sea levels periodically caused
salt "famines" and communities were forced to depend upon those who controlled the scarce
inland mines and salt springs, which were often in hostile areas (the Sahara desert) requiring
well-organised security for transport, storage, and distribution. The "Gabelle", a notoriously high
tax levied upon salt, played a role in the start of the French Revolution, when strict legal controls
were in place over who was allowed to sell and distribute salt.

Robin Gollan argues in The Coalminers of New South Wales that anti-competitive practices
developed in the Newcastle coal industry as a result of the business cycle. The monopoly was
generated by formal meetings of the local management of coal companies agreeing to fix a
minimum price for sale at dock. This collusion was known as "The Vend". The Vend collapsed
and was reformed repeatedly throughout the late nineteenth century, cracking under recession in
the business cycle. "The Vend" was able to maintain its monopoly due to trade union support,
and material advantages (primarily coal geography). In the early twentieth century as a result of
comparable monopolistic practices in the Australian coastal shipping business, the vend took on
a new form as an informal and illegal collusion between the steamship owners and the coal
industry, eventually going to the High Court as Adelaide Steamship Co. Ltd v. R. & AG.[51]
Examples of legal (and or) illegal monopolies

The salt commission, a legal monopoly in China formed in 758.

British East India Company; created as a legal trading monopoly in 1600.

Dutch East India Company; created as a legal trading monopoly in 1602.

Western Union was criticized as a price gouging monopoly in the late 19th century.[52]

Standard Oil; broken up in 1911, two of its surviving "baby companies" are ExxonMobil and
the Chevron Corporation.

U.S. Steel; anti-trust prosecution failed in 1911.

Major League Baseball; survived U.S. anti-trust litigation in 1922, though its special status is
still in dispute as of 2009.

United Aircraft and Transport Corporation; aircraft manufacturer holding company forced to
divest itself of airlines in 1934.

National Football League; survived anti-trust lawsuit in the 1960s, convicted of being an illegal
monopoly in the 1980s.

American Telephone & Telegraph; telecommunications giant broken up in 1982.

De Beers; settled charges of price fixing in the diamond trade in the 2000s.

Microsoft; settled anti-trust litigation in the U.S. in 2001; fined by the European Commission in
2004 for 497 million Euros,[53] which was upheld for the most part by the Court of First
Instance of the European Communities in 2007. The fine was 1.35 Billion USD in 2008 for
noncompliance with the 2004 rule.[54][55]

Joint Commission; has a monopoly over whether or not US hospitals are able to participate in
the Medicare and Medicaid programs.

Telecom New Zealand; local loop unbundling enforced by central government.

Deutsche Telekom; former state monopoly, still partially state owned, currently monopolizes
high-speed VDSL broadband network.[56]

Monsanto has been sued by competitors for anti-trust and monopolistic practices. They hold
between 70% and 100% of the commercial seed market.

AAFES has a monopoly on retail sales at overseas military installations.

SAQ is a monopoly.
Long Island Power Authority (LIPA)

Long Island Rail Road (LIRR)

]Countering monopolies

According to professor Milton Friedman, laws against monopolies cause more harm than good,
but unnecessary monopolies should be countered by removing tariffs and other regulation that
upholds monopolies.

A monopoly can seldom be established within a country without overt and covert government
assistance in the form of a tariff or some other device. It is close to impossible to do so on a
world scale. The De Beers diamond monopoly is the only one we know of that appears to have
succeeded. - - In a world of  free trade, international cartels would disappear even more quickly.
[57]

On the other hand, professor Steve H. Hanke believes that although private monopolies are more
efficient than public ones, often by factor two, sometimes private natural monopolies, such as
local water distribution, should be regulated (not prohibited) through, e.g., price auctions[58].